<PAGE> 1
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- --- EXCHANGE ACT OF 1934
For the quarterly period ended October 31, 1998
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- --- EXCHANGE ACT OF 1934
For the transition period from ________________ to ________________
Commission File Number 1-3876
HOLLY CORPORATION
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 75-1056913
------------------------------- -----------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 Crescent Court, Suite 1600
Dallas, Texas 75201-6927
- ---------------------------------------- -----------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (214) 871-3555
--------------------
- --------------------------------------------------------------------------------
Former name, former address and former fiscal year, if changed since last report
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
---- ----
8,253,514 shares of Common Stock, par value $.01 per share, were outstanding on
December 7, 1998.
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HOLLY CORPORATION
INDEX
<TABLE>
<CAPTION>
Page No.
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<S> <C> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheet -
October 31, 1998 (Unaudited) and July 31, 1998 3
Consolidated Statement of Income (Unaudited) -
Three Months Ended October 31, 1998 and 1997 4
Consolidated Statement of Cash Flows (Unaudited) -
Three Months Ended October 31, 1998 and 1997 5
Consolidated Statement of Comprehensive Income (Unaudited) -
Three Months Ended October 31, 1998 and 1997 6
Notes to Consolidated Financial Statements (Unaudited) 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10
Item 3. Quantitative and Qualitative Disclosures
About Market Risk 18
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 19
Item 4. Submission of Matters to a Vote of Security Holders 19
Item 6. Exhibits and Reports on Form 8-K 20
</TABLE>
This Quarterly Report on Form 10-Q (including documents incorporated by
reference herein) contains statements with respect to the Company's
expectations or beliefs as to future events. These types of statements are
"forward-looking" and are subject to uncertainties. See "Factors Affecting
Forward-Looking Statements" on page 10.
2
<PAGE> 3
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
HOLLY CORPORATION
CONSOLIDATED BALANCE SHEET
(Dollars in Thousands, Except Per Share Amounts)
<TABLE>
<CAPTION>
Unaudited
October 31, July 31,
ASSETS 1998 1998
----------- --------
<S> <C> <C>
Current assets
Cash and cash equivalents $ 2,833 $ 2,602
Accounts receivable: Product 39,627 33,346
Crude oil resales 52,007 49,033
----------- --------
91,634 82,379
Inventories: Crude oil and refined products 44,819 46,754
Materials and supplies 10,830 12,081
Reserve for lower of cost or market (4,384) (2,993)
----------- --------
51,265 55,842
Income taxes receivable -- 653
Prepayments and other 13,517 12,911
----------- --------
Total current assets 159,249 154,387
Properties, plants and equipment, at cost 330,735 325,993
Less accumulated depreciation, depletion and amortization (156,946) (152,696)
------------ --------
173,789 173,297
Investments and advances to joint ventures 5,394 5,510
Other assets 16,187 16,663
----------- --------
$ 354,619 $349,857
=========== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable $ 106,174 $109,139
Accrued liabilities 14,674 13,392
Income taxes payable 1,388 288
Current maturities of long-term debt 5,175 5,175
Borrowings under credit agreement 16,100 11,600
----------- --------
Total current liabilities 143,511 139,594
Deferred income taxes 25,286 25,573
Long-term debt, less current maturities 70,341 70,341
Commitments and contingencies
Stockholders' equity
Preferred stock, $1.00 par value - 1,000,000 shares authorized; none issued -- --
Common stock, $.01 par value - 20,000,000 shares authorized; 8,650,282 shares issued 87 87
Additional capital 6,132 6,132
Retained earnings 110,983 109,686
----------- --------
117,202 115,905
Common stock held in treasury, at cost - 396,768 shares (569) (569)
Accumulated other comprehensive income - net unrealized loss on
securities available for sale (1,152) (987)
----------- --------
Total stockholders' equity 115,481 114,349
----------- --------
$ 354,619 $349,857
=========== ========
</TABLE>
See accompanying notes.
3
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HOLLY CORPORATION
CONSOLIDATED STATEMENT OF INCOME
(Dollars in Thousands, Except Per Share Amounts)
<TABLE>
<CAPTION>
Unaudited
Three Months Ended
October 31,
------------------------
1998 1997
---- ----
<S> <C> <C>
Revenues
Refined products $ 140,061 $ 166,106
Oil and gas 731 2,629
Miscellaneous 179 187
--------- ---------
140,971 168,922
Costs and expenses
Cost of refined products 124,573 149,733
General and administrative 4,328 3,151
Depreciation, depletion and amortization 5,987 5,174
Exploration expenses, including dry holes 305 790
--------- ---------
135,193 158,848
--------- ---------
Income from operations 5,778 10,074
Other
Equity in earnings of joint ventures 394 351
Interest income 50 398
Interest expense (1,931) (2,144)
--------- ---------
(1,487) (1,395)
--------- ---------
Income before income taxes 4,291 8,679
Income tax provision (benefit)
Current 1,851 1,708
Deferred (178) 1,764
--------- ---------
1,673 3,472
--------- ---------
Net income $ 2,618 $ 5,207
========= =========
Income per common share (basic $ .32 $ .63
and diluted)
Cash dividends paid per share $ .16 $ .15
Average number of shares of common
stock outstanding (in thousands) 8,254 8,254
</TABLE>
See accompanying notes.
4
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HOLLY CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
(Dollars in Thousands)
<TABLE>
<CAPTION>
Unaudited
Three Months Ended
October 31,
-----------------------------
1998 1997
-------- --------
<S> <C> <C>
Cash flows from operating activities
Net income $ 2,618 $ 5,207
Adjustments to reconcile net income
to net cash provided by operating activities
Depreciation, depletion and amortization 5,987 5,174
Deferred income taxes (178) 1,764
Equity in earnings of joint venture (394) (351)
Dry hole costs and leasehold impairment 2 177
(Increase) decrease in operating assets
Accounts receivable (9,255) (16,036)
Inventories 4,577 8,833
Income taxes receivable 653 203
Prepayments and other (605) (518)
Increase (decrease) in operating liabilities
Accounts payable (2,965) 20,939
Accrued liabilities 1,282 1,933
Income taxes payable 1,100 1,283
Turnaround expenditures -- (13,150)
Other, net (1,526) 44
-------- --------
Net cash provided by operating activities 1,296 15,502
Cash flows from financing activities
Increase in borrowings under credit agreement 4,500 --
Debt issuance costs -- (500)
Cash dividends (1,321) (1,238)
-------- --------
Net cash provided by (used for) financing activities 3,179 (1,738)
Cash flows from investing activities
Additions to properties, plants and equipment (4,794) (12,830)
Distribution from joint venture 550 --
-------- --------
Net cash used for investing activities (4,244) (12,830)
-------- --------
Cash and cash equivalents
Increase for the period 231 934
Beginning of year 2,602 20,042
-------- --------
End of period $ 2,833 $ 20,976
======== ========
Supplemental disclosure of cash flow information
Cash paid during period for
Interest $ 220 $ 337
Income taxes $ 50 $ 175
</TABLE>
See accompanying notes.
5
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HOLLY CORPORATION
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(Dollars in millions)
<TABLE>
<CAPTION>
Unaudited
Three Months Ended
October 31,
--------------------
1998 1997
------- -------
<S> <C> <C>
Net income $ 2,618 $ 5,207
Other comprehensive income, net of tax
Unrealized loss on securities available for sale (165) --
------- -------
Comprehensive income $ 2,453 $ 5,207
======= =======
</TABLE>
See accompanying notes.
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HOLLY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note A - Presentation of Financial Statements
In the opinion of the Company, the accompanying consolidated financial
statements, which have not been audited by independent accountants (except for
the consolidated balance sheet as of July 31, 1998), reflect all adjustments
(consisting only of normal recurring adjustments) necessary to present fairly
the Company's consolidated financial position as of October 31, 1998, the
consolidated results of operations for the three months ended October 31, 1998
and 1997, and consolidated cash flows for the three months ended October 31,
1998 and 1997.
Certain notes and other information have been condensed or omitted.
Therefore, these financial statements should be read in conjunction with the
consolidated financial statements and related notes included in the Company's
Annual Report on Form 10-K for the fiscal year ended July 31, 1998.
References herein to the "Company" are for convenience of presentation
and may include obligations, commitments or contingencies that pertain solely to
one or more affiliates of the Company. Results of operations for the first three
months of fiscal 1999 are not necessarily indicative of the results to be
expected for the full year.
Note B - Adoption of New Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 130, "Reporting Comprehensive Income," and SFAS No. 131, "Disclosures
about Segments of an Enterprise and Related Information." In February 1998, the
FASB issued SFAS No. 132, "Employers' Disclosures about Pensions and Other
Postretirement Benefits." The Company is adopting all three statements in the
current fiscal year ending July 31, 1999.
SFAS No. 130 establishes standards for reporting and display of
comprehensive income and its components in a full set of general-purpose
financial statements. In this Report, the Company has added a separate statement
of comprehensive income to conform with the new requirements of SFAS No. 130.
SFAS No. 131 establishes new standards for reporting information about
operating segments in annual financial statements and requires selected
operating segment information to be reported in interim financial reports issued
to shareholders. It also establishes standards for related disclosures about
products and services, geographic areas and major customers. This statement
becomes effective for the Company's financial statements beginning with the
fiscal year ending July 31, 1999 at which time prior period segment information
presented for comparative purposes is required. Interim period information is
not required until the second year of application, at which time comparative
information is required. Because interim period information is not required
under this statement for the Company's current fiscal year, the requirements of
this statement are not reflected in this Report. Because this statement
addresses how supplemental financial information is disclosed
7
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HOLLY CORPORATION
in annual and interim reports, the adoption will have no impact on the Company's
financial condition or results of operations.
SFAS No. 132 standardizes the disclosure requirements for pensions and
other postretirement benefits to the extent practicable, requires additional
information on changes in the benefit obligations and fair values of plan
assets, and eliminates certain disclosures that are no longer useful. This
statement becomes effective for the Company's financial statements beginning
with the fiscal year ending July 31, 1999 at which time restatement of prior
period disclosures presented for comparative purposes is required unless the
information is not readily available. Because interim period information is not
required under this statement, the requirements of this statement are not
reflected in this Report. Because this statement addresses how supplemental
financial information is disclosed in annual reports, the adoption will have no
impact on the Company's financial condition or results of operations.
Note C - Earnings Per Share
The following is a reconciliation of the numerators and denominators of
the basic and diluted per share computations for net income as required by SFAS
No. 128:
<TABLE>
<CAPTION>
Three Months Ended October 31, 1998
----------------------------------------
Per
Income Shares Share
(Numerator) (Denominator) Amount
----------- ------------- ------
(in thousands, except per share amounts)
<S> <C> <C> <C>
Income per common share - basic
Net income $2,618 8,254 $ .32
Effect of dilutive stock options -- -- --
------ ------ ------
Income per common share -
assuming dilution
Net income $2,618 8,254 $ .32
====== ===== ======
</TABLE>
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HOLLY CORPORATION
<TABLE>
<CAPTION>
Three Months Ended October 31, 1997
----------------------------------------
Per
Income Shares Share
(Numerator) (Denominator) Amount
----------- ------------- ------
(in thousands, except per share amounts)
<S> <C> <C> <C>
Income per common share - basic
Net income $5,207 8,254 $ .63
Effect of dilutive stock options -- -- --
------ ------ ------
Income per common share -
assuming dilution
Net income $5,207 8,254 $ .63
====== ====== ======
</TABLE>
Note D - Contingencies
In July 1993, the United States Department of Justice ("DOJ"), on behalf of
the United States Environmental Protection Agency ("EPA"), filed a suit against
the Company's subsidiary, Navajo Refining Company ("Navajo") alleging that,
beginning in September 1990 and continuing through the present, Navajo has
violated and continues to violate the Resource Conservation and Recovery Act
("RCRA") and implementing regulations of the EPA by treating, storing and
disposing of certain hazardous wastes in the refinery's wastewater treatment
system without compliance with regulatory requirements. An agreement among
Navajo, the DOJ and the State of New Mexico for settlement of this litigation
has become final. Under the settlement agreement, the Company will close the
existing evaporation ponds of its wastewater treatment system. The agreement
also provides that the Company will utilize an alternative to the existing
wastewater treatment system at an estimated total cost of approximately $5
million, of which $2 million has been incurred. The costs to implement the
alternative wastewater treatment system will be capitalized and amortized over
the future useful life of the resulting asset in accordance with generally
accepted accounting principles. Finally, the agreement involves the payment of a
civil penalty of less than $2 million. In fiscal 1993, the Company recorded a $2
million reserve for this litigation.
On August 31, 1998, a lawsuit (the "Longhorn Suit") was filed in state
district court in El Paso, Texas against the Company, two of its subsidiaries
and an Austin, Texas law firm. The suit was filed by Longhorn Partners Pipeline,
L.P. ("Longhorn Partners"), a Delaware limited partnership composed of Longhorn
Partners GP, L.L.C. as general partner and affiliates of Exxon Pipeline Company,
Amoco Pipeline Company, Williams Pipeline Company, and the Beacon Group Energy
Investment Fund, L.P. as well as Chisholm Holdings as limited partners. The suit
seeks damages against the Company and the law firm alleged to total up to
$1,050,000,000 and injunctive relief based on claims of violations of the Texas
Free Enterprise and Antitrust Act, unlawful interference with contractual
relations, and conspiracy to abuse process. The Longhorn Suit has been removed
by the Company to
9
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HOLLY CORPORATION
the Federal Court in Austin, Texas before which is pending the Environmental
Suit described below; Longhorn Partners' motion to remand the suit to the state
district court in El Paso is pending before the Federal Court. The Company
believes that the Longhorn Suit is wholly without merit and plans to defend
itself vigorously. The Company also plans to pursue at the appropriate time any
affirmative remedies that may be available to it with respect to the filing of
the Longhorn Suit.
The Longhorn Suit appears to relate principally to the alleged
involvement of subsidiaries of the Company and the named law firm in a federal
lawsuit (the "Environmental Suit") in Austin, Texas filed by ranchers and joined
by the Barton Springs-Edwards Aquifer Conservation District, the City of Austin
and the Lower Colorado River Authority. The Environmental Suit resulted in a
preliminary injunction issued by the Federal Court on August 25, 1998 requiring
preparation of an environmental impact statement under the National
Environmental Policy Act before Longhorn Partners uses an existing crude oil
pipeline and a newly constructed pipeline to transport refined petroleum
products across Texas, including areas overlying the Edwards Aquifer in Central
Texas. Motions by Longhorn Partners to the U.S. Court of Appeals for the Fifth
Circuit for a stay of the District Court order and for an expedited appeal were
recently denied by the Federal Appeals Court.
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Factors Affecting Forward-Looking Statements
This Quarterly Report on Form 10-Q contains certain "forward-looking
statements" within the meaning of the U.S. Private Securities Litigation Reform
Act of 1995. All statements, other than statements of historical facts included
in this Form 10-Q, including without limitation statements in this Item 2 under
the headings "Results of Operations" and "Liquidity and Capital Resources"
(including "Risk Management" and "The Year 2000 Problem") are forward-looking
statements. Such statements are subject to risks and uncertainties, including
but not limited to risks and uncertainties with respect to the actions of actual
or potential competitive suppliers of refined petroleum products in the
Company's markets, the demand for and supply of crude oil and refined products,
the spread between market prices for refined products and crude oil, the
possibility of constraints on the transportation of refined products, the
possibility of inefficiencies or shutdowns in refinery operations, governmental
regulations and policies, the availability of financing to the Company on
favorable terms, the effectiveness of Company capital investments and marketing
strategies, the outcome of material litigation against the Company, the accuracy
of technical analysis and evaluations relating to the Year 2000 Problem, and the
abilities of third-party suppliers to the Company to avoid adverse effects of
the Year 2000 Problem on their capacities to supply the Company. Because of
these and other risks and uncertainties, actual results may vary materially from
those estimated, anticipated or projected. Although the Company believes that
the expectations reflected by the forward-looking statements
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HOLLY CORPORATION
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (Continued)
contained in this Quarterly Report are reasonable based on information currently
available to the Company, no assurances can be given that such expectations will
prove to be correct. This summary discussion of risks and uncertainties that may
cause actual results to differ from those indicated in forward-looking
statements should be read in conjunction with the discussion under the heading
"Additional Factors That May Affect Future Results" included in Item 7 of the
Company's Annual Report on Form 10-K for the fiscal year ended July 31, 1998 and
in conjunction with the discussion below under the heading "Liquidity and
Capital Resources." All forward-looking statements included in this Form 10-Q
and all subsequent oral forward-looking statements attributable to the Company
or persons acting on its behalf are expressly qualified in their entirety by the
cautionary statements set forth above.
Results of Operations
Net income for the first quarter ended October 31, 1998 was $2.6
million as compared to $5.2 million for the first quarter of the prior year.
The decrease in income in the first quarter of fiscal 1999 was
principally due to decreased refinery margins, as compared to the same quarter
of the prior year. Also reducing earnings in the first quarter of fiscal 1999
was a charge incurred to reduce the value of inventory by $1.4 million as a
result of a decrease in crude oil and refined product prices. The decrease in
earnings due to the reduced margins and inventory charge was partially offset by
an increase in sales volumes to a record level, which represents a 19% increase
from volumes in the first quarter of the prior year (when volumes were reduced
due to a planned turnaround). Earnings in the first quarter of the current year
were also favorably affected by the beginning of pipeline and terminalling
revenues resulting from the alliance with FINA, Inc., which creates a
comprehensive supply network of refined products in the Company's markets, and
by transportation service income resulting from the West Texas crude oil
gathering system which the Company recently purchased. Other items negatively
impacting earnings in the first quarter of the current year were lower oil and
gas income due to the reduction in scope of the Company's oil and gas program,
an increase in general and administrative expenses relating to legal and
administrative proceedings, and an increase in depreciation and amortization
expense in the current year resulting from the prior year's turnaround
expenditures. Revenues decreased in the three months ended October 31, 1998 from
the prior year's comparable period as a result of reduced sales prices,
partially offset by the increase in volumes.
Liquidity and Capital Resources
This discussion should be read in conjunction with the discussion
under the heading "Additional Factors That May Affect Future Results" included
in Item 7 of the Company's Annual Report on Form 10-K for the fiscal year ended
July 31, 1998.
11
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HOLLY CORPORATION
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (Continued)
Cash and cash equivalents increased during the three months ended
October 31, 1998 by only $.2 million, as cash flows required for capital
expenditures and dividends paid were approximately the same as cash flows
generated from operations and new borrowings under the Credit Agreement. Working
capital increased during the three months ended October 31, 1998 by $.9 million
to $15.7 million. The Company's long-term debt at October 31, 1998 represents
39.5% of total capitalization as compared to 39.8% at July 31, 1998. At October
31, 1998, the Company had $33.9 million of unused borrowing capacity available
under the Credit Agreement. The Company believes that these sources of funds,
together with future cash flows from operations, should provide sufficient
resources, financial strength and flexibility to enable the Company for the
foreseeable future to satisfy its liquidity needs, capital requirements, and
debt service obligations while continuing the payment of dividends.
Net cash provided by operating activities amounted to $1.3 million in
the first three months of fiscal 1999, as compared to $15.5 million in the same
period of the prior year. Cash flows provided by operations in the current
year's three months were unusually low, while last year's first quarter cash
flow from operations was relatively high, despite the significant turnaround
expenditures incurred. The reduced earnings in the first quarter of fiscal 1999,
as compared to the first quarter of fiscal 1998, had a negative impact on cash
flows provided by operating activities. More significant were changes in certain
working capital accounts, specifically accounts receivable, inventory and
accounts payable. Last year's changes in these working capital accounts were
somewhat unusual in that they related to the Navajo Refinery turnaround in the
first quarter and early part of the second quarter of fiscal 1998, and combined
had a favorable effect of cash flows from operations for that period. In the
current year's first quarter, product accounts receivable increased
significantly from a relatively low level at July 31, 1998 to a level at October
31, 1998 that was slightly higher than normal.
Cash flows provided by financing activities amounted to $3.2 million
in the first three months of fiscal 1999, as compared to cash flows used for
financing activities of $1.7 million in the same period of the prior year. In
October 1997, the Company entered into a new three-year Credit Agreement. The
Credit Agreement provides for a total facility of $100 million, the full amount
of which may be used to support letters of credit and $50 million of which may
be used for direct borrowings. The Company increased its net borrowings under
the Credit Agrement by $4.5 million during the first quarter to an outstanding
balance of $16.1 million as of October 31, 1998. The next principal payment of
$5.2 million on the Company's Senior Notes is due in June 1999.
Cash flows used for investing activities were $4.2 million in the
first three months of fiscal 1999, as compared to $12.8 million in the same
period of the prior year. All amounts expended were on capital projects. The net
negative cash flow for investing activities was reduced in the first quarter of
fiscal 1999 by a $.6 million distribution to the Company from
12
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HOLLY CORPORATION
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (Continued)
the Rio Grande joint venture. The Company has adopted capital budgets totalling
$20 million for fiscal 1999. The components of this budget are $7 million for
various refinery improvements and environmental and safety enhancements, $12
million for various pipeline and transportation projects and $1 million for oil
and gas exploration and production activities. In addition to these projects,
the Company plans to expend in the 1999 fiscal year a total of $8 million on
items that were approved in previous capital budgets. These include projects at
the Navajo Refinery, certain environmental enhancements, and additional
expenditures for connecting pipelines and related product terminals to be used
in conjunction with the leased pipeline to northwest New Mexico described below.
The Company has leased from Mid-America Pipeline Company more than 300
miles of 8" pipeline running from Chavez County to San Juan County, New Mexico
(the "Leased Pipeline"). The Company has completed a 12" pipeline from the
Navajo Refinery to the Leased Pipeline and is in the process of completing
terminalling facilities in Bloomfield. Although portions of the construction
project have been completed, several alternatives are still being pursued to
address terminalling needs in the Albuquerque area. When the project, including
the Albuquerque portion, is completed, these facilities will allow the Company
to use the Leased Pipeline to transport petroleum products from the Navajo
Refinery to Albuquerque and markets in northwest New Mexico. The Leased Pipeline
and recently constructed facilities will be available during fiscal 1999 for the
transport of petroleum products to certain markets in northwest New Mexico. The
total estimated cost of this project is $17 million, of which $7 million remains
to be spent.
The additional pipeline capacity resulting from the new pipelines
constructed in conjunction with the Rio Grande joint venture and expected to
result from the Leased Pipeline and completion of the planned related pipeline
and terminalling facilities should reduce pipeline operating expenses at current
throughputs. In addition, the new pipeline capacity would allow the Company to
increase volumes, through refinery expansion or otherwise, that are shipped into
existing and new markets and could allow the Company to shift volumes among
markets in response to any future increased competition in particular markets.
The Company plans to construct for approximately $5 million 65 miles
of new pipeline between Lovington and Artesia, NM, to permit the delivery of
isobutane (and/or other LPGs) to the Chevron refinery in El Paso.
Longhorn Partners Pipeline, L.P. ("Longhorn Partners"), a partnership
composed of Longhorn Partners GP, L.L.C. as general partner and affiliates of
Exxon Pipeline Company, Amoco Pipeline Company, Williams Pipeline Company, and
The Beacon Group Energy Investment Fund, L.P. as well as Chisholm Holdings as
limited partners, is in the process of reversing an existing crude oil pipeline
and constructing a connecting pipeline for the
13
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HOLLY CORPORATION
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (Continued)
transportation of petroleum products from Gulf Coast refineries to El Paso. It
has been reported that Longhorn had planned to transport initially 72,000 BPD of
gasoline to the West Texas markets starting in October 1998 on the reversed
existing crude oil pipeline. It had also been reported that once fully
operational the pipeline would have the ultimate capacity to transport 225,000
BPD of refined products from Houston to terminals in Midland and El Paso. Use of
this pipeline is currently prohibited by an injunction issued by the Federal
District Court in Austin, Texas in the Environmental Suit described below. This
new pipeline could significantly increase the supply of products in the
Company's current principal markets that are served from El Paso.
On August 31, 1998, a lawsuit (the "Longhorn Suit") was filed by
Longhorn Partners in state district court in El Paso, Texas against the Company,
two of its subsidiaries and an Austin, Texas law firm. The suit seeks damages
against the Company and the law firm alleged to total up to $1,050,000,000 and
injunctive relief based on claims of violations of the Texas Free Enterprise and
Antitrust Act, unlawful interference with contractual relations, and conspiracy
to abuse process. The Longhorn Suit appears to relate principally to the alleged
involvement of subsidiaries of the Company and the named law firm in a federal
lawsuit (the "Environmental Suit") in Austin, Texas filed by ranchers and joined
by the Barton Springs-Edwards Aquifer Conservation District, the City of Austin
and the Lower Colorado River Authority. The Environmental Suit resulted in a
preliminary injunction issued by the Federal Court in August 1998 requiring
preparation of an environmental impact statement under the National
Environmental Policy Act before Longhorn Partners uses its pipeline to transport
refined petroleum products across Texas. The Company believes the Longhorn Suit
is wholly without merit and plans to defend itself vigorously. The Company also
plans to pursue at the appropriate time any affirmative remedies that may be
available to it with respect to the filing of the Longhorn Suit.
In July 1993, the United States Department of Justice ("DOJ"), on
behalf of the United States Environmental Protection Agency ("EPA"), filed a
suit against the Company's subsidiary, Navajo Refining Company ("Navajo")
alleging that, beginning in September 1990 and continuing through the present,
Navajo has violated and continues to violate the Resource Conservation and
Recovery Act ("RCRA") and implementing regulations of the EPA by treating,
storing and disposing of certain hazardous wastes in the refinery's wastewater
treatment system without compliance with regulatory requirements. An agreement
among Navajo, the DOJ and the State of New Mexico for settlement of this
litigation has become final. Under the settlement agreement, the Company will
close the existing evaporation ponds of its wastewater treatment system. The
agreement also provides that the Company
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HOLLY CORPORATION
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (Continued)
will utilize an alternative to the existing wastewater treatment system at an
estimated total cost of approximately $5 million, of which $2 million already
has been incurred. The costs to implement the alternative wastewater treatment
system will be capitalized and amortized over the future useful life of the
resulting asset in accordance with generally accepted accounting principles.
Finally, the agreement involves the payment of a civil penalty of less than $2
million. In fiscal 1993, the Company recorded a $2 million reserve for this
litigation.
Risk Management
The Company uses certain strategies to reduce some commodity price and
operational risks. The Company does not attempt to eliminate all market risk
exposures when the Company believes that the exposure relating to such risk
would not be significant to the Company's future earnings, financial position,
capital resources or liquidity or that the cost of eliminating the exposure
would outweigh the benefit.
The Company's profitability depends largely on the spread between
market prices for refined products and crude oil prices. A substantial or
prolonged decrease in this spread could have a significant negative effect on
the Company's earnings, financial condition and cash flows. At times, the
Company utilizes petroleum commodity future contracts to minimize a portion of
its exposure to price fluctuations associated with crude oil and refined
products. Such contracts do not increase the market risks to which the Company
is exposed and are used solely to help manage the price risk inherent in
purchasing crude oil in advance of the delivery date and as a hedge for
fixed-price sales contracts of refined products. Gains and losses on contracts
are deferred and recognized in cost of refined products when the related
inventory is sold or the hedged transaction is consummated.
The Company has outstanding unsecured debt of $75.5 million and
short-term borrowings under the Credit Agreement of $16.1 million at October 31,
1998. The Company does not have significant exposure to changing interest rates
on its long-term debt because the interest rates are fixed and long-term debt
now represents less than 40% of the Company's total capitalization. Borrowings
under the Credit Agreement are based primarily on the bank's daily effective
prime rate, thus the interest rate market risk is very low. Additionally, the
Company invests any available cash only in investment grade, highly liquid
investments with maturities of three months or less. As a result, the interest
rate market risk implicit in these cash investments is low, as the investments
mature within three months. A ten percent change in the market interest rate
over the next year would not materially impact
15
<PAGE> 16
HOLLY CORPORATION
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (Continued)
the Company's earnings or cash flow, as the interest rates on the Company's
long-term debt are fixed and the Company's borrowings under the Credit Agreement
and cash investments are short-term, and such a change in interest rates would
therefore not have a material effect on the value of such debt or cash
investments.
The Company's operations are subject to normal hazards of operations,
including fire, explosion and weather-related perils. The Company maintains
various insurance coverages, including business interruption insurance, subject
to certain deductibles. The Company is not fully insured against certain risks
because such risks are not fully insurable, coverage is unavailable or premium
costs, in the judgement of the Company, do not justify such expenditures.
The Year 2000 Problem
The Year 2000 Problem is the result of older computer systems using a
two-digit format rather than a four-digit format to define the applicable year
with the result that such computer systems may be unable to interpret properly
dates beyond the year 1999. This inability could lead to a failure of
information systems and disruptions of business and financial operations. Year
2000 risks exist both in information technology ("IT") systems that employ
computer hardware and software and in non-IT systems such as embedded computer
chips or microcontrollers that control the operation of the equipment in which
they are installed. Computer failures because of the Year 2000 problem could
affect the Company either because of failures of computers used in the Company's
operations and record-keeping or because of computer failures that adversely
affect third parties that are suppliers to or customers of the Company.
Partly with the assistance of outside consultants, the Company has
taken steps to identify key financial, informational and operational systems
that may be affected by the Year 2000 Problem. Based on certifications by
third-party suppliers of the Company's principal IT systems, the Company
believes that its principal IT systems either are now unaffected by the Year
2000 Problem or are the subject of currently scheduled replacement or upgrading
that will make these systems free of Year 2000 issues. Under the Company's
current plans, all IT systems believed by the Company to have significance to
the Company's operations or financial condition will be free of Year 2000 issues
by September 1999.
Because of the nature of non-IT systems embedded in equipment used in
the Company's operations, the Company has not yet fully assessed the extent to
which these non-IT systems could fail because of the Year 2000 Problem and
thereby cause significant problems for the Company's operations, financial
condition or liquidity. The Company plans by January 1999 to identify, based on
information and/or certifications from suppliers or other third parties, the
types of non-IT systems that appear to be significantly at risk of
16
<PAGE> 17
HOLLY CORPORATION
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (Continued)
failure due to the Year 2000 Problem; by January 1999 it is planned that items
of equipment possibly or certainly containing at-risk chips will be identified
and ranked in order of the consequences of a failure on the Company's
operations; the Company plans by April 1999 to repair or replace those pieces of
equipment for which a failure would be expected to create serious problems for
Company operations. Because of the nature of the non-IT systems, there can be no
assurance that the Company will correctly identify all non-IT systems that are
subject to failure because of the Year 2000 Problem or that all non-IT systems
significant to the Company's operations will be repaired or replaced as
necessary prior to the end of 1999.
To the extent possible the Company plans to test or receive
certifications with respect to all significant IT and non-IT systems by
September 30, 1999.
The Company has begun to assess the possible effects of the Year 2000
Problem on third parties that are important to the Company's operations. The
Company plans to communicate regularly on this issue with critical third
parties, such as suppliers of power or telecommunications services to the
Company's operational facilities, third-party carriers of raw materials and
refined products, and major customers. As problems of third parties are
identified, the Company will take any steps available to reduce the impact on
the Company of a failure in a third party caused by the Year 2000 Problem.
The cost to the Company of dealing with the Year 2000 Problem is not
expected to be material. Although a portion of the time of IT personnel and
related management has been and will be employed in evaluating the problem,
taking corrective actions and preparing contingency plans, the Company does not
believe that other IT projects or operations have been or will be adversely
affected. Monetary costs expected to be involved in dealing with the Year 2000
Problem are not expected to be significant: all costs of review, analysis and
corrective action (excluding IT system upgrades that were scheduled to be
implemented without regard to the Year 2000 Problem) are expected to total less
than $250,000.
Based on the analysis performed to this point, the Company believes
that the most important risk of the Year 2000 Problem to the Company's results
of operations and financial condition is that third-party suppliers important to
the operations of the Company's principal operating asset, the Navajo refinery
at Artesia and Lovington, New Mexico, would for a period of time be unable to
perform their normal roles because of difficulties created by the Year 2000
Problem for the third parties and/or for persons supplying the third parties.
The greatest vulnerability is in the case of providers that are the Company's
principal or sole source for an essential input -- for example power to operate
the refinery. If such a provider were to be unable to continue supplying the
refinery because of the Year 2000 Problem, the Company would be forced to
suspend the affected operations until the provider could solve the problem or in
some cases until an alternative supply could be arranged. The
17
<PAGE> 18
HOLLY CORPORATION
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (Continued)
Company has begun, and intends to continue until the year 2000, regular contacts
with critical suppliers to determine their evaluations of their vulnerability to
the Year 2000 Problem. In the event that a particular supplier appears to be
vulnerable, the Company will seek to obtain alternative supplies to the extent
they are available. However, in the case of some inputs, alternative supplies
may not realistically be available even if the supply problem is identified
months in advance. In other cases, an unexpected third-party failure could occur
in spite of extensive prior communications with key suppliers and the only
feasible remedy to the Company for a substantial period might be emergency
corrective action by the affected third party if the third party were capable of
taking such action.
The Company has begun contingency planning for actions to be taken in
the event its operations are adversely affected by the Year 2000 Problem. A
contingency plan is expected to be completed by July 1999.
Item 3. Quantitative and Qualitative
Disclosures About Market Risk
See "Risk Management" under "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
18
<PAGE> 19
HOLLY CORPORATION
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
In July 1993, the DOJ, acting on behalf of the EPA, filed a complaint in
the United States District Court for the District of New Mexico alleging that
Navajo, beginning in September 1990 and continuing until the present, had
violated and continues to violate RCRA and implementing regulations of the EPA
by treating, storing and disposing of certain hazardous wastes without necessary
authorization and without compliance with regulatory requirements. The complaint
seeks a court order directing Navajo to comply with these regulatory standards
and civil penalties for the alleged non-compliance. As discussed in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and Note D to the Consolidated Financial Statements, an agreement
for settlement of this case has become final.
On August 31, 1998, a lawsuit was filed by Longhorn Partners Pipeline,
L.P. in state district court in El Paso, Texas against the Company, two of its
subsidiaries and an Austin, Texas law firm. The suit seeks damages against the
Company and the law firm alleged to total up to $1,050,000,000 and injunctive
relief based on claims of violations of the Texas Free Enterprise and Antitrust
Act, unlawful interference with contractual relations, and conspiracy to abuse
process. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and Note D to the Consolidated Financial Statements for a
further discussion of this lawsuit.
Item 4. Submission of Matters to a Vote of Securities Holders
At the annual meeting of stockholders on December 10, 1998, all eight of
the management's nominees for directors as listed in the proxy statement were
elected.
SCHEDULE OF VOTES CAST FOR EACH DIRECTOR
<TABLE>
<CAPTION>
Total Shares Voted Total Shares Voted
"For" "Withheld"
------------------ ------------------
<S> <C> <C>
Matthew P. Clifton 7,406,756 33,642
William J. Gray 7,406,256 34,142
Marcus R. Hickerson 7,406,176 34,222
A.J. Losee 7,405,876 34,522
Thomas K. Matthews, II 7,405,876 34,522
Robert G. McKenzie 7,405,876 34,522
Lamar Norsworthy 7,406,956 33,442
Jack P. Reid 7,406,556 33,842
</TABLE>
19
<PAGE> 20
HOLLY CORPORATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits: See Index to Exhibits on page 22.
(b) Reports on Form 8-K: As previously reported on the Form 10-K Annual
Report for the fiscal year ended July 31, 1998, a Form 8-K report
for the date September 1, 1998, was filed with respect to the
mutually agreed termination of the proposed merger with Giant
Industries, Inc.
20
<PAGE> 21
SIGNATURE
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HOLLY CORPORATION
---------------------------
(Registrant)
Date: December 15, 1998 By /s/ Henry A. Teichholz
------------------- -------------------------
Henry A. Teichholz
Vice President, Treasurer
and Controller
(Duly Authorized Principal
Financial and Accounting
Officer)
21
<PAGE> 22
HOLLY CORPORATION
INDEX TO EXHIBITS
(Exhibits are numbered to correspond to the
exhibit table in Item 601 of Regulation S-K)
<TABLE>
<CAPTION>
Exhibit
Number Description
------- -----------
<S> <C> <C>
27 - Financial Data Schedule
</TABLE>
22
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JUL-31-1999
<PERIOD-END> OCT-31-1998
<CASH> 2,833
<SECURITIES> 0
<RECEIVABLES> 91,634
<ALLOWANCES> 0
<INVENTORY> 51,265
<CURRENT-ASSETS> 159,249
<PP&E> 330,735
<DEPRECIATION> 156,946
<TOTAL-ASSETS> 354,619
<CURRENT-LIABILITIES> 143,511
<BONDS> 70,341
0
0
<COMMON> 87
<OTHER-SE> 115,394
<TOTAL-LIABILITY-AND-EQUITY> 354,619
<SALES> 140,792
<TOTAL-REVENUES> 140,971
<CGS> 124,573
<TOTAL-COSTS> 130,865
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,931
<INCOME-PRETAX> 4,291
<INCOME-TAX> 1,673
<INCOME-CONTINUING> 2,618
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,618
<EPS-PRIMARY> .32
<EPS-DILUTED> .32
</TABLE>
