Attached files
| file | filename |
|---|---|
| EX-32.2 - EXHIBIT 32.2 - HollyFrontier Corp | hfcex3229-30x201710q.htm |
| EX-32.1 - EXHIBIT 32.1 - HollyFrontier Corp | hfcex3219-30x201710q.htm |
| EX-31.2 - EXHIBIT 31.2 - HollyFrontier Corp | hfcex3129-30x201710q.htm |
| EX-31.1 - EXHIBIT 31.1 - HollyFrontier Corp | hfcex3119-30x201710q.htm |
| EX-10.1 - EXHIBIT 10.1 - HollyFrontier Corp | ex101firstamendmenttofourt.htm |
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_________________________________________________________________
FORM 10-Q
_________________________________________________________________
(Mark One)
ý | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2017
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
_________________________________________________________________
HOLLYFRONTIER CORPORATION
(Exact name of registrant as specified in its charter)
_________________________________________________________________
Delaware | 75-1056913 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
2828 N. Harwood, Suite 1300 Dallas, Texas | 75201 | |
(Address of principal executive offices) | (Zip Code) | |
(214) 871-3555
(Registrant’s telephone number, including area code)
_________________________________________________________________
(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 ý No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer | ý | Accelerated filer | ¨ | Non-accelerated filer | ¨ | Smaller reporting company | ¨ |
Emerging growth company | ¨ | ||||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No ý
177,273,061 shares of Common Stock, par value $.01 per share, were outstanding on October 31, 2017.
HOLLYFRONTIER CORPORATION
INDEX
Page | |
September 30, 2017 (Unaudited) and December 31, 2016 | |
Three and Nine Months Ended September 30, 2017 and 2016 | |
Three and Nine Months Ended September 30, 2017 and 2016 | |
Nine Months Ended September 30, 2017 and 2016 | |
Index to Exhibits | |
Signatures | |
FORWARD-LOOKING STATEMENTS
References herein to HollyFrontier Corporation (“HollyFrontier”) include HollyFrontier and its consolidated subsidiaries. In accordance with the Securities and Exchange Commission’s (“SEC”) “Plain English” guidelines, this Quarterly Report on Form 10-Q has been written in the first person. In this document, the words “we,” “our,” “ours” and “us” refer only to HollyFrontier and its consolidated subsidiaries or to HollyFrontier or an individual subsidiary and not to any other person with certain exceptions. Generally, the words “we,” “our,” “ours” and “us” include Holly Energy Partners, L.P. (“HEP”) and its subsidiaries as consolidated subsidiaries of HollyFrontier, unless when used in disclosures of transactions or obligations between HEP and HollyFrontier or its other subsidiaries. This document contains certain disclosures of agreements that are specific to HEP and its consolidated subsidiaries and do not necessarily represent obligations of HollyFrontier. When used in descriptions of agreements and transactions, “HEP” refers to HEP and its consolidated subsidiaries.
This Quarterly Report on Form 10-Q contains certain “forward-looking statements” within the meaning of the federal securities laws. All statements, other than statements of historical fact included in this Form 10-Q, including, but not limited to, those under “Results of Operations,” “Liquidity and Capital Resources” and “Risk Management” in Part I, Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and those in Part II, Item 1 “Legal Proceedings” are forward-looking statements. Forward-looking statements use words such as “anticipate,” “project,” “expect,” “plan,” “goal,” “forecast,” “intend,” “should,” “would,” “could,” “believe,” “may,” and similar expressions and statements regarding our plans and objectives for future operations. These statements are based on management’s beliefs and assumptions using currently available information and expectations as of the date hereof, are not guarantees of future performance and involve certain risks and uncertainties. All statements concerning our expectations for future results of operations are based on forecasts for our existing operations and do not include the potential impact of any future acquisitions. Although we believe that the expectations reflected in these forward-looking statements are reasonable, we cannot assure you that our expectations will prove to be correct. Therefore, actual outcomes and results could materially differ from what is expressed, implied or forecast in these statements. Any differences could be caused by a number of factors including, but not limited to:
• | risks and uncertainties with respect to the actions of actual or potential competitive suppliers of refined petroleum products in our markets; |
• | the demand for and supply of crude oil and refined products; |
• | the spread between market prices for refined products and market prices for crude oil; |
• | the possibility of constraints on the transportation of refined products; |
• | the possibility of inefficiencies, curtailments or shutdowns in refinery operations or pipelines; |
• | effects of governmental and environmental regulations and policies; |
• | the availability and cost of our financing; |
• | the effectiveness of our capital investments and marketing strategies; |
• | our efficiency in carrying out construction projects; |
• | our ability to acquire refined product operations or pipeline and terminal operations on acceptable terms and to integrate any recent or future acquired operations, including Petro-Canada Lubricants Inc.; |
• | the possibility of terrorist attacks and the consequences of any such attacks; |
• | general economic conditions; and |
• | other financial, operational and legal risks and uncertainties detailed from time to time in our SEC filings. |
Cautionary statements identifying important factors that could cause actual results to differ materially from our expectations are set forth in this Form 10-Q, including without limitation, the forward-looking statements that are referred to above. This summary discussion should be read in conjunction with the discussion of the known material risk factors and other cautionary statements under the heading “Risk Factors” included in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2016 and our Quarterly Report on Form 10-Q for the quarter ended March 31, 2017 and in conjunction with the discussion in this Form 10-Q in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the heading “Liquidity and Capital Resources.” All forward-looking statements included in this Form 10-Q and all subsequent written or oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. The forward-looking statements speak only as of the date made and, other than as required by law, we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
3
PART I. FINANCIAL INFORMATION
DEFINITIONS
Within this report, the following terms have these specific meanings:
“BPD” means the number of barrels per calendar day of crude oil or petroleum products.
“BPSD” means the number of barrels per stream day (barrels of capacity in a 24 hour period) of crude oil or petroleum products.
“Biodiesel” means a clean alternative fuel produced from renewable biological resources.
“Black wax crude oil” is a low sulfur, low gravity crude oil produced in the Uintah Basin in Eastern Utah that has certain characteristics that require specific facilities to transport, store and refine into transportation fuels.
“Cracking” means the process of breaking down larger, heavier and more complex hydrocarbon molecules into simpler and lighter molecules.
“Crude oil distillation” means the process of distilling vapor from liquid crudes, usually by heating, and condensing the vapor slightly above atmospheric pressure turning it back to liquid in order to purify, fractionate or form the desired products.
“Ethanol” means a high octane gasoline blend stock that is used to make various grades of gasoline.
“FCC,” or fluid catalytic cracking, means a refinery process that breaks down large complex hydrocarbon molecules into smaller more useful ones using a circulating bed of catalyst at relatively high temperatures.
“Hydrodesulfurization” means to remove sulfur and nitrogen compounds from oil or gas in the presence of hydrogen and a catalyst at relatively high temperatures.
“Hydrogen plant” means a refinery unit that converts natural gas and steam to high purity hydrogen, which is then used in the hydrodesulfurization, hydrocracking and isomerization processes.
“Isomerization” means a refinery process for rearranging the structure of C5/C6 molecules without changing their size or chemical composition and is used to improve the octane of C5/C6 gasoline blendstocks.
“LPG” means liquid petroleum gases.
“Lubricant” or “lube” means a solvent neutral paraffinic product used in commercial heavy duty engine oils, passenger car oils and specialty products for industrial applications such as heat transfer, metalworking, rubber and other general process oil.
“MSAT2” means Control of Hazardous Air Pollutants from Mobile Sources, a rule issued by the U.S. Environmental Protection Agency to reduce hazardous emissions from motor vehicles and motor vehicle fuels.
“MMBTU” means one million British thermal units.
“Refinery gross margin” means the difference between average net sales price and average product costs per produced barrel of refined products sold. This does not include the associated depreciation and amortization costs.
“RINs” means renewable identification numbers and refers to serial numbers assigned to credits generated from biodiesel production under the Environmental Protection Agency’s Renewable Fuel Standard 2 (“RFS2”) regulations that mandate increased volumes of renewable fuels blended into the nation’s fuel supply. In lieu of blending, refiners may purchase these transferable credits in order to comply with the regulations.
“Sour crude oil” means crude oil containing quantities of sulfur greater than 0.4 percent by weight, while “sweet crude oil” means crude oil containing quantities of sulfur equal to or less than 0.4 percent by weight.
“Vacuum distillation” means the process of distilling vapor from liquid crudes, usually by heating, and condensing the vapor below atmospheric pressure turning it back to a liquid in order to purify, fractionate or form the desired products.
“WTI” means West Texas Intermediate and is a grade of crude oil used as a common benchmark in oil pricing. WTI is a sweet crude oil and has a relatively low density.
Item 1. | Financial Statements |
HOLLYFRONTIER CORPORATION
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
September 30, 2017 | December 31, 2016 | |||||||
(Unaudited) | ||||||||
ASSETS | ||||||||
Current assets: | ||||||||
Cash and cash equivalents (HEP: $7,476 and $3,657, respectively) | $ | 630,742 | $ | 710,579 | ||||
Marketable securities | — | 424,148 | ||||||
Total cash, cash equivalents and short-term marketable securities | 630,742 | 1,134,727 | ||||||
Accounts receivable: Product and transportation (HEP: $7,330 and $7,846, respectively) | 644,695 | 449,036 | ||||||
Crude oil resales | 69,653 | 30,163 | ||||||
714,348 | 479,199 | |||||||
Inventories: Crude oil and refined products | 1,261,245 | 970,361 | ||||||
Materials, supplies and other (HEP: $888 and $1,402, respectively) | 158,597 | 165,315 | ||||||
1,419,842 | 1,135,676 | |||||||
Income taxes receivable | — | 68,371 | ||||||
Prepayments and other (HEP: $1,407 and $1,486, respectively) | 32,129 | 33,036 | ||||||
Total current assets | 2,797,061 | 2,851,009 | ||||||
Properties, plants and equipment, at cost (HEP: $1,730,903 and $1,702,703, respectively) | 6,175,414 | 5,546,856 | ||||||
Less accumulated depreciation (HEP: $(389,133) and $(337,135), respectively) | (1,738,583 | ) | (1,538,408 | ) | ||||
4,436,831 | 4,008,448 | |||||||
Other assets: Turnaround costs | 238,877 | 217,340 | ||||||
Goodwill (HEP: $288,991 and $288,991, respectively) | 2,213,805 | 2,022,463 | ||||||
Intangibles and other (HEP: $212,692 and $208,975, respectively) | 461,781 | 336,401 | ||||||
2,914,463 | 2,576,204 | |||||||
Total assets | $ | 10,148,355 | $ | 9,435,661 | ||||
LIABILITIES AND EQUITY | ||||||||
Current liabilities: | ||||||||
Accounts payable (HEP: $13,659 and $10,518, respectively) | $ | 1,101,668 | $ | 935,387 | ||||
Income taxes payable | 64,255 | — | ||||||
Accrued liabilities (HEP: $31,333 and $37,793, respectively) | 235,092 | 147,842 | ||||||
Total current liabilities | 1,401,015 | 1,083,229 | ||||||
Long-term debt (HEP: $1,245,066 and $1,243,912, respectively) | 2,236,514 | 2,235,137 | ||||||
Deferred income taxes (HEP: $522 and $509, respectively) | 842,122 | 620,414 | ||||||
Other long-term liabilities (HEP: $61,361 and $62,971, respectively) | 202,927 | 194,896 | ||||||
Equity: | ||||||||
HollyFrontier stockholders’ equity: | ||||||||
Preferred stock, $1.00 par value – 5,000,000 shares authorized; none issued | — | — | ||||||
Common stock $.01 par value – 320,000,000 shares authorized; 256,009,012 and 255,962,866 shares issued as of September 30, 2017 and December 31, 2016, respectively | 2,560 | 2,560 | ||||||
Additional capital | 4,067,836 | 4,026,805 | ||||||
Retained earnings | 2,884,524 | 2,776,728 | ||||||
Accumulated other comprehensive income | 31,440 | 10,612 | ||||||
Common stock held in treasury, at cost – 78,732,977 and 78,617,600 shares as of September 30, 2017 and December 31, 2016, respectively | (2,137,496 | ) | (2,135,311 | ) | ||||
Total HollyFrontier stockholders’ equity | 4,848,864 | 4,681,394 | ||||||
Noncontrolling interest | 616,913 | 620,591 | ||||||
Total equity | 5,465,777 | 5,301,985 | ||||||
Total liabilities and equity | $ | 10,148,355 | $ | 9,435,661 | ||||
Parenthetical amounts represent asset and liability balances attributable to Holly Energy Partners, L.P. (“HEP”) as of September 30, 2017 and December 31, 2016. HEP is a consolidated variable interest entity.
See accompanying notes.
5
HOLLYFRONTIER CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(In thousands, except per share data)
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2017 | 2016 | 2017 | 2016 | |||||||||||||
Sales and other revenues | $ | 3,719,247 | $ | 2,847,270 | $ | 10,258,594 | $ | 7,580,632 | ||||||||
Operating costs and expenses: | ||||||||||||||||
Cost of products sold (exclusive of depreciation and amortization): | ||||||||||||||||
Cost of products sold (exclusive of lower of cost or market inventory valuation adjustment) | 2,888,530 | 2,341,837 | 8,283,127 | 6,215,155 | ||||||||||||
Lower of cost or market inventory valuation adjustment | (111,128 | ) | 312 | (15,323 | ) | (194,282 | ) | |||||||||
2,777,402 | 2,342,149 | 8,267,804 | 6,020,873 | |||||||||||||
Operating expenses (exclusive of depreciation and amortization) | 321,668 | 256,232 | 944,437 | 760,151 | ||||||||||||
Selling, general and administrative expenses (exclusive of depreciation and amortization) | 68,013 | 32,994 | 184,659 | 88,270 | ||||||||||||
Depreciation and amortization | 102,884 | 91,130 | 304,206 | 269,433 | ||||||||||||
Goodwill and asset impairment | — | — | 19,247 | 654,084 | ||||||||||||
Total operating costs and expenses | 3,269,967 | 2,722,505 | 9,720,353 | 7,792,811 | ||||||||||||
Income (loss) from operations | 449,280 | 124,765 | 538,241 | (212,179 | ) | |||||||||||
Other income (expense): | ||||||||||||||||
Earnings of equity method investments | 5,072 | 3,767 | 10,965 | 10,155 | ||||||||||||
Interest income | 1,074 | 778 | 2,069 | 1,380 | ||||||||||||
Interest expense | (28,731 | ) | (19,550 | ) | (85,534 | ) | (45,888 | ) | ||||||||
Loss on early extinguishment of debt | — | — | (12,225 | ) | (8,718 | ) | ||||||||||
Gain on foreign currency swap | — | — | 24,545 | — | ||||||||||||
Gain on foreign currency transactions | 19,122 | — | 19,517 | — | ||||||||||||
Other, net | 286 | 107 | 23 | 300 | ||||||||||||
(3,177 | ) | (14,898 | ) | (40,640 | ) | (42,771 | ) | |||||||||
Income (loss) before income taxes | 446,103 | 109,867 | 497,601 | (254,950 | ) | |||||||||||
Income tax expense (benefit): | ||||||||||||||||
Current | 72,307 | 10,094 | 80,242 | (32,272 | ) | |||||||||||
Deferred | 86,079 | 12,102 | 93,351 | 38,731 | ||||||||||||
158,386 | 22,196 | 173,593 | 6,459 | |||||||||||||
Net income (loss) | 287,717 | 87,671 | 324,008 | (261,409 | ) | |||||||||||
Less net income attributable to noncontrolling interest | 15,703 | 13,174 | 39,695 | 52,209 | ||||||||||||
Net income (loss) attributable to HollyFrontier stockholders | $ | 272,014 | $ | 74,497 | $ | 284,313 | $ | (313,618 | ) | |||||||
Earnings (loss) per share attributable to HollyFrontier stockholders: | ||||||||||||||||
Basic | $ | 1.53 | $ | 0.42 | $ | 1.60 | $ | (1.78 | ) | |||||||
Diluted | $ | 1.53 | $ | 0.42 | $ | 1.60 | $ | (1.78 | ) | |||||||
Cash dividends declared per common share | $ | 0.33 | $ | 0.33 | $ | 0.99 | $ | 0.99 | ||||||||
Average number of common shares outstanding: | ||||||||||||||||
Basic | 176,149 | 175,871 | 176,143 | 176,157 | ||||||||||||
Diluted | 176,530 | 175,993 | 176,616 | 176,157 | ||||||||||||
See accompanying notes.
6
HOLLYFRONTIER CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(In thousands)
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2017 | 2016 | 2017 | 2016 | |||||||||||||
Net income (loss) | $ | 287,717 | $ | 87,671 | $ | 324,008 | $ | (261,409 | ) | |||||||
Other comprehensive income: | ||||||||||||||||
Foreign currency translation adjustment | 16,702 | — | 24,287 | — | ||||||||||||
Securities available-for-sale: | ||||||||||||||||
Unrealized gain (loss) on marketable securities | — | (29 | ) | (4 | ) | 61 | ||||||||||
Reclassification adjustments to net income on sale or maturity of marketable securities | — | — | — | 23 | ||||||||||||
Net unrealized gain (loss) on marketable securities | — | (29 | ) | (4 | ) | 84 | ||||||||||
Hedging instruments: | ||||||||||||||||
Change in fair value of cash flow hedging instruments | (2,094 | ) | (1,310 | ) | 2,708 | (19,307 | ) | |||||||||
Reclassification adjustments to net income on settlement of cash flow hedging instruments | 5,115 | 4,141 | 5,049 | 37,450 | ||||||||||||
Amortization of unrealized loss attributable to discontinued cash flow hedges | 270 | 270 | 810 | 810 | ||||||||||||
Net unrealized gain on hedging instruments | 3,291 | 3,101 | 8,567 | 18,953 | ||||||||||||
Other comprehensive income before income taxes | 19,993 | 3,072 | 32,850 | 19,037 | ||||||||||||
Income tax expense | 7,140 | 1,119 | 11,841 | 7,436 | ||||||||||||
Other comprehensive income | 12,853 | 1,953 | 21,009 | 11,601 | ||||||||||||
Total comprehensive income (loss) | 300,570 | 89,624 | 345,017 | (249,808 | ) | |||||||||||
Less noncontrolling interest in comprehensive income (loss) | 15,663 | 13,353 | 39,638 | 52,028 | ||||||||||||
Comprehensive income (loss) attributable to HollyFrontier stockholders | $ | 284,907 | $ | 76,271 | $ | 305,379 | $ | (301,836 | ) | |||||||
See accompanying notes.
7
HOLLYFRONTIER CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
Nine Months Ended September 30, | ||||||||
2017 | 2016 | |||||||
Cash flows from operating activities: | ||||||||
Net income (loss) | $ | 324,008 | $ | (261,409 | ) | |||
Adjustments to reconcile net income (loss) to net cash provided by operating activities: | ||||||||
Depreciation and amortization | 304,206 | 269,433 | ||||||
Goodwill and asset impairment | 19,247 | 654,084 | ||||||
Lower of cost or market inventory valuation adjustment | (15,323 | ) | (194,282 | ) | ||||
Earnings of equity method investments, inclusive of distributions | 816 | 313 | ||||||
(Gain) loss on sale of assets | 540 | (107 | ) | |||||
Loss on early extinguishment of debt attributable to unamortized discount | 2,475 | 8,718 | ||||||
Deferred income taxes | 93,351 | 38,731 | ||||||
Equity-based compensation expense | 26,430 | 16,696 | ||||||
Change in fair value – derivative instruments | 2,073 | (12,319 | ) | |||||
Excess tax expense from equity-based compensation | — | (4,051 | ) | |||||
(Increase) decrease in current assets: | ||||||||
Accounts receivable | (116,986 | ) | (43,959 | ) | ||||
Inventories | (43,822 | ) | (54,643 | ) | ||||
Income taxes receivable | 68,371 | (42,683 | ) | |||||
Prepayments and other | (5,268 | ) | 18,236 | |||||
Increase (decrease) in current liabilities: | ||||||||
Accounts payable | 88,010 | 114,771 | ||||||
Income taxes payable | 60,661 | (8,142 | ) | |||||
Accrued liabilities | 83,918 | 39,527 | ||||||
Turnaround expenditures | (111,513 | ) | (104,224 | ) | ||||
Other, net | 4,219 | 9,584 | ||||||
Net cash provided by operating activities | 785,413 | 444,274 | ||||||
Cash flows from investing activities: | ||||||||
Additions to properties, plants and equipment | (162,442 | ) | (291,362 | ) | ||||
Additions to properties, plants and equipment – HEP | (30,675 | ) | (96,115 | ) | ||||
Purchase of equity method investment - HEP | — | (42,550 | ) | |||||
Purchase of PCLI, net of cash acquired | (870,627 | ) | — | |||||
Purchases of marketable securities | (41,565 | ) | (155,091 | ) | ||||
Sales and maturities of marketable securities | 465,716 | 187,358 | ||||||
Other, net | 2,297 | 606 | ||||||
Net cash used for investing activities | (637,296 | ) | (397,154 | ) | ||||
Cash flows from financing activities: | ||||||||
Borrowings under credit agreements | 654,000 | 625,500 | ||||||
Repayments under credit agreements | (457,000 | ) | (957,500 | ) | ||||
Proceeds from issuance of senior notes - HFC | — | 246,690 | ||||||
Proceeds from issuance of senior notes - HEP | 101,750 | 394,000 | ||||||
Proceeds from issuance of term loan - HFC | — | 350,000 | ||||||
Redemption of senior notes - HEP | (309,750 | ) | — | |||||
Repayment of financing obligation | — | (39,500 | ) | |||||
Proceeds from issuance of common units - HEP | 52,285 | 22,791 | ||||||
Purchase of treasury stock | — | (133,430 | ) | |||||
Dividends | (176,519 | ) | (175,194 | ) | ||||
Distributions to noncontrolling interest | (81,797 | ) | (66,571 | ) | ||||
Other, net | (13,421 | ) | (14,118 | ) | ||||
Net cash provided by (used for) financing activities | (230,452 | ) | 252,668 | |||||
Effect of exchange rate on cash flow | 2,498 | — | ||||||
Cash and cash equivalents: | ||||||||
Increase (decrease) for the period | (79,837 | ) | 299,788 | |||||
Beginning of period | 710,579 | 66,533 | ||||||
End of period | $ | 630,742 | $ | 366,321 | ||||
Supplemental disclosure of cash flow information: | ||||||||
Cash (paid) received during the period for: | ||||||||
Interest | $ | (84,380 | ) | $ | (39,671 | ) | ||
Income taxes, net | $ | 50,957 | $ | (23,557 | ) | |||
See accompanying notes.
8
HOLLYFRONTIER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1: | Description of Business and Presentation of Financial Statements |
References herein to HollyFrontier Corporation (“HollyFrontier”) include HollyFrontier and its consolidated subsidiaries. In accordance with the Securities and Exchange Commission’s (“SEC”) “Plain English” guidelines, this Quarterly Report on Form 10-Q has been written in the first person. In these financial statements, the words “we,” “our,” “ours” and “us” refer only to HollyFrontier and its consolidated subsidiaries or to HollyFrontier or an individual subsidiary and not to any other person, with certain exceptions. Generally, the words “we,” “our,” “ours” and “us” include Holly Energy Partners, L.P. (“HEP”) and its subsidiaries as consolidated subsidiaries of HollyFrontier, unless when used in disclosures of transactions or obligations between HEP and HollyFrontier or its other subsidiaries. These financial statements contain certain disclosures of agreements that are specific to HEP and its consolidated subsidiaries and do not necessarily represent obligations of HollyFrontier. When used in descriptions of agreements and transactions, “HEP” refers to HEP and its consolidated subsidiaries.
We are principally an independent petroleum refiner that produces high-value light products such as gasoline, diesel fuel, jet fuel, specialty lubricant products, and specialty and modified asphalt. We own and operate petroleum refineries that serve markets throughout the Mid-Continent, Southwest and Rocky Mountain regions of the United States. In addition, we own and operate a lubricant production facility with retail and wholesale marketing of its products through a global sales network with locations in Canada, United States, Europe and China. As of September 30, 2017, we:
• | owned and operated a petroleum refinery in El Dorado, Kansas (the “El Dorado Refinery”), two refinery facilities located in Tulsa, Oklahoma (collectively, the “Tulsa Refineries”), a refinery in Artesia, New Mexico that is operated in conjunction with crude oil distillation and vacuum distillation and other facilities situated 65 miles away in Lovington, New Mexico (collectively, the “Navajo Refinery”), a refinery located in Cheyenne, Wyoming (the “Cheyenne Refinery”) and a refinery in Woods Cross, Utah (the “Woods Cross Refinery”); |
• | owned and operated HollyFrontier Asphalt Company LLC (“HFC Asphalt”) which operates various asphalt terminals in Arizona, New Mexico and Oklahoma; |
• | owned and operated Petro-Canada Lubricants Inc. (“PCLI”) located in Mississauga, Ontario which produces base oils and other specialized lubricant products; and |
• | owned a 36% interest in HEP, a consolidated variable interest entity (“VIE”), which includes our 2% general partner interest. |
On October 29, 2016, our wholly-owned subsidiary, 9952110 Canada Inc., entered into a Share Purchase Agreement (“SPA”) with Suncor Energy Inc. (“Suncor”) to acquire 100% of the outstanding capital stock of PCLI. The acquisition closed on February 1, 2017. See Note 2 for additional information.
We have prepared these consolidated financial statements without audit. In management’s opinion, these consolidated financial statements include all normal recurring adjustments necessary for a fair presentation of our consolidated financial position as of September 30, 2017, the consolidated results of operations and comprehensive income for the three and nine months ended September 30, 2017 and 2016 and consolidated cash flows for the nine months ended September 30, 2017 and 2016 in accordance with the rules and regulations of the SEC. Although certain notes and other information required by generally accepted accounting principles in the United States (“GAAP”) have been condensed or omitted, we believe that the disclosures in these consolidated financial statements are adequate to make the information presented not misleading. These consolidated financial statements should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2016 that has been filed with the SEC.
Our results of operations for the nine months ended September 30, 2017 are not necessarily indicative of the results of operations to be realized for the year ending December 31, 2017.
Accounts Receivable: Our accounts receivable consist of amounts due from customers that are primarily companies in the petroleum industry. Credit is extended based on our evaluation of the customer’s financial condition, and in certain circumstances collateral, such as letters of credit or guarantees, is required. We reserve for doubtful accounts based on our historical loss experience as well as specific accounts identified as high risk, which historically have been minimal. Credit losses are charged to the allowance for doubtful accounts when an account is deemed uncollectible. Our allowance for doubtful accounts was $4.0 million and $2.3 million at September 30, 2017 and December 31, 2016, respectively.
9
HOLLYFRONTIER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Continued
Inventories: Inventories related to our refining operations are stated at the lower of cost, using the last-in, first-out (“LIFO”) method for crude oil and unfinished and finished refined products, or market. In periods of rapidly declining prices, LIFO inventories may have to be written down to market value due to the higher costs assigned to LIFO layers in prior periods. In addition, the use of the LIFO inventory method may result in increases or decreases to cost of sales in years that inventory volumes decline as the result of charging cost of sales with LIFO inventory costs generated in prior periods. An actual valuation of inventory under the LIFO method is made at the end of each year based on the inventory levels at that time. Accordingly, interim LIFO calculations are based on management’s estimates of expected year-end inventory levels and are subject to the final year-end LIFO inventory valuation.
Inventories consisting of process chemicals, materials and maintenance supplies and renewable identification numbers (“RINs”) are stated at the lower of weighted-average cost or net realizable value.
Inventories of our PCLI operations are stated at the lower of cost, using the first-in, first-out (“FIFO”) method, or net realizable value.
Goodwill and Long-lived Assets: As of September 30, 2017, our goodwill balance was $2.2 billion, with goodwill assigned to our Refining, PCLI and HEP segments of $1.7 billion, $0.2 billion and $0.3 billion, respectively. During 2017, we recognized $185.2 million in goodwill as a result of our PCLI acquisition, all of which has been assigned to our PCLI segment. See Note 16 for additional information on our segments. Goodwill represents the excess of the cost of an acquired entity over the fair value of the assets acquired and liabilities assumed. Goodwill is not subject to amortization and is tested annually or more frequently if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. Our goodwill impairment testing first entails a comparison of our reporting unit fair values relative to their respective carrying values. If carrying value exceeds fair value for a reporting unit, we measure goodwill impairment as the excess of the carrying amount of reporting unit goodwill over the implied fair value of that goodwill based on estimates of the fair value of all assets and liabilities in the reporting unit. As of September 30, 2017, we have a cumulative goodwill impairment of $309.3 million, all of which relates to goodwill assigned to our Cheyenne Refinery reporting unit that was fully impaired in the second quarter of 2016.
Additionally, the carrying amount of our goodwill may fluctuate from period to period due to the effects of foreign currency translation adjustments on goodwill assigned to our PCLI segment.
We performed our annual goodwill impairment testing as of July 1, 2017 and determined the fair value of our El Dorado reporting unit exceeded its carrying value by approximately 10%. A reasonable expectation exists that further deterioration in gross margins could result in an impairment of goodwill and the long-lived assets of the El Dorado reporting unit at some point in the future and such impairment charges could be material. Additionally, testing indicated no impairment of goodwill attributable to our HEP or PCLI reporting units.
Our long-lived assets principally consist of our refining assets that are organized as refining asset groups and our PCLI business. The refinery asset groups also constitute our individual refinery reporting units that are used for testing and measuring goodwill impairments. Our long-lived assets are evaluated for impairment by identifying whether indicators of impairment exist and if so, assessing whether the long-lived assets are recoverable from estimated future undiscounted cash flows. The actual amount of impairment loss measured, if any, is equal to the amount by which the asset group’s carrying value exceeds its fair value. As a result of our impairment testing in the second quarter of 2016, we determined that the carrying value of the long-lived assets of the Cheyenne Refinery had been impaired and recorded long-lived asset impairment charges of $344.8 million.
During the second quarter of 2017, we incurred long-lived asset impairment charges totaling $23.2 million, including $19.2 million of construction-in-progress consisting primarily of engineering work for a planned expansion of our Woods Cross refinery to add lubricants production capabilities. During the second quarter of 2017, we concluded to no longer pursue this expansion for various reasons including our recent acquisition of PCLI. The remaining $4.0 million in charges relate to property, plant and equipment that we expensed in the form of accelerated depreciation in the income statement.
Revenue Recognition: Refined product sales and related cost of sales are recognized when products are shipped and title has passed to customers. HEP recognizes pipeline transportation revenues as products are shipped through its pipelines. All revenues are reported inclusive of shipping and handling costs billed and exclusive of any taxes billed to customers. Shipping and handling costs incurred are reported in cost of products sold.
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HOLLYFRONTIER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Continued
For PCLI subsidiaries in Canada and in the U.S., a portion of sales are made to marketers and distributors under agreements which provide certain rights of return or provisions for PCLI to repurchase product in order to sell directly to end customers. Based on the terms of these agreements, PCLI defers revenues and cost of revenues on sales to Canadian marketers until the related products have been sold to end customers, and PCLI recognizes revenues for sales to its U.S. distributors when products are shipped to the distributors, net of allowances for returns related to inventories PCLI is expected to repurchase from the distributors to sell directly to end customers.
Foreign Currency Translation: The functional currency of our PCLI operations consists of the respective local currency of its foreign operations, which includes the Canadian dollar, the euro and Chinese renminbi. Balance sheet accounts are translated into U.S. dollars using exchange rates in effect as of the balance sheet date. Revenue and expense accounts are translated using the weighted-average exchange rates during the period presented. Foreign currency translation adjustments are recorded as a component of accumulated other comprehensive income.
In connection with our PCLI acquisition on February 1, 2017, we issued intercompany notes to initially fund certain of PCLI’s foreign businesses. Remeasurement adjustments resulting from the conversion of such intercompany financing from local currencies to the U.S. dollar are recorded as gains and losses as a component of other income (expense) in the income statement. Such adjustments are not recorded to the PCLI segment operations, but to corporate and other. See Note 16 for additional information on our segments.
Income Taxes: Provisions for income taxes include deferred taxes resulting from temporary differences in income for financial and tax purposes, using the liability method of accounting for income taxes. The liability method requires the effect of tax rate changes on deferred income taxes to be reflected in the period in which the rate change was enacted. The liability method also requires that deferred tax assets be reduced by a valuation allowance unless it is more likely than not that the assets will be realized.
For the nine months ended September 30, 2017, we recorded an income tax expense of $173.6 million compared to $6.5 million for the nine months ended September 30, 2016. This increase was due principally to pre-tax income during the nine months ended September 30, 2017 compared to a pre-tax loss in the same period of 2016. Our effective tax rates, before consideration of earnings attributable to the noncontrolling interest, were 34.9% and 2.5% for the nine months ended September 30, 2017 and 2016, respectively.
Potential interest and penalties related to income tax matters are recognized in income tax expense. We believe we have appropriate support for the income tax positions taken and to be taken on our income tax returns and that our accruals for tax liabilities are adequate for all open years based on an assessment of many factors, including past experience and interpretations of tax law applied to the facts of each matter.
Inventory Repurchase Obligations: We periodically enter into same-party sell / buy transactions, whereby we sell certain refined product inventory and subsequently repurchase the inventory in order to facilitate delivery to certain locations. Such sell / buy transactions are accounted for as inventory repurchase obligations under which proceeds received under the initial sell is recognized as an inventory repurchase obligation that is subsequently reversed when the inventory is repurchased. For the nine months ended September 30, 2017 and 2016, we received proceeds of $36.7 million and $43.9 million, respectively, and repaid $37.9 million and $44.9 million, respectively, under these sell / buy transactions.
New Accounting Pronouncements
Hedge Accounting
In August 2017, Accounting Standard Update (“ASU”) 2017-12, “Derivatives and Hedging: Targeted Improvements to Accounting for Hedging Activities,” was issued amending hedge accounting recognition and presentation requirements, including elimination of the requirement to separately measure and report hedge ineffectiveness, and eases certain documentation and assessment requirements. This standard has an effective date of January 1, 2019. We do not expect adoption of this standard to have a material impact on our financial condition, results of operations or cash flows.
Post-retirement Benefit Cost
In March 2017, ASU 2017-07, “Improving the Presentation of Net Periodic Pension Cost and Net Periodic Post-retirement Benefit Cost,” was issued amending current GAAP related to the income statement presentation of the components of net periodic post-retirement cost (credit). This standard has an effective date of January 1, 2018. We do not expect adoption of this standard to have a material impact on our financial condition, results of operations or cash flows.
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HOLLYFRONTIER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Continued
Share-Based Compensation
In March 2016, ASU 2016-09, “Improvements to Employee Share-Based Payment Accounting,” was issued which simplifies the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures and statutory tax withholding requirements, as well as classification in the statement of cash flows. We adopted this standard effective January 1, 2017 on a prospective basis with the excess tax expense from stock-based compensation recognized as a discrete item in our provision for income taxes. We had no such excess tax expense for the three and nine months ended September 30, 2017. The new standard also requires that employee taxes paid when an employer withholds shares for tax-withholding purposes be reported as financing activities in the statement of cash flows on a retrospective basis. Previously, this activity was included in operating activities. The impact of this change for the nine months ended September 30, 2017 and 2016 was $0.3 million and $0.1 million, respectively. Finally, consistent with our existing policy, we have elected to account for forfeitures on an estimated basis.
Leases
In February 2016, ASU 2016-02, “Leases,” was issued requiring leases to be measured and recognized as a lease liability, with a corresponding right-of-use asset on the balance sheet. This standard has an effective date of January 1, 2019, and we are evaluating the impact of this standard.
Inventories Measurement
In July 2015, ASU 2015-11, “Inventory - Simplifying the Measurement of Inventory,” was issued requiring measurement of inventories, other than inventories accounted for using the LIFO method, to be measured at the lower of cost or net realizable value. Net realizable value is defined as the estimated selling price in the ordinary course of business less reasonable, predictable cost of completion, disposal and transportation. We adopted this standard effective January 1, 2017 for our affected inventories, which is primarily our PCLI inventory valued on a FIFO basis, and it had no material effect on our financial condition, results of operations or cash flows.
Revenue Recognition
In May 2014, ASU 2014-09, “Revenue from Contracts with Customers” was issued requiring revenue to be recognized when promised goods or services are transferred to customers in an amount that reflects the expected consideration for these goods or services. This standard has an effective date of January 1, 2018, and we anticipate using the modified retrospective implementation method, whereby a cumulative effect adjustment is recorded to retained earnings as of the date of initial application. In preparing for adoption, we have evaluated the terms conditions and performance obligations under our existing contracts with customers. Furthermore, we have implemented policies to ensure compliance with this new standard, which we do not expect to have a material impact on our financial condition, results of operations or cash flows.
NOTE 2: | PCLI Acquisition |
On October 29, 2016, our wholly-owned subsidiary, 9952110 Canada Inc., entered into an SPA with Suncor to acquire 100% of the outstanding capital stock of PCLI. The acquisition closed on February 1, 2017. Cash consideration paid at that time was approximately $862.0 million, or $1.125 billion in Canadian dollars. PCLI is located in Mississauga, Ontario, Canada and is a producer of lubricant products such as base oils, white oils, specialty products and finished lubricants. PCLI’s operations also include marketing of its products to both retail and wholesale outlets through a global sales network with locations in Canada, the United States, Europe and China.
Aggregate consideration totaled approximately $904.3 million and consists of $862.0 million in cash paid to Suncor at acquisition, a closing date working capital settlement of $30.6 million that was paid to Suncor in the second quarter of 2017, an accrued payable in the amount of $6.5 million and $5.1 million, representing a portion of the fair value of replacement restricted stock unit awards issued to PCLI employees that relate to pre-acquisition services.
This transaction is accounted for as a business combination using the acquisition method of accounting, with the purchase price allocated to the fair value of the acquired PCLI assets and liabilities as of the February 1 acquisition date, with the excess purchase price recorded as goodwill assigned to our PCLI segment. This goodwill is not deductible for income tax purposes.
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HOLLYFRONTIER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Continued
The following summarizes our preliminary value estimates of the PCLI assets and liabilities acquired:
(in millions) | ||||
Cash and cash equivalents | $ | 21.6 | ||
Accounts receivable and other current assets | 118.5 | |||
Inventories | 214.9 | |||
Properties, plants and equipment | 468.8 | |||
Goodwill | 185.2 | |||
Intangibles and precious metals | 103.5 | |||
Accounts payable and accrued liabilities | (88.7 | ) | ||
Deferred income tax liabilities | (106.2 | ) | ||
Other long-term liabilities | (13.3 | ) | ||
Net assets acquired | $ | 904.3 | ||
Intangibles include trademarks, patents, technical know-how and customer relationships totaling $100.5 million that are being amortized on a straight-line basis over periods ranging from 10 to 20 years.
These values are preliminary and reflect revisions to our February 1, 2017 fair value estimates that were initially recorded during the first quarter of 2017. These estimated values are not final and may be subject to additional change once all needed information has become available and we complete our valuations.
Our consolidated financial and operating results reflect the PCLI operations beginning February 1, 2017. Our results of operations for the three months ended September 30, 2017 included PCLI revenues and net income of $298.1 million and $22.6 million, respectively, and $809.6 million and $43.6 million for the period from February 1, 2017 through September 30, 2017.
As of September 30, 2017, we have incurred $23.5 million in incremental direct acquisition and integration costs that principally relate to legal, advisory and other professional fees and are presented as general and administrative expenses.
NOTE 3: | Holly Energy Partners |
HEP, a consolidated VIE, is a publicly held master limited partnership that owns and operates logistic assets consisting of petroleum product and crude oil pipelines, terminals, tankage, loading rack facilities and refinery processing units that principally support our refining and marketing operations in the Mid-Continent, Southwest and Rocky Mountain regions of the United States and Alon USA, Inc.’s (“Alon”) refinery in Big Spring, Texas. Additionally, as of September 30, 2017, HEP owned a 75% interest in UNEV Pipeline, LLC (“UNEV”), the owner of a pipeline running from Woods Cross, Utah to Las Vegas, Nevada (the “UNEV Pipeline”) and associated product terminals; a 50% interest in Frontier Aspen LLC, the owner of a pipeline running from Wyoming to Frontier Station, Utah (the “Frontier Pipeline”); a 50% interest in Osage Pipe Line Company, LLC, the owner of a pipeline running from Cushing, Oklahoma to El Dorado, Kansas (the “Osage Pipeline”); a 50% interest in Cheyenne Pipeline, LLC, the owner of a pipeline running from Fort Laramie, Wyoming to Cheyenne, Wyoming (the “Cheyenne Pipeline”); and a 25% interest in SLC Pipeline LLC, the owner of a pipeline (the “SLC Pipeline”) that serves refineries in the Salt Lake City, Utah area.
As of September 30, 2017, we owned a 36% interest in HEP, including the 2% general partner interest. As the general partner of HEP, we have the sole ability to direct the activities that most significantly impact HEP’s financial performance, and therefore we consolidate HEP.
HEP has two primary customers (including us) and generates revenues by charging tariffs for transporting petroleum products and crude oil through its pipelines, by charging fees for terminalling refined products and other hydrocarbons, and storing and providing other services at its storage tanks and terminals. Under our long-term transportation agreements with HEP (discussed further below), we accounted for 85% of HEP’s total revenues for the nine months ended September 30, 2017. We do not provide financial or equity support through any liquidity arrangements and / or debt guarantees to HEP.
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HOLLYFRONTIER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Continued
HEP has outstanding debt under a senior secured revolving credit agreement and its senior notes. HEP’s creditors have no recourse to our assets. Furthermore, our creditors have no recourse to the assets of HEP and its consolidated subsidiaries. See Note 10 for a description of HEP’s debt obligations.
HEP has risk associated with its operations. If a major customer of HEP were to terminate its contracts or fail to meet desired shipping or throughput levels for an extended period of time, revenue would be reduced and HEP could suffer substantial losses to the extent that a new customer is not found. In the event that HEP incurs a loss, our operating results will reflect HEP’s loss, net of intercompany eliminations, to the extent of our ownership interest in HEP at that point in time.
SLC Pipeline and Frontier Aspen
On October 31, 2017, HEP acquired the remaining 75% interest in SLC Pipeline LLC and the remaining 50% interest in Frontier Aspen LLC from subsidiaries of Plains All American Pipeline, L.P. (“Plains”) for total cash consideration of $250.0 million.
Following close of the SLC Pipeline and Frontier Aspen joint venture interest acquisitions, HEP holds a 100% ownership interest in both of these entities and therefore, they shall be consolidated. These acquisitions will be accounted for as business combinations with the purchase price allocated to the acquisition date fair value of the assets and liabilities acquired.
Cheyenne Pipeline
On June 3, 2016, HEP acquired a 50% interest in Cheyenne Pipeline LLC, owner of the Cheyenne Pipeline, in exchange for a contribution of $42.6 million in cash to Cheyenne Pipeline LLC. Cheyenne Pipeline will continue to be operated by an affiliate of Plains, which owns the remaining 50% interest. The 87-mile crude oil pipeline runs from Fort Laramie, Wyoming to Cheyenne, Wyoming and has an 80,000 BPD capacity.
Tulsa Tanks
On March 31, 2016, HEP acquired crude oil tanks located at our Tulsa Refineries from Plains for $39.5 million. Previously in 2009, we sold these tanks to Plains and leased them back, and due to our continuing interest in the tanks, we accounted for the transaction as a financing arrangement. Accordingly, the tanks remained on our balance sheet and were depreciated for accounting purposes, and the proceeds received from Plains were recorded as a financing obligation and presented as a component of outstanding debt.
In accounting for HEP’s March 2016 purchase from Plains, the amount paid was recorded against our outstanding financing obligation balance of $30.8 million, with the excess $8.7 million payment resulting in a loss on early extinguishment of debt.
Magellan Asset Exchange
On February 22, 2016, we acquired a 50% membership interest in Osage Pipe Line Company, LLC (“Osage”) in exchange for a 20-year terminalling services agreement, whereby a subsidiary of Magellan Midstream Partners (“Magellan Midstream”) will provide terminalling services for all of our products originating in Artesia, New Mexico that require terminalling in or through El Paso, Texas. Under the agreement, we will be charged tariffs based on the volumes of refined product processed. Osage is the owner of the Osage Pipeline, a 135-mile pipeline that transports crude oil from Cushing, Oklahoma to our El Dorado Refinery in Kansas and also has a connection to the Jayhawk pipeline that services the CHS refinery in McPherson, Kansas. This exchange was accounted for at fair value, whereby the 50% membership interest in the Osage Pipeline was recorded at appraised fair value and an offsetting residual deferred credit in the amount of $38.9 million was recorded, which will be amortized to cost of products sold over the 20-year service period. No gain or loss was recorded for this exchange.
Also on February 22, 2016, we contributed the 50% membership interest in Osage to HEP, and in exchange received HEP’s El Paso terminal. Pursuant to this exchange, HEP agreed to build two connections to Magellan Midstream’s El Paso terminal. In addition, HEP agreed to become operator of the Osage Pipeline. This exchange was accounted for at carry-over basis with no resulting gain or loss.
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HOLLYFRONTIER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Continued
HEP Common Unit Continuous Offering Program
On May 10, 2016, HEP established a continuous offering program under which HEP may issue and sell common units from time to time, representing limited partner interests, up to an aggregate gross sales amount of $200 million. During the nine months ended September 30, 2017, HEP issued 1,538,452 units under this program, providing $52.3 million in net proceeds. In connection with this program and to maintain our 2% general partner interest in HEP, we made capital contributions totaling $1.1 million during the nine months ended September 30, 2017. As of September 30, 2017, HEP has issued 2,241,907 units with an aggregate gross sales amount of $77.1 million.
HEP intends to use the net proceeds for general partnership purposes, which may include funding working capital, repayment of debt, acquisitions and capital expenditures. Amounts repaid under HEP’s credit facility may be reborrowed from time to time.
As a result of this transaction and resulting HEP ownership changes, we adjusted additional capital and equity attributable to HEP's noncontrolling interest holders to reallocate HEP's equity among its unitholders.
Incentive Distribution Rights Simplification Agreement
On October 31, 2017, HEP Logistics Holdings, L.P., our wholly-owned subsidiary and general partner of HEP, closed the restructuring transaction set forth in a definitive agreement with HEP to cancel its incentive distribution rights and convert our 2% general partner interest in HEP into a non-economic interest in exchange for 37,250,000 newly issued HEP common units. As of October 31, 2017, our ownership represents approximately 59% of outstanding HEP common units.
Transportation Agreements
HEP serves our refineries under long-term pipeline, terminal and tankage throughput agreements and refinery processing tolling agreements expiring from 2017 through 2036. Under these agreements, we pay HEP fees to transport, store and process throughput volumes of refined products, crude oil and feedstocks on HEP’s pipeline, terminals, tankage, loading rack facilities and refinery processing units that result in minimum annual payments to HEP including UNEV (a consolidated subsidiary of HEP). Under these agreements, the agreed upon tariff rates are subject to annual tariff rate adjustments on July 1 at a rate based upon the percentage change in Producer Price Index or Federal Energy Regulatory Commission index. As of September 30, 2017, these agreements result in minimum annualized payments to HEP of $321.3 million.
NOTE 4: | Fair Value Measurements |
Our financial instruments measured at fair value on a recurring basis consist of investments in marketable securities, derivative instruments and RINs credit obligations.
Fair value measurements are derived using inputs (assumptions that market participants would use in pricing an asset or liability, including assumptions about risk). GAAP categorizes inputs used in fair value measurements into three broad levels as follows:
• | (Level 1) Quoted prices in active markets for identical assets or liabilities. |
• | (Level 2) Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets, similar assets and liabilities in markets that are not active or can be corroborated by observable market data. |
• | (Level 3) Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. This includes valuation techniques that involve significant unobservable inputs. |
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HOLLYFRONTIER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Continued
The carrying amounts of marketable securities, derivative instruments and RINs credit obligations at September 30, 2017 and December 31, 2016 were as follows:
Fair Value by Input Level | ||||||||||||||||
Carrying Amount | Level 1 | Level 2 | Level 3 | |||||||||||||
(In thousands) | ||||||||||||||||
September 30, 2017 | ||||||||||||||||
Assets: | ||||||||||||||||
Commodity price swaps | $ | 5,556 | $ | — | $ | 5,556 | $ | — | ||||||||
Commodity forward contracts | 1,358 | — | 1,358 | — | ||||||||||||
Total assets | $ | 6,914 | $ | — | $ | 6,914 | $ | — | ||||||||
Liabilities: | ||||||||||||||||
NYMEX futures contracts | $ | 5,881 | $ | 5,881 | $ | — | $ | — | ||||||||
Commodity price swaps | 16,030 | — | 12,401 | 3,629 | ||||||||||||
Commodity forward contracts | 1,611 | — | 1,611 | — | ||||||||||||
RINs credit obligations (1) | 22,586 | — | 22,586 | — | ||||||||||||
Total liabilities | $ | 46,108 | $ | 5,881 | $ | 36,598 | $ | 3,629 | ||||||||
December 31, 2016 | ||||||||||||||||
Assets: | ||||||||||||||||
Marketable securities | $ | 424,148 | $ | — | $ | 424,148 | $ | — | ||||||||
Commodity price swaps | 14,563 | — | 14,358 | 205 | ||||||||||||
Commodity forward contracts | 5,905 | — | 5,905 | — | ||||||||||||
HEP interest rate swaps | 91 | — | 91 | — | ||||||||||||
Total assets | $ | 444,707 | $ | — | $ | 444,502 | $ | 205 | ||||||||
Liabilities: | ||||||||||||||||
NYMEX futures contracts | $ | 1,975 | $ | 1,975 | $ | — | $ | — | ||||||||
Commodity price swaps | 26,845 | — | 24,086 | 2,759 | ||||||||||||
Commodity forward contracts | 8,316 | — | 8,316 | — | ||||||||||||
Foreign currency forward contracts | 6,519 | — | 6,519 | — | ||||||||||||
Total liabilities | $ | 43,655 | $ | 1,975 | $ | 38,921 | $ | 2,759 | ||||||||
(1) | Represent obligations for RINs credits for which we do not have sufficient quantities at September 30, 2017 to satisfy our Environmental Protection Agency (“EPA”) regulatory blending requirements. |
Level 1 Instruments
Our NYMEX futures contracts are exchange traded and are measured and recorded at fair value using quoted market prices, a Level 1 input.
Level 2 Instruments
Investments in marketable securities, derivative instruments consisting of commodity price swaps and forward sales and purchase contracts and HEP’s interest rate swaps are measured and recorded at fair value using Level 2 inputs. The fair values of the commodity price and interest rate swap contracts are based on the net present value of expected future cash flows related to both variable and fixed rate legs of the respective swap agreements. The measurements are computed using market-based observable inputs, quoted forward commodity prices with respect to our commodity price swaps and the forward London Interbank Offered Rate (“LIBOR”) yield curve with respect to HEP’s interest rate swaps. RINs credit obligations are valued based on current market RINs prices. The fair value of the marketable securities is based on values provided by a third-party, which were derived using market quotes for similar type instruments, a Level 2 input.
Level 3 Instruments
We at times have commodity price swap contracts that relate to forecasted sales of unleaded gasoline and forward commodity sales and purchase contracts for which quoted forward market prices are not readily available. The forward rate used to value these price swaps and forward sales and purchase contracts are derived using a projected forward rate using quoted market rates for similar products, adjusted for regional pricing and grade differentials, a Level 3 input.
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HOLLYFRONTIER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Continued
The following table presents the changes in fair value of our Level 3 assets and liabilities (all related to derivative instruments) for the three and nine months ended September 30, 2017:
Three Months Ended September 30, 2017 | Nine Months Ended September 30, 2017 | |||||||
Level 3 Instruments | ||||||||
(In thousands) | ||||||||
Liability balance at beginning of period | $ | — | $ | (2,554 | ) | |||
Change in fair value: | ||||||||
Recognized in other comprehensive income | — | 1,625 | ||||||
Recognized in cost of products sold | (3,629 | ) | (3,630 | ) | ||||
Settlement date fair value of contractual maturities: | ||||||||
Recognized in sales and other revenues | — | (165 | ) | |||||
Recognized in cost of products sold | — | 1,095 | ||||||
Liability balance at end of period | $ | (3,629 | ) | $ | (3,629 | ) | ||
A hypothetical change of 10% to the estimated future cash flows attributable to our Level 3 commodity price swaps would result in an estimated fair value change of $0.2 million.
NOTE 5: | Earnings Per Share |
Basic earnings per share is calculated as net income (loss) attributable to HollyFrontier stockholders divided by the average number of shares of common stock outstanding. Diluted earnings per share assumes, when dilutive, the issuance of the net incremental shares from restricted shares and performance share units. The following is a reconciliation of the denominators of the basic and diluted per share computations for net income (loss) attributable to HollyFrontier stockholders:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2017 | 2016 | 2017 | 2016 | |||||||||||||
(In thousands, except per share data) | ||||||||||||||||
Net income (loss) attributable to HollyFrontier stockholders | $ | 272,014 | $ | 74,497 | $ | 284,313 | $ | (313,618 | ) | |||||||
Participating securities’ (restricted stock) share in earnings | 1,735 | 275 | 1,822 | 647 | ||||||||||||
Net income (loss) attributable to common shares | $ | 270,279 | $ | 74,222 | $ | 282,491 | $ | (314,265 | ) | |||||||
Average number of shares of common stock outstanding | 176,149 | 175,871 | 176,143 | 176,157 | ||||||||||||
Effect of dilutive variable restricted shares and performance share units (1) | 381 | 122 | 473 | — | ||||||||||||
Average number of shares of common stock outstanding assuming dilution | 176,530 | 175,993 | 176,616 | 176,157 | ||||||||||||
Basic earnings (loss) per share | $ | 1.53 | $ | 0.42 | $ | 1.60 | $ | (1.78 | ) | |||||||
Diluted earnings (loss) per share | $ | 1.53 | $ | 0.42 | $ | 1.60 | $ | (1.78 | ) | |||||||
(1) Excludes anti-dilutive restricted and performance share units of: | 104 | 204 | 120 | 188 | ||||||||||||
17
HOLLYFRONTIER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Continued
NOTE 6: | Stock-Based Compensation |
As of September 30, 2017, we have two principal share-based compensation plans (collectively, the “Long-Term Incentive Compensation Plan”).
The compensation cost charged against income for these plans was $9.1 million and $6.2 million for the three months ended September 30, 2017 and 2016, respectively, and $24.5 million and $14.8 million for the nine months ended September 30, 2017 and 2016, respectively. Our accounting policy for the recognition of compensation expense for awards with pro-rata vesting is to expense the costs ratably over the vesting periods.
Additionally, HEP maintains a share-based compensation plan for Holly Logistic Services, L.L.C.’s non-employee directors and certain executives and employees. Compensation cost attributable to HEP’s share-based compensation plan was $0.8 million and $0.7 million for the three months ended September 30, 2017 and 2016, respectively, and $1.9 million for each of the nine months ended September 30, 2017 and 2016.
Restricted Stock and Restricted Stock Units
Under our Long-Term Incentive Compensation Plan, we grant certain officers and other key employees restricted stock and restricted stock unit awards with awards generally vesting over a period of two to three years. Restricted stock award recipients are generally entitled to all the rights of absolute ownership of the restricted shares from the date of grant including the right to vote the shares and to receive dividends. Upon vesting, restrictions on the restricted shares lapse at which time they convert to common shares. In addition, we grant non-employee directors restricted stock unit awards, which typically vest over a period of one year and are payable in stock. The fair value of each restricted stock and restricted stock unit award is measured based on the grant date market price of our common shares and is amortized over the respective vesting period.
A summary of restricted stock and restricted stock unit activity and changes during the nine months ended September 30, 2017 is presented below:
Restricted Stock and Restricted Stock Units | Grants | Weighted Average Grant Date Fair Value | Aggregate Intrinsic Value ($000) | ||||||||
Outstanding at January 1, 2017 (non-vested) | 1,188,774 | $ | 28.87 | ||||||||
Granted (1) | 735,478 | 28.19 | |||||||||
Vesting (transfer/conversion to common stock) | (33,177 | ) | 32.53 | ||||||||
Forfeited | (49,711 | ) | 30.38 | ||||||||
Outstanding at September 30, 2017 (non-vested) | 1,841,364 | $ | 28.82 | $ | 66,234 | ||||||
(1) Includes restricted stock units issued to PCLI employees.
In connection with our February 1, 2017 PCLI acquisition, we issued 472,276 restricted stock units to PCLI employees as replacement units for unvested awards issued under the legacy PCLI plan. The fair value of these awards totaled $13.3 million and is based on a February 1, 2017 grant date value of $28.12 per unit. Of this total, $5.1 million is recognized as an increase to our PCLI purchase price as it represents the value of the awards attributable to pre-acquisition services, and the remaining $8.2 million to be recognized as compensation expense over the two-year vesting period.
For the nine months ended September 30, 2017, restricted stock and restricted stock units vested having a grant date fair value of $1.1 million. As of September 30, 2017, there was $23.7 million of total unrecognized compensation cost related to non-vested restricted stock and restricted stock unit grants. That cost is expected to be recognized over a weighted-average period of 1.2 years.
18
HOLLYFRONTIER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Continued
Performance Share Units
Under our Long-Term Incentive Compensation Plan, we grant certain officers and other key employees performance share units, which are payable in stock upon meeting certain criteria over the service period, and generally vest over a period of three years. Under the terms of our performance share unit grants, awards are subject to “financial performance” and “market performance” criteria. Financial performance is based on our financial performance compared to a peer group of independent refining companies, while market performance is based on the relative standing of total shareholder return achieved by HollyFrontier compared to peer group companies. The number of shares ultimately issued under these awards can range from zero to 200% of target award amounts. As of September 30, 2017, estimated share payouts for outstanding non-vested performance share unit awards averaged approximately 60% of target amounts.
A summary of performance share unit activity and changes during the nine months ended September 30, 2017 is presented below:
Performance Share Units | Grants | ||
Outstanding at January 1, 2017 (non-vested) | 703,939 | ||
Granted | 21,923 | ||
Forfeited | (88,893 | ) | |
Outstanding at September 30, 2017 (non-vested) | 636,969 | ||
As of September 30, 2017, there was $8.6 million of total unrecognized compensation cost related to non-vested performance share units having a grant date fair value of $33.37 per unit. That cost is expected to be recognized over a weighted-average period of 1.5 years.
NOTE 7: | Cash and Cash Equivalents and Investments in Marketable Securities |
Our investment portfolio at September 30, 2017 consisted of cash and cash equivalents.
We periodically invest in marketable debt securities with the maximum maturity or put date of any individual issue generally not greater than one year from the date of purchase, which are usually held until maturity. All of these instruments are classified as available-for-sale and are reported at fair value. Interest income is recorded as earned. Unrealized gains and losses, net of related income taxes, are reported as a component of accumulated other comprehensive income. Upon sale or maturity, realized gains on our marketable debt securities are recognized as interest income. These gains are computed based on the specific identification of the underlying cost of the securities, net of unrealized gains and losses previously reported in other comprehensive income. Unrealized gains and losses on our available-for-sale securities are due to changes in market prices and are considered temporary.
The following is a summary of our marketable securities as of December 31, 2016:
Amortized Cost | Gross Unrealized Gain | Gross Unrealized Loss | Fair Value (Net Carrying Amount) | |||||||||||||
(In thousands) | ||||||||||||||||
December 31, 2016 | ||||||||||||||||
Commercial paper | $ | 7,687 | $ | 1 | $ | (1 | ) | $ | 7,687 | |||||||
Corporate debt securities | 4,001 | — | — | 4,001 | ||||||||||||
State and political subdivisions debt securities | 412,462 | 1 | (3 | ) | 412,460 | |||||||||||
Total marketable securities | $ | 424,150 | $ | 2 | $ | (4 | ) | $ | 424,148 | |||||||
Interest income recognized on our marketable securities was zero and $0.2 million for the three months ended September 30, 2017 and 2016 respectively, and $0.3 million and $0.4 million for the nine months ended September 30, 2017 and 2016, respectively.
19
HOLLYFRONTIER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Continued
NOTE 8: | Inventories |
Inventory consists of the following components:
September 30, 2017 | December 31, 2016 | |||||||
(In thousands) | ||||||||
Crude oil | $ | 544,837 | $ | 549,886 | ||||
Other raw materials and unfinished products(1) | 363,483 | 287,561 | ||||||
Finished products(2) | 670,120 | 465,432 | ||||||
Lower of cost or market reserve | (317,195 | ) | (332,518 | ) | ||||
Process chemicals(3) | 26,173 | 2,767 | ||||||
Repair and maintenance supplies and other (4) | 132,424 | 162,548 | ||||||
Total inventory | $ | 1,419,842 | $ | 1,135,676 | ||||
(1) | Other raw materials and unfinished products include feedstocks and blendstocks, other than crude. |
(2) | Finished products include gasolines, jet fuels, diesels, lubricants, asphalts, LPG’s and residual fuels. |
(3) | Process chemicals include additives and other chemicals. |
(4) | Includes RINs. |
We acquired $214.9 million of other raw materials, unfinished and finished products and repair and maintenance supplies in connection with our February 1, 2017 acquisition of PCLI. We value these inventories at the lower of FIFO cost or net realizable value.
Inventories, which are valued at the lower of LIFO cost or market, reflect a valuation reserve of $317.2 million and $332.5 million at September 30, 2017 and December 31, 2016, respectively. The December 31, 2016 market reserve of $332.5 million was reversed due to the sale of inventory quantities that gave rise to the 2016 reserve. A new market reserve of $317.2 million was established as of September 30, 2017 based on market conditions and prices at that time. The effect of the change in lower of cost or market reserve was a decrease to cost of goods sold totaling $111.1 million for the three months ended September 30, 2017 and an increase of $0.3 million for the three months ended September 30, 2016, respectively, and a decrease to cost of goods sold totaling $15.3 million and $194.3 million for the nine months ended September 30, 2017 and 2016, respectively.
At September 30, 2017, the LIFO value of inventory, net of the lower of cost or market reserve, was equal to current costs.
In May 2017, the EPA granted the Cheyenne Refinery a one-year small refinery exemption from the Renewable Fuel Standard (“RFS”) program requirements for the 2016 calendar year. As a result, the Cheyenne Refinery’s gasoline and diesel production are not subject to the percentage of production that must satisfy a Renewable Volume Obligation (“RVO”) for 2016. In September 2017, the EPA reinstated the RINs previously submitted to meet our Cheyenne Refinery’s 2016 RVO. The cost of the RINs used earlier to satisfy the Cheyenne Refinery’s 2016 RVO of $30.5 million was charged to cost of products sold in 2016. In the second quarter of 2017, we increased our inventory of RINs and reduced our cost of products sold by this amount, representing the cost of the RINs that were reinstated as a result of the RFS exemption received by the Cheyenne Refinery.
20
HOLLYFRONTIER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Continued
NOTE 9: | Environmental |
Environmental costs are charged to operating expenses if they relate to an existing condition caused by past operations and do not contribute to current or future revenue generation. We have ongoing investigations of environmental matters at various locations and routinely assess our recorded environmental obligations, if any, with respect to such matters. Liabilities are recorded when site restoration and environmental remediation, cleanup and other obligations are either known or considered probable and can be reasonably estimated. Such estimates are undiscounted and require judgment with respect to costs, time frame and extent of required remedial and cleanup activities and are subject to periodic adjustments based on currently available information. Recoveries of environmental costs through insurance, indemnification arrangements or other sources are included in other assets to the extent such recoveries are considered probable.
We incurred expense of $0.1 million for the three months ended September 30, 2017, and reduced expense by $0.8 million for the nine months ended September 30, 2017 for environmental remediation obligations. For the three and the nine months ended September 30, 2016, we incurred expense of $0.6 million and $2.0 million, respectively, for environmental remediation obligations. The accrued environmental liability reflected in our consolidated balance sheets was $93.6 million and $96.4 million at September 30, 2017 and December 31, 2016, respectively, of which $80.4 million and $82.9 million, respectively, were classified as other long-term liabilities. These accruals include remediation and monitoring costs expected to be incurred over an extended period of time (up to 30 years for certain projects). The amount of our accrued liability includes PCLI environmental obligations of $3.6 million assumed upon our February 1, 2017 acquisition. Estimated liabilities could increase in the future when the results of ongoing investigations become known, are considered probable and can be reasonably estimated.
NOTE 10: | Debt |
HollyFrontier Credit Agreement
In February 2017, we increased the size of our senior unsecured revolving credit facility from $1 billion to $1.35 billion and extended the maturity date to February 2022 (the “HollyFrontier Credit Agreement”). The Holly Frontier Credit Agreement may be used for revolving credit loans and letters of credit from time to time and is available to fund general corporate purposes. During the nine months ended September 30, 2017, we received advances totaling $26.0 million and repaid $26.0 million under the HollyFrontier Credit Agreement. At September 30, 2017, we were in compliance with all covenants, had no outstanding borrowings and had outstanding letters of credit totaling $2.8 million under the HollyFrontier Credit Agreement.
HEP Credit Agreement
In July 2017, HEP increased the size of its senior secured revolving credit facility from $1.2 billion to $1.4 billion and extended the maturity date to July 2022 (the “HEP Credit Agreement”). The HEP Credit Agreement is available to fund capital expenditures, investments, acquisitions, distribution payments, working capital and for general partnership purposes. It is also available to fund letters of credit up to a $50 million sub-limit and has a $300 million accordion. During the nine months ended September 30, 2017, HEP received advances totaling $628.0 million and repaid $431.0 million under the HEP Credit Agreement. At September 30, 2017, HEP was in compliance with all of its covenants, had outstanding borrowings of $750.0 million and no outstanding letters of credit under the HEP Credit Agreement.
HEP’s obligations under the HEP Credit Agreement are collateralized by substantially all of HEP’s assets and is guaranteed by HEP’s material wholly-owned subsidiaries. Any recourse to the general partner would be limited to the extent of HEP Logistics Holdings, L.P.’s assets, which other than its investment in HEP are not significant. HEP’s creditors have no recourse to our other assets. Furthermore, our creditors have no recourse to the assets of HEP and its consolidated subsidiaries.
HollyFrontier Senior Notes
Our 5.875% senior notes ($1 billion aggregate principal amount maturing April 2026) (the “HollyFrontier Senior Notes”) are unsecured and unsubordinated obligations of ours and rank equally with all our other existing and future unsecured and unsubordinated indebtedness.
HollyFrontier Financing Obligation
In March 2016, we extinguished a financing obligation at a cost of $39.5 million and recognized an $8.7 million loss on the early termination. The financing obligation related to a sale and lease-back of certain crude oil tankage that we sold to an affiliate of Plains in October 2009 for $40.0 million.
21
HOLLYFRONTIER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Continued
HollyFrontier Term Loan
In April 2016, we entered into a $350 million senior unsecured term loan (the “HollyFrontier Term Loan”) maturing in April 2019. The HollyFrontier Term Loan was fully repaid with proceeds received upon the November 2016 issuance of the HollyFrontier Senior Notes.
HEP Senior Notes
In September 2017, HEP issued an additional $100 million in aggregate principal amount of 6.0% HEP senior notes maturing in August 2024 in a private placement. HEP used the net proceeds of $101.8 million to repay indebtedness under the HEP Credit Agreement.
HEP’s 6.0% senior notes ($500 million aggregate principal amount maturing August 2024) (the “HEP Senior Notes”) are unsecured and impose certain restrictive covenants, including limitations on HEP’s ability to incur additional indebtedness, make investments, sell assets, incur certain liens, pay distributions, enter into transactions with affiliates, and enter into mergers. At any time when the HEP Senior Notes are rated investment grade by both Moody’s and Standard & Poor’s and no default or event of default exists, HEP will not be subject to many of the foregoing covenants. Additionally, HEP has certain redemption rights under the HEP Senior Notes.
In January 2017, HEP redeemed its $300 million aggregate principal amount of 6.5% senior notes maturing March 2020 at a redemption cost of $309.8 million, at which time HEP recognized a $12.2 million early extinguishment loss consisting of a $9.8 million debt redemption premium and unamortized discount and financing costs of $2.4 million. HEP funded the redemption with borrowings under the HEP Credit Agreement.
Indebtedness under the HEP Senior Notes is guaranteed by HEP’s wholly-owned subsidiaries. HEP’s creditors have no recourse to our assets. Furthermore, our creditors have no recourse to the assets of HEP and its consolidated subsidiaries.
The carrying amounts of long-term debt are as follows:
September 30, 2017 | December 31, 2016 | |||||||
(In thousands) | ||||||||
HollyFrontier 5.875% Senior Notes | ||||||||
Principal | $ | 1,000,000 | $ | 1,000,000 | ||||
Unamortized discount and debt issuance costs | (8,552 | ) | (8,775 | ) | ||||
991,448 | 991,225 | |||||||
HEP Credit Agreement | 750,000 | 553,000 | ||||||
HEP 6% Senior Notes | ||||||||
Principal | 500,000 | 400,000 | ||||||
Unamortized discount and debt issuance costs | (4,934 | ) | (6,607 | ) | ||||
495,066 | 393,393 | |||||||
HEP 6.5% Senior Notes | ||||||||
Principal | — | 300,000 | ||||||
Unamortized discount and debt issuance costs | — | (2,481 | ) | |||||
— | 297,519 | |||||||
Total HEP long-term debt | 1,245,066 | 1,243,912 | ||||||
Total long-term debt | $ | 2,236,514 | $ | 2,235,137 | ||||
22
HOLLYFRONTIER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Continued
The fair values of the senior notes are as follows:
September 30, 2017 | December 31, 2016 | |||||||
(In thousands) | ||||||||
HollyFrontier senior notes | $ | 1,091,470 | $ | 1,022,500 | ||||
HEP senior notes | $ | 524,390 | $ | 723,750 | ||||
These fair values are based on estimates provided by a third party using market quotes for similar type instruments, a Level 2 input. See Note 4 for additional information on Level 2 inputs.
We capitalized interest attributable to construction projects of $1.0 million and $1.8 million for the three months ended September 30, 2017 and 2016, respectively, and $4.2 million and $6.0 million for the nine months ended September 30, 2017 and 2016, respectively.
NOTE 11: Derivative Instruments and Hedging Activities
Commodity Price Risk Management
Our primary market risk is commodity price risk. We are exposed to market risks related to the volatility in crude oil and refined products, as well as volatility in the price of natural gas used in our refining operations. We periodically enter into derivative contracts in the form of commodity price swaps, forward purchase and sales and futures contracts to mitigate price exposure with respect to:
• | our inventory positions; |
• | natural gas purchases; |
• | costs of crude oil and related grade differentials; |
• | prices of refined products; and |
• | our refining margins. |
Accounting Hedges
We have swap contracts serving as cash flow hedges against price risk on forecasted purchases of natural gas. We also periodically have forward sales contracts that lock in the prices of future sales of crude oil and refined product and swap contracts serving as cash flow hedges against price risk on forecasted purchases of WTI crude oil and forecasted sales of refined product. These contracts have been designated as accounting hedges and are measured at fair value with offsetting adjustments (gains/losses) recorded directly to other comprehensive income. These fair value adjustments are later reclassified to earnings as the hedging instruments mature. On a quarterly basis, hedge ineffectiveness is measured by comparing the change in fair value of the swap contracts against the expected future cash inflows/outflows on the respective transaction being hedged. Any hedge ineffectiveness is also recognized in earnings.
23
HOLLYFRONTIER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Continued
The following table presents the pre-tax effect on other comprehensive income (“OCI”) and earnings due to fair value adjustments and maturities of commodity price swaps and forward sales under hedge accounting:
Unrealized Gain (Loss) Recognized in OCI | Gain (Loss) Recognized in Earnings Due to Settlements | Gain (Loss) Attributable to Hedge Ineffectiveness Recognized in Earnings | |||||||||||||
Location | Amount | Location | Amount | ||||||||||||
(In thousands) | |||||||||||||||
Three Months Ended September 30, 2017 | |||||||||||||||
Change in fair value | $ | (2,095 | ) | ||||||||||||
Loss reclassified to earnings due to settlements | 5,179 | Sales and other revenues | $ | (488 | ) | ||||||||||
Amortization of discontinued hedges reclassified to earnings | 270 | Operating expenses | (4,961 | ) | Operating expenses | $ | 18 | ||||||||
Total | $ | 3,354 | $ | (5,449 | ) | $ | 18 | ||||||||
Three Months Ended September 30, 2016 | |||||||||||||||
Change in fair value | $ | (1,511 | ) | ||||||||||||
Loss reclassified to earnings due to settlements | 4,046 | Sales and other revenue | $ | 228 | |||||||||||
Amortization of discontinued hedges reclassified to earnings | 270 | Operating expenses | (4,544 | ) | Operating expenses | $ | — | ||||||||
Total | $ | 2,805 | $ | (4,316 | ) | $ | — | ||||||||
Nine Months Ended September 30, 2017 | |||||||||||||||
Change in fair value | $ | 2,620 | Sales and other revenues | $ | 7,937 | ||||||||||
Loss reclassified to earnings due to settlements | 5,228 | Cost of products sold | (299 | ) | |||||||||||
Amortization of discontinued hedge reclassified to earnings | 810 | Operating expenses | (13,676 | ) | Operating expenses | $ | — | ||||||||
Total | $ | 8,658 | $ | (6,038 | ) | $ | — | ||||||||
Nine Months Ended September 30, 2016 | |||||||||||||||
Change in fair value | $ | (18,570 | ) | ||||||||||||
Loss reclassified to earnings due to settlements | 37,012 | Sales and other revenues | $ | (20,425 | ) | ||||||||||
Amortization of discontinued hedge reclassified to earnings | 810 | Operating expenses | (17,397 | ) | Operating expenses | $ | — | ||||||||
Total | $ | 19,252 | $ | (37,822 | ) | $ | — | ||||||||
As of September 30, 2017, we have the following notional contract volumes related to outstanding derivative instruments serving as cash flow hedges against price risk on forecasted transactions:
Notional Contract Volumes by Year of Maturity | ||||||||||||||||||||
Derivative Instrument | Total Outstanding Notional | 2017 | 2018 | 2019 | 2020 | 2021 | Unit of Measure | |||||||||||||
Natural gas price swaps - long | 9,600,000 | 2,400,000 | 1,800,000 | 1,800,000 | 1,800,000 | 1,800,000 | MMBTU | |||||||||||||
Physical crude contracts - short | 150,000 | 150,000 | — | — | — | — | Barrels | |||||||||||||
In 2013, we dedesignated certain commodity price swaps (long positions) that previously received hedge accounting treatment. These contracts now serve as economic hedges against price risk on forecasted natural gas purchases totaling 2,400,000 MMBTU’s to be purchased ratably through 2017. As of September 30, 2017, we have an unrealized loss of $0.3 million classified in accumulated other comprehensive income that relates to the application of hedge accounting prior to dedesignation that is amortized as a charge to operating expenses as the contracts mature.
24
HOLLYFRONTIER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Continued
Economic Hedges
We also have swap contracts that serve as economic hedges (derivatives used for risk management, but not designated as accounting hedges) to lock in basis spread differentials on forecasted purchases of crude oil and natural gas. Also, we have commodity forward contracts and NYMEX futures contracts to lock in prices on forecasted purchases of inventory. In addition, we had Canadian currency swap contracts that effectively fixed the conversion rate on $1.125 billion Canadian dollars (the PCLI purchase price), which were settled on February 1, 2017, in connection with the closing of the PCLI acquisition. These contracts are measured at fair value with offsetting adjustments (gains/losses) recorded directly to income.
The following table presents the pre-tax effect on income due to maturities and fair value adjustments of our economic hedges:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
Location of Gain (Loss) Recognized in Earnings | 2017 | 2016 | 2017 | 2016 | ||||||||||||
(In thousands) | ||||||||||||||||
Cost of products sold | $ | (10,632 | ) | $ | (2,438 | ) | $ | 3,403 | $ | (1,135 | ) | |||||
Operating expenses | (629 | ) | (2,291 | ) | (6,392 | ) | 2,322 | |||||||||
Gain on foreign currency swap | — | — | 24,545 | — | ||||||||||||
Total | $ | (11,261 | ) | $ | (4,729 | ) | $ | 21,556 | $ | 1,187 | ||||||
As of September 30, 2017, we have the following notional contract volumes related to our outstanding derivative contracts serving as economic hedges:
Notional Contract Volumes by Year of Maturity | |||||||||||
Derivative Instrument | Total Outstanding Notional | 2017 | 2018 | Unit of Measure | |||||||
Crude price swaps (basis spread) - long | 918,000 | 918,000 | — | Barrels | |||||||
WTI and sub-octane gasoline crack spread swaps - short | 700,000 | 700,000 | — | Barrels | |||||||
Natural gas price swaps (basis spread) - long | 2,577,000 | 2,577,000 | — | MMBTU | |||||||
Natural gas price swaps - long | 2,400,000 | 2,400,000 | — | MMBTU | |||||||
Natural gas price swaps - short | 2,400,000 | 2,400,000 | — | MMBTU | |||||||
NYMEX futures (WTI) - short | 1,870,000 | 955,000 | 915,000 | Barrels | |||||||
Forward gasoline and diesel contracts - long | 715,000 | 705,000 | 10,000 | Barrels | |||||||
25
HOLLYFRONTIER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Continued
Interest Rate Risk Management
HEP used interest rate swaps to manage its exposure to interest rate risk. These swap contracts, which matured in July 2017, had been designated as cash flow hedges.
The following table presents the pre-tax effect on other comprehensive income and earnings due to fair value adjustments and maturities of HEP’s interest rate swaps under hedge accounting:
Unrealized Gain (Loss) Recognized in OCI | Gain (Loss) Recognized in Earnings Due to Settlements | ||||||||
Location | Amount | ||||||||
(In thousands) | |||||||||
Three Months Ended September 30, 2017 | |||||||||
Interest rate swaps | |||||||||
Change in fair value | $ | 1 | |||||||
Gain reclassified to earnings due to settlements | (64 | ) | Interest expense | $ | 64 | ||||
Total | $ | (63 | ) | $ | 64 | ||||
Three Months Ended September 30, 2016 | |||||||||
Interest rate swaps | |||||||||
Change in fair value | $ | 201 | |||||||
Loss reclassified to earnings due to settlements | 95 | Interest expense | $ | (95 | ) | ||||
Total | $ | 296 | $ | (95 | ) | ||||
Nine Months Ended September 30, 2017 | |||||||||
Interest rate swaps | |||||||||