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Holly Energy Partners L.P (NYSE:HEP)

Q2 2012 Earnings Call

July 31, 2012 4:00 pm ET

Executives

M. Neale Hickerson - Vice President of Investor Relations of Holly Logistic Services, L.L.C

Bruce R. Shaw - Chief Financial Officer of Holly Logistic Services Llc and Senior Vice President of Holly Logistic Services Llc

Matthew P. Clifton - Chairman of Holly Logistic Services LLC, Chief Executive Officer of Holly Logistic Services LLC, President of Holly Logistic Services LLC and Chairman of Executive Committee

Analysts

Edward Rowe

Brian J. Zarahn - Barclays Capital, Research Division

Theodore Durbin - Goldman Sachs Group Inc., Research Division

Operator

Welcome to Holly Energy Partners' Second Quarter 2012 Conference Call and Webcast. Hosting the call today from Holly Energy Partners is Matt Clifton, Chairman and Chief Executive Officer. He is joined by Bruce Shaw, Senior Vice President and Chief Financial Officer. [Operator Instructions] Please note that this conference is being recorded. It is now my pleasure to turn the floor over to Neale Hickerson. Sir, you may begin.

M. Neale Hickerson

Well, thank you, Paula. Good afternoon, everyone. I'd like to welcome you to Holly Energy Second Quarter 2012 Earnings Conference Webcast. I'm Neale Hickerson, Vice President of Investor Relations of Holly Energy. In addition to Matt and Bruce, who our operator, Paula, has introduced to you already, we have other senior management team with -- members with us today to assist us in the Q&A portion of our call.

This morning, we issued a press release announcing the results for the quarter ended June 30, 2012. This press release can be found on our HEP website at www.hollyenergy.com.

For our call this afternoon, Bruce will begin with prepared remarks and comments regarding our financial performance for the quarter. Matt will then follow up with some additional remarks. And at the conclusion of these prepared remarks, our team will be available to take your questions.

Before we turn things over to Matt and Bruce for their comments, we want to make the following Safe Harbor disclosure statement. The statement is made under the Private Securities Litigation Reform Act of 1995.

In summary, this Safe Harbor statement says that statements made in our press release and on this conference webcast with partnership or management expectations or predictions of the future are forward-looking statements and are intended to be covered under the Safe Harbor provisions of federal securities laws. There are many factors which could cause actual outcomes and results to materially differ from our expectations, including those we described in our 10-K and other filings with the SEC. These statements are not guarantees of future outcomes.

This call may also include a discussion of non-GAAP financial measures that we use in analyzing our financial results. Please refer to today's press release for required reconciliations to GAAP financial measures and other related disclosures and information on where you may find this reconciliations and disclosures and a full reading of our Safe Harbor statement.

Lastly, please note that information presented on our call today speaks only as of today, July 31, 2012, and any time-sensitive information provided may no longer be accurate at the time of any webcast replay or rereading of the transcript of our call.

And now, I'd like to turn things over to Bruce Shaw.

Bruce R. Shaw

Thanks, Neale, and thanks, everybody, for joining us this afternoon. Today, I will cover HEP's financial result for the second quarter. And as a reminder, since we closed the UNEV transaction on July 12, 2012, UNEV results are not part of HEP's second quarter results and will not be included in my comments this afternoon.

On Wednesday, July 25, we announced the 31st consecutive increase in our quarterly distribution to $0.91 per unit, which is a 5% increase over the $0.865 per unit we declared for 2011 second quarter. Our distributable cash flow for the quarter ended June 30 was $34.5 million, up $13.1 million from the same period the previous year. Net income for the second quarter was $23.2 million versus $19 million for the same period in 2011. And the drivers of increased distributable cash flow and net income compared to the year-ago period are basically the same, the financial contribution of the assets that HEP acquired from HollyFrontier in November 2011, increased pipeline volumes and annual tariff increases.

As a reminder, the majority of HEP's revenues and, therefore, income and DCF are supported by minimum commitments from our major customers. These commitments as of June 30, 2012, totaled approximately $220 million per year or about $55 million per quarter and amount to 85% to 90% of our total revenue.

Operating expenses of approximately $17.9 million for the quarter were higher than 2011 second quarter amount of $14.4 million, primarily due to the inclusion of operating cost associated with our recently acquired assets serving HollyFrontier's El Dorado and Cheyenne Refineries and year-over-year increases in maintenance service, payroll and power costs. G&A expenses of $2.5 million for the quarter were higher than the previous year's second quarter number and a bit higher than our typical quarterly run rate, primarily due to transaction expenses related to the UNEV acquisition, which was announced June 28.

Now I'll cover a few details relating to shortfalls billed and deferred revenue recognized during the quarter. As a reminder, the payments we received from HollyFrontier and Alon for quarterly shortfall billings under their minimum commitments are included in distributable cash flow in the current accounting period but classified as deferred revenues, so not recorded as revenue on our income statement until such time as they can be recognized. Deferred revenue recognition results from shortfall billings in prior quarters for which clawback rights either are used or expire.

Shortfalls billed for the second quarter 2012 for shipments below committed volumes was $1 million, of which $700,000 related to affiliate pipelines and $300,000 related to third-party shippers. Offsetting this amount and recognized as revenue in the quarter were total forfeitures of about $800,000, all of which related to affiliate pipeline shipments. As of June 30, 2012, we have $3.6 million in deferred revenue recorded on the balance sheet, and these deferrals will be recognized in revenue in the future as the shippers' contractual clawback rights are utilized or expire. The total shortfall amount billed in the third quarter of 2011, which remains outstanding and for which clawback rights expire on June 30, 2012, or expire actually on September 30, 2012, will be approximately $700,000.

EBITDA for the quarter was $44.1 million, benefiting from the previously discussed higher pipeline volumes, tariff increases and EBITDA from the November acquisition compared to 2011 second quarter. Adjusting for shortfall billings and deferred revenue, EBITDA for the quarter was $44.3 million.

Shifting to capital expenditures. For 2012, we expect our maintenance capital expenditures to be $7 million to $8 million for the year, and we currently forecast our expansion capital expenditures to be about $20 million for the year. The majority of the expansion dollars will be spent on increasing the capacity and flexibility of HEP's Permian Basin crude pipeline system in order to accommodate increasing crude production in the region. Total capital expenditures in the second quarter was $5.7 million, bringing year-to-date total capital expenditures to $12 million.

In June 2012, we upsized our revolving credit facility to $550 million, extend the term through June of 2017 and secured better pricing. We also retained the $200 million accordion feature on the revolver. As of June 30, 2012, we had $170 million borrowed under the facility. In conjunction with the closing of the UNEV transaction on July 12, we borrowed an additional $260 million to fund the cash portion of the consideration. We currently have $410 million borrowed under the facility, leaving HEP with about $140 million of liquidity remaining. We have $450 million of senior notes outstanding, made up of $150 million of our 8¼% notes that are due 2018 and $300 million of our 6½% notes due 2020.

We're currently slightly higher than our target range of 3.5 to 4x for debt to EBITDA, but fully expect this ratio to come back down into that range as unit volumes and EBITDA contribution improve over time, especially after refinery expansions take place in Salt Lake City. The total distribution declared on July 25 will result in approximately $31.1 million to be paid August 14, 2012, to unitholders of record as of August 7.

Now I believe Matt has a few comments before we turn to questions. Matt?

Matthew P. Clifton

Thanks, Bruce. A couple of comments. As we said in our press release, we're pleased with our quarterly results, and in particular, we're pleased with the strong level of product pipeline movements during May and June, which have continued at high levels through July.

The acquisition of the HollyFrontier storage and logistic assets and the startup of our newly constructed interplant pipelines at Tulsa late last year continued to add value to our results. These additions, in conjunction with our recently closed UNEV acquisition, represent almost $700 million of asset additions in the last 9 months.

The seamless assimilation of the Frontier assets and the safe startup of UNEV and the interconnect pipes is a testament to the quality of our employees. We are proud that HEP just reached an impressive milestone of 1 million man-hours without a loss time accident. Bottom line, we are optimistic with respect to the condition of our company and the prospects for a continued -- to deliver quality returns to our unitholders.

I'll just turn it back to Neale to -- if you have any questions.

M. Neale Hickerson

I think we'll turn things back over to Paula. If you could -- Paula, if you could read, announce the process for asking questions, we're ready to move to that part of our call.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Edward Rowe of Raymond James.

Edward Rowe

In regards to the operating expenses, they came in a little bit higher than what you guys gave us in terms of guidance. Going forward, is this something that you see on a run-rate basis, or is this something that is a onetime anomaly in regards to the operating expenses?

Bruce R. Shaw

Yes. Edward, I think we talked about kind of a $16.5 million to $17.5 million kind of per-quarter million operating expense run rate. I guess we're on $17.9 million for the quarter. If you kind of average of the first and second quarter, we're kind of on top of that range. Some of the maintenance expenses that we have kind of come in lumpy. So kind of pre-UNEV, that I think that range is still a good range. And we'll talk more about kind of post-UNEV run rates once we get through the third quarter and have a bit more to work with at the end of September 30.

Edward Rowe

Okay. And the next question that I had is in regards to the third-party refined products, as well as terminal and tankage, et cetera. They arrived a little bit lower compared to the previous quarters. Could you provide some color around these segments? Were there structural changes, or -- and what's your sense on these segments going forward?

Bruce R. Shaw

And you were talking specifically about third-party refined product pipelines and third-party terminals, is that right?

Edward Rowe

Yes.

Bruce R. Shaw

Those are driven largely by our business that surrounds the Big Spring's area and related to the acquisition we made back in '05 from Alon USA. And that refinery, as all refineries do, will have kind of ups and downs. So that -- the volume that we saw was lower than the first quarter, that we saw extraordinarily strong volumes in the first quarter. If you compare the volumes we had on those pipelines, just third-party pipelines in general to the second quarter of last year, they're actually a little better. And so the run rate that we have here could be slightly underneath, kind of a go-forward run rate, but it's not too far off of the range we've seen in the past.

Matthew P. Clifton

And the only thing I'd add is that, I think to what Bruce said, I think they had some malfunctions of equipment during one of the months there. Since that time, they're back up at the higher levels that we saw beginning of the year. And that refinery, as well as HollyFrontier's, New Mexico refinery and most refineries that are enjoying lower domestic crude prices, have all the incentive in the world to run all out. So we're pretty optimistic that absent this, now and again, problems at plants that -- for the foreseeable future, we're pretty optimistic about flow rates on our product lines.

Edward Rowe

And kind of the segue off what you alluded to on the Permian crude pipeline. I remember from the previous quarter, you guys said the scale and scope is still somewhat ongoing, given the Plain's acquisition of the line from Western. Do you guys have any more color around that growth project?

Matthew P. Clifton

We don't have anything definitive. I think we're very close. And as soon as we get something nailed down, we'll put something out and get some information out for everybody to digest.

Operator

Your next question comes from the line of Brian Zarahn of Barclays.

Brian J. Zarahn - Barclays Capital, Research Division

Can you talk a little about the impact of Tulsa Refinery turnarounds in the fourth quarter?

Bruce R. Shaw

In terms of the Tulsa contracts that we have, if you think about the business we have around Tulsa, it's mostly storage related. There are also some, obviously, the truck rack that are there in the interconnect pipelines, those are all supported by commitments. So we would kind of expect the impact on HEP to be very minimal at worst. Matt, I don't know if you add to that.

Matthew P. Clifton

I think that's right. I think the -- we -- though we probably have throughput rates through those tanks and loading rack up above the minimum commitment, I think they're at incrementally lower tariffs or charges. So I wouldn't expect much of a downward effect to the turnaround as far as the impact on HEP.

Brian J. Zarahn - Barclays Capital, Research Division

Okay. And then on the distribution bump this quarter was a little bit above the $0.01 a quarter you've had for many years. Is this something do you expect to continue as a run rate, or how do you think about the distribution growth?

Matthew P. Clifton

Well, I think we're pretty optimistic with where we are right now. But that -- as you would expect, that's a decision that's made on a quarterly basis, so we'll be visiting with our board this time next quarter.

Operator

[Operator Instructions] Your next question comes from the line of Ted Durbin of Goldman Sachs.

Theodore Durbin - Goldman Sachs Group Inc., Research Division

I know it's still early, but can you call about some of the initial spot volume trends you're seeing on UNEV? I think you had talked about 5,000 to 10,000 barrels a day. And any progress you've made on getting some contracts beyond the 23,000 barrels per day you have?

Matthew P. Clifton

There's been no real change to date on any additional long-term contracts. This is the time of the year before there's increase in the expansion capacity in Woods Cross that we didn't really expect to see much spot volume in the summer since the demand is always high in the Rocky Mountains at that time period. It's really in the winter months where demand drops off and refineries in the current environment, at least, would have an incentive to keep run rates up and move incremental production down the line to Vegas. So not much spot business, but not really different that we would expect for this time of the year.

Theodore Durbin - Goldman Sachs Group Inc., Research Division

Got it. And then can you talk a little bit more, just about financing plans. I think you mentioned that the credit metrics are probably a little bit wider than you like, a little bit of -- that are higher. I'm just wondering if you'll get credit for the EBITDA ramp on UNEV that you're expecting. It sounds like it may not actually happen till 2014 and '15 until some of those refineries expand. Maybe we just talk about the financing side of the business.

Bruce R. Shaw

Well, as you know, there's 2 parts to that debt-to-EBITDA equation, and the EBITDA growth is not just not coming from UNEV. And so we -- when we say we're a little higher than our 3.5 to 4x range, it's not much higher and we think through organic growth and tariff increases and just base business doing better. In addition to UNEV, which most of that growth will happen with those refinery expansions, that metric will come back kind of below that 4x. But nothing in the immediate, immediate future to talk about in specifics. I don't think. Matt?

Matthew P. Clifton

Yes, I would think, just to add to what Bruce said, is that we basically had kind of consciously delevered quite a bit, leading up to the UNEV acquisition on raising some capital and issuing a fair amount of equity, in conjunction with the Frontier drop-down. So -- though we're slightly above that target, we have -- we're optimistic on pipeline run rates that we're seeing now, crude-gathering activity. Of course, we've got a pretty strong deferred PPI index that will start impacting results starting in July. So there'll be a number of things that directionally will move us back down in the right direction, not only increased volumes on UNEV.

Operator

At this time, there are no further questions. I would now like to turn the floor back over to Neale Hickerson for any additional or closing remarks.

M. Neale Hickerson

We appreciate everyone listening in and participating today, and we look forward to sharing our third quarter results with you in October of this year. Thanks a lot, everyone.

Operator

Thank you. This concludes today's teleconference. Please disconnect your lines at this time, and have a wonderful day.

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