HOLLYFRONTIER CO. This Item 2 contains "forward-looking" statements. See "Forward-Looking Statements" at the beginning of Part I of this Quarterly Report on Form 10-Q. In this document, the words "we," "our," "ours" and "us" refer only toHollyFrontier Corporation ("HollyFrontier") and its consolidated subsidiaries or toHollyFrontier or an individual subsidiary and not to any other person with certain exceptions. Generally, the words "we," "our," "ours" and "us" includeHolly Energy Partners, L.P. ("HEP") and its subsidiaries as consolidated subsidiaries ofHollyFrontier , unless when used in disclosures of transactions or obligations between HEP andHollyFrontier 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 ofHollyFrontier . When used in descriptions of agreements and transactions, "HEP" refers to HEP and its consolidated subsidiaries.
OVERVIEW
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 refineries located inEl Dorado, Kansas (the "El Dorado Refinery "),Tulsa, Oklahoma (the "Tulsa Refineries"), which comprise two production facilities, the Tulsa West and East facilities,Artesia, New Mexico , which operates in conjunction with crude, vacuum distillation and other facilities situated 65 miles away inLovington, New Mexico (collectively, the "Navajo Refinery "),Cheyenne, Wyoming (the "Cheyenne Refinery ") andWoods Cross, Utah (the "Woods Cross Refinery "). We market our refined products principally in theSouthwest United States , theRocky Mountains extending into thePacific Northwest and in other neighboring Plains states. In addition, we produce base oils and other specialized lubricants inthe United States ,Canada andthe Netherlands , and export products to more than 80 countries. We also own a 57% limited partner interest and a non-economic general partner interest in HEP, a master limited partnership that provides petroleum product and crude oil transportation, terminalling, storage and throughput services to the petroleum industry, includingHollyFrontier Corporation subsidiaries. OnNovember 12, 2018 , we entered into an equity purchase agreement to acquire 100% of the issued and outstanding capital stock ofSonneborn US Holdings Inc. and 100% of the membership rights in Sonneborn Coöperatief U.A. (collectively, "Sonneborn"). The acquisition closed onFebruary 1, 2019 . Cash consideration paid was$662.7 million . Sonneborn is a producer of specialty hydrocarbon chemicals such as white oils, petrolatums and waxes with manufacturing facilities inthe United States andEurope . For the three months endedMarch 31, 2020 , net loss attributable toHollyFrontier stockholders was$(304.6) million compared to net income of$253.1 million for the three months endedMarch 31, 2019 . Overall gross refining margins per produced barrel sold for the three months endedMarch 31, 2020 decreased 11% over the same period of 2019 due to a decrease in the average per barrel sold sales price during the current year quarter, partially offset by decreased crude oil and feedstock prices. Included in our financial results for the first quarter was an inventory lower of cost or market adjustment that decreased pre-tax earnings by$560.5 million .
Pursuant to the 2007 Energy Independence and Security Act, the
Impact of COVID-19 on Our Business The COVID-19 pandemic caused a decline inU.S. and global economic activities during the first quarter of 2020. The demand for, and the resulting price we receive for, the sale of our products, including gasoline, jet fuel, lubricants and other products, has decreased during the last weeks of the first quarter of 2020. We expect the lower product prices to continue into the second quarter of 2020. Likewise, the price we pay for crude oil decreased in the first quarter of 2020. We expect these lower crude oil prices to continue into the second quarter of 2020. These decreases had the effect of reducing our gross margins during the latter part of the first quarter of 2020, which in certain markets resulted in negative gross margins for some of our products. During the first quarter of 2020, we operated our Refining segment refineries at an average crude charge of 436,360 BPD. These lower prices caused the market value of our inventories held atMarch 31, 2020 to decrease below the costs of these inventories using the last-in, first-out ("LIFO") method resulting in a first quarter lower of cost or market valuation charge of$560.5 million . 32
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The lower product and crude prices also caused use of cash from our operating activities because of a larger decrease in accounts payable for crude oil than the decrease in accounts receivable for the sale of our products atMarch 31, 2020 .
As a result of these conditions, we have reduced our 2020 expected total
consolidated capital expenditures by approximately 15%, to a range of
HollyFrontier's standalone (excluding HEP) liquidity was over$2.2 billion atMarch 31, 2020 , consisting of a cash balance of$889.8 million and an undrawn$1.35 billion credit facility maturing in 2022.HollyFrontier's earliest standalone (excluding HEP) debt maturity is$1.0 billion of senior notes due in 2026. OUTLOOK The impact of COVID-19 on the global macroeconomy has created unprecedented reduction in demand, as well as lack of forward visibility, for many of the transportation fuels, lubricants and specialty products and the associated transportation and terminal services we provide. Other factors expected to impact crude oil supply include production levels implemented byOPEC members, other large oil producers such asRussia and domestic and Canadian oil producers. While we expect a strong recovery of demand for all of these essential products in the long-run, there is little visibility on the timing for or extent of this recovery in the near-term.
In response to the COVID-19 pandemic, and with the health and safety of our employees as a top priority, we took several actions, including limiting onsite staff at all of our facilities to essential operational personnel only, implementing a work from home policy for certain employees and restricting travel unless approved by senior leadership. We will continue to monitor COVID-19 developments and the dynamic environment to properly address these policies going forward.
Within our Refining segment, for the second quarter 2020, we expect to run between 300,000-340,000 barrels per day of crude oil based on market demand for transportation fuels. Currently the primary determinants of demand are the various government orders and guidance restricting and discouraging most forms of travel. We expect to adjust refinery production levels commensurate with market demand. In the second quarter, we expect to consume$100 million to$300 million of working capital based primarily on the impact of falling crude and product prices, as well as reducing refinery throughput to match demand. We expect to recover this working capital as commodity prices and demand for product normalize. In our Lubricants and Specialty Products segment, we have withdrawn 2020 guidance for the Rack Forward business. Within our industrial and passenger car-related end markets, demand has dropped substantially, while in our personal care end markets, demand is running slightly below normal. We expect industrial demand to rebound with the broader economy. Within the Rack Back portion, we expect base oil demand to rebound with the reopening of its primary transportation-related end markets. Similar to our Refining segment, we intend to match production to market demand. At HEP, we expect a reduction in demand for transportation and terminal services in line with the ultimate demand for transportation fuels. HEP has reduced its quarterly distribution to$0.35 per unit, representative of a new distribution policy focused on funding all capital expenditures and distributions within cash flow, improving distributable cash flow coverage to 1.3x or greater and reducing leverage to 3.0-3.5x. Given the risks and lack of visibility, we have reduced the range of our 2020 consolidated capital budget to$525 million to$625 million from$623 million to$729 million , and we are evaluating additional ways to reduce cash costs including operating, sales, general and administrative spending reductions as well as incremental capital spending reductions. In order to preserve liquidity, we do not intend to repurchase common stock under our$1.0 billion share repurchase program until commodity prices and demand for products normalize. OnMarch 27, 2020 , theU.S. government passed the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act"), an approximately$2 trillion stimulus package that includes various provisions intended to provide relief to individuals and businesses in the form of tax changes, loans and grants, among others. At this time, we have not sought relief in the form of loans or grants from the CARES Act; however, we have benefited from certain tax deferrals in the CARES Act and may benefit from other tax provisions if we meet the requirements to do so. 33
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The extent to which HFC's future results are affected by COVID-19 will depend on various factors and consequences beyond our control, such as the duration and scope of the pandemic; additional actions by businesses and governments in response to the pandemic, and the speed and effectiveness of responses to combat the virus. COVID-19, and the volatile regional and global economic conditions stemming from the pandemic, could also exacerbate the risk factors identified in our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2019 and in this Form 10-Q. COVID-19 may also materially adversely affect our results in a manner that is either not currently known or that we do not currently consider to be a significant risk to our business.
See "Item 1A - Risk Factors" for other potential impacts of COVID-19 on our business.
A more detailed discussion of our financial and operating results for the three
months ended
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RESULTS OF OPERATIONS
Financial Data
Three Months Ended March 31, Change from 2019
2020 2019 Change Percent
(In thousands, except per share data)
Sales and other revenues $ 3,400,545 $ 3,897,247 $ (496,702 ) (13 )%
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) 2,693,726 3,199,205 (505,479 ) (16 )
Lower of cost or market inventory
valuation adjustment 560,464 (232,346 ) 792,810 (341 )
3,254,190 2,966,859 287,331 10
Operating expenses (exclusive of
depreciation and amortization) 328,345 331,592 (3,247 ) (1 )
Selling, general and administrative
expenses (exclusive of depreciation and
amortization) 87,737 88,034 (297 ) -
Depreciation and amortization 140,575 121,421 19,154 16
Total operating costs and expenses 3,810,847 3,507,906 302,941 9
Income (loss) from operations (410,302 ) 389,341 (799,643 ) (205 )
Other income (expense):
Earnings of equity method investments 1,714 2,100 (386 ) (18 )
Interest income 4,073 6,375 (2,302 ) (36 )
Interest expense (22,639 ) (36,647 ) 14,008 (38 )
Loss on early extinguishment of debt (25,915 ) - (25,915 ) -
Gain (loss) on foreign currency
transactions (4,233 ) 2,265 (6,498 ) (287 )
Other, net 1,850 557 1,293 232
(45,150 ) (25,350 ) (19,800 ) 78
Income (loss) before income taxes (455,452 ) 363,991 (819,443 ) (225 )
Income tax expense (benefit) (162,166 ) 87,505 (249,671 ) (285 )
Net income (loss) (293,286 ) 276,486 (569,772 ) (206 )
Less net income attributable to
noncontrolling interest 11,337 23,431 (12,094 ) (52 )
Net income (loss) attributable to
HollyFrontier stockholders $ (304,623 ) $ 253,055 $ (557,678 ) (220 )%
Earnings (loss) per share attributable
to HollyFrontier stockholders:
Basic $ (1.88 ) $ 1.48 $ (3.36 ) (227 )%
Diluted $ (1.88 ) $ 1.47 $ (3.35 ) (228 )%
Cash dividends declared per common
share $ 0.35 $ 0.33 $ 0.02 6 %
Average number of common shares
outstanding:
Basic 161,873 170,851 (8,978 ) (5 )%
Diluted 161,873 172,239 (10,366 ) (6 )%
Balance Sheet Data
March 31, 2020 December 31, 2019
(Unaudited)
(In thousands)
Cash and cash equivalents $ 909,126 $ 885,162
Working capital $ 1,200,258 $ 1,620,261
Total assets $ 11,221,794 $ 12,164,841
Long-term debt $ 2,496,006 $ 2,455,640
Total equity $ 6,110,478 $ 6,509,426
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Other Financial Data
Three Months Ended March 31,
2020 2019
(In thousands)
Net cash provided by operating activities $ 190,098 $ 216,816
Net cash used for investing activities $ (86,094 ) $ (726,725 )
Net cash used for financing activities $ (71,457 ) $ (150,128 )
Capital expenditures $ 83,749 $ 63,735
EBITDA (1) $ (307,648 ) $ 492,253 (1) Earnings before interest, taxes, depreciation and amortization, which we
refer to as "EBITDA," is calculated as net income (loss) attributable to
(ii) income tax provision, and (iii) depreciation and amortization. EBITDA is
not a calculation provided for under GAAP; however, the amounts included in
the EBITDA calculation are derived from amounts included in our consolidated
financial statements. EBITDA should not be considered as an alternative to
net income or operating income as an indication of our operating performance
or as an alternative to operating cash flow as a measure of liquidity. EBITDA
is not necessarily comparable to similarly titled measures of other
companies. EBITDA is presented here because it is a widely used financial
indicator used by investors and analysts to measure performance. EBITDA is
also used by our management for internal analysis and as a basis for
financial covenants. EBITDA presented above is reconciled to net income under
"Reconciliations to Amounts Reported Under Generally Accepted Accounting
Principles" following Item 3 of Part I of this Form 10-Q.
Segment Operating Data
Our operations are organized into three reportable segments, Refining, Lubricants and Specialty Products and HEP. See Note 15 "Segment Information" in the Notes to Consolidated Financial Statements for additional information on our reportable segments.
Refining Segment Operating Data
Our refinery operations include theEl Dorado ,Tulsa , Navajo,Cheyenne and Woods Cross Refineries. The following tables set forth information, including non-GAAP performance measures, about our consolidated refinery operations. The cost of products and refinery gross and net operating margins do not include the non-cash effects of lower of cost or market inventory valuation adjustments and depreciation and amortization. Reconciliations to amounts reported under GAAP are provided under "Reconciliations to Amounts Reported Under Generally Accepted Accounting Principles" following Item 3 of Part I of this Form 10-Q. Three Months
Ended
2020 2019
252,380 213,180
Refinery throughput (BPD) (2) 270,920
230,050
Sales of produced refined products (BPD) (3) 259,240
217,600
Refinery utilization (4) 97.1 % 82.0 % Average per produced barrel (5) Refinery gross margin $ 9.54$ 11.14 Refinery operating expenses (6) 5.30 6.66 Net operating margin $ 4.24
$ 4.48
Refinery operating expenses per throughput barrel (7) $ 5.07
$ 6.30
Feedstocks:
Sweet crude oil 52 % 50 %
Sour crude oil 22 % 26 %
Heavy sour crude oil 19 % 17 %
Other feedstocks and blends 7 % 7 %
Total 100 % 100 %
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Three Months Ended March 31,
2020 2019
Mid-Continent Region (El Dorado and Tulsa Refineries)
Sales of produced refined products:
Gasolines 51 % 53 %
Diesel fuels 32 % 28 %
Jet fuels 7 % 9 %
Fuel oil 1 % 1 %
Asphalt 3 % 3 %
Base oils 4 % 4 %
LPG and other 2 % 2 %
Total 100 % 100 %
Southwest Region (Navajo Refinery )
Crude charge (BPD) (1) 106,810 106,030
Refinery throughput (BPD) (2) 117,440
116,220
Sales of produced refined products (BPD) (3) 113,590
123,390
Refinery utilization (4) 106.8 %
106.0 %
Average per produced barrel (5) Refinery gross margin$ 12.63 $
15.95
Refinery operating expenses (6) 5.28
4.94
Net operating margin$ 7.35 $
11.01
Refinery operating expenses per throughput barrel (7)$ 5.10 $ 5.24 Feedstocks: Sweet crude oil 23 % 16 % Sour crude oil 68 % 75 % Other feedstocks and blends 9 % 9 % Total 100 % 100 % Sales of produced refined products: Gasolines 54 % 54 % Diesel fuels 38 % 37 % Fuel oil 2 % 3 % Asphalt 3 % 3 % LPG and other 3 % 3 % Total 100 % 100 %
77,170 81,220
Refinery throughput (BPD) (2) 83,200 87,450
Sales of produced refined products (BPD) (3) 79,460 82,040
Refinery utilization (4) 79.6 % 83.7 %
Average per produced barrel (5)
Refinery gross margin $ 15.27 $ 12.14
Refinery operating expenses (6) 11.01 10.73
Net operating margin $ 4.26 $ 1.41 Refinery operating expenses per throughput barrel (7)
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Three Months Ended March 31,
2020 2019
Rocky Mountain Region (Cheyenne and Woods Cross Refineries)
Feedstocks:
Sweet crude oil 34 % 36 %
Heavy sour crude oil 36 % 35 %
Black wax crude oil 23 % 22 %
Other feedstocks and blends 7 % 7 %
Total 100 % 100 %
Sales of produced refined products:
Gasolines 56 % 54 %
Diesel fuels 33 % 34 %
Fuel oil 3 % 3 %
Asphalt 5 % 5 %
LPG and other 3 % 4 %
Total 100 % 100 %
Consolidated
Crude charge (BPD) (1) 436,360 400,430
Refinery throughput (BPD) (2) 471,560 433,720
Sales of produced refined products (BPD) (3) 452,290 423,030
Refinery utilization (4) 95.5 %
87.6 %
Average per produced barrel (5) Refinery gross margin$ 11.32 $
12.74
Refinery operating expenses (6) 6.30
6.95
Net operating margin$ 5.02 $
5.79
Refinery operating expenses per throughput barrel (7)$ 6.04 $ 6.78 Feedstocks: Sweet crude oil 42 % 38 % Sour crude oil 29 % 34 % Heavy sour crude oil 18 % 16 % Black wax crude oil 4 % 4 % Other feedstocks and blends 7 % 8 % Total 100 % 100 % Sales of produced refined products: Gasolines 53 % 53 % Diesel fuels 33 % 32 % Jet fuels 4 % 5 % Fuel oil 1 % 2 % Asphalt 4 % 3 % Base oils 2 % 2 % LPG and other 3 % 3 % Total 100 % 100 %
(1) Crude charge represents the barrels per day of crude oil processed at our
refineries.
(2) Refinery throughput represents the barrels per day of crude and other
refinery feedstocks input to the crude units and other conversion units at
our refineries.
(3) Represents barrels sold of refined products produced at our refineries
(including HFC Asphalt) and does not include volumes
of refined products purchased for resale or volumes of excess crude oil sold. (4) Represents crude charge divided by total crude capacity (BPSD). Our
consolidated crude capacity is 457,000 BPSD.
(5) Represents average amount per produced barrel sold, which is a non-GAAP
measure. Reconciliations to amounts reported under GAAP are provided under
"Reconciliations to Amounts Reported Under Generally Accepted Accounting
Principles" following Item 3 of Part I of this Form 10-Q.
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(6) Represents total refining segment operating expenses, exclusive of
depreciation and amortization, divided by sales volumes
of refined products produced at our refineries.
(7) Represents total refining segment operating expenses, exclusive of
depreciation and amortization, divided by refinery throughput.
Lubricants and Specialty Products Operating Data
The following table sets forth information about our lubricants and specialty products operations. Sonneborn is included for the periodFebruary 1, 2019 (date of acquisition) throughMarch 31, 2019 . Three Months Ended March 31, 2020 2019 Lubricants and Specialty Products Throughput (BPD) 21,750 19,800 Sales of produced refined products (BPD) 36,800 34,770 Sales of produced refined products: Finished products 47 % 49 % Base oils 26 % 26 % Other 27 % 25 % Total 100 % 100 %
Supplemental financial data attributable to our Lubricants and Specialty Products segment is presented below.
Total Lubricants and
Rack Back (1) Rack Forward (2) Eliminations (3) Specialty Products
(In thousands)
Three months ended March 31,
2020
Sales and other revenues $ 164,829 $ 474,057 $ (112,283 ) $ 526,603
Cost of products sold $ 180,600 $ 323,063 $ (112,283 ) $ 391,380
Operating expenses $ 23,269 $ 30,862 $ - $ 54,131
Selling, general and
administrative expenses $ 5,363 $ 43,599 $ - $ 48,962
Depreciation and
amortization $ 10,867 $ 11,182 $ - $ 22,049
Income (loss) from
operations $ (55,270 ) $ 65,351 $ - $ 10,081
Three months ended March 31,
2019
Sales and other revenues $ 156,455 $ 444,342 $ (107,463 ) $ 493,334
Cost of products sold $ 145,818 $ 350,662 $ (107,463 ) $ 389,017
Operating expenses $ 29,560 $ 23,999 $ - $ 53,559
Selling, general and
administrative expenses $ 13,479 $ 26,240 $ - $ 39,719
Depreciation and
amortization $ 10,526 $ 9,645 $ - $ 20,171
Income (loss) from
operations $ (42,928 ) $ 33,796 $ - $ (9,132 )
(1) Rack back consists of our PCLI base oil production activities, by-product
sales to third parties and intra-segment base oil sales to rack forward.
(2) Rack forward activities include the purchase of base oils from rack back and
the blending, packaging, marketing and distribution and sales of finished
lubricants and specialty products to third parties.
(3) Intra-segment sales of rack back produced base oils to rack forward are
eliminated under the "Eliminations" column.
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Results of Operations - Three Months Ended
Summary
Net loss attributable toHollyFrontier stockholders for the three months endedMarch 31, 2020 was$(304.6) million ($(1.88) per basic and diluted share), a$557.7 million decrease compared to net income of$253.1 million ($1.48 per basic and$1.47 per diluted share) for the three months endedMarch 31, 2019 . Net income decreased due principally to lower gross refining margins, partially offset by higher refining segment sales volumes. For the three months endedMarch 31, 2020 , lower of cost or market inventory reserve adjustments decreased pre-tax earnings by$560.5 million compared to an increase of$232.3 million for the three months endedMarch 31, 2019 . Refinery gross margins for the three months endedMarch 31, 2020 decreased to$11.32 per barrel sold from$12.74 for the three months endedMarch 31, 2019 . Sales and Other Revenues Sales and other revenues decreased 13% from$3,897.2 million for the three months endedMarch 31, 2019 to$3,400.5 million for the three months endedMarch 31, 2020 due to a year-over-year decrease in first quarter sales prices, partially offset by higher refined product sales volumes. A trend began in late first quarter 2020 of reduced refined product sales prices, and we expect this trend to continue into the second quarter 2020. Sales and other revenues for the three months endedMarch 31, 2020 and 2019 included$26.4 million and$31.1 million , respectively, in HEP revenues attributable to pipeline and transportation services provided to unaffiliated parties. Additionally, sales and other revenues included$523.5 million and$493.3 million in unaffiliated revenues related to our Lubricants and Specialty Products segment for the three months endedMarch 31, 2020 and 2019, respectively. Cost of Products Sold Total cost of products sold increased 10% from$2,966.9 million for the three months endedMarch 31, 2019 to$3,254.2 million for the three months endedMarch 31, 2020 due principally to a lower of cost or market inventory valuation adjustment charge of$560.5 million recognized during the first quarter of 2020 compared to a benefit of$232.3 million for the same period of 2019, resulting in a new$800.8 million inventory lower of cost or market reserve atMarch 31, 2020 . The lower of cost or market reserve atMarch 31, 2020 is based on market conditions and prices at that time. Cost of products sold exclusive of lower of cost or market inventory valuation adjustment decreased$505.5 million due primarily to lower crude oil costs, partially offset by higher refined product sales volumes. A trend began in late first quarter 2020 of lower crude oil costs, and we expect this trend to continue into the second quarter. Gross Refinery MarginsGross refinery margin per barrel sold decreased 11% from$12.74 for the three months endedMarch 31, 2019 to$11.32 for the three months endedMarch 31, 2020 . This was due to the effects of a decrease in the average per barrel sold sales price during the current year quarter, partially offset by decreased crude oil and feedstock prices. A trend began in late first quarter 2020 of reduced gross refinery margin per barrel sold primarily due to lower average per barrel sold sales prices. Gross refinery margin per barrel does not include the non-cash effects of lower of cost or market inventory valuation adjustments or depreciation and amortization. See "Reconciliations to Amounts Reported Under Generally Accepted Accounting Principles" following Item 3 of Part I of this Form 10-Q for a reconciliation to the income statement of sale prices of products sold and cost of products purchased. Operating Expenses Operating expenses, exclusive of depreciation and amortization, decreased 1% from$331.6 million for the three months endedMarch 31, 2019 to$328.3 million for the three months endedMarch 31, 2020 due principally to lower repair and maintenance costs for the three months endedMarch 31, 2020 compared to prior period. Prior year period operating expenses included higher repair and maintenance costs related to aFebruary 2019 fire in an FCC unit at ourEl Dorado Refinery . Selling, General and Administrative Expenses Selling, general and administrative expenses were$87.7 million for the three months endedMarch 31, 2020 compared to$88.0 million for the three months endedMarch 31, 2019 . We incurred$1.3 million and$12.6 million in direct acquisition and integration costs of our Sonneborn business during the three months endedMarch 31, 2020 and 2019, respectively. Depreciation and Amortization Expenses Depreciation and amortization increased 16% from$121.4 million for the three months endedMarch 31, 2019 to$140.6 million for the three months endedMarch 31, 2020 . This increase was due principally to depreciation and amortization attributable to capitalized improvement projects and capitalized refinery turnaround costs. 40
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Interest Income Interest income for the three months endedMarch 31, 2020 was$4.1 million compared to$6.4 million for the three months endedMarch 31, 2019 . This decrease was primarily due to lower cash balances on hand and lower interest rates on cash investments during the current year quarter. Interest Expense Interest expense was$22.6 million for the three months endedMarch 31, 2020 compared to$36.6 million for the three months endedMarch 31, 2019 . This decrease was primarily due to an unrealized gain on the mark-to-market change of the fair value of the embedded derivative in our catalyst financing arrangements during the current year quarter. For the three months endedMarch 31, 2020 and 2019, interest expense included$16.1 million and$19.0 million , respectively, in interest costs attributable to HEP operations. This decrease in interest expense attributable to HEP operations is due to lower market interest rates on HEP's credit facility and HEP's refinancing of its 6.0% senior notes due 2024. Loss on Early Extinguishment of Debt For the three months endedMarch 31, 2020 , HEP recorded a$25.9 million loss on the redemption of its$500 million aggregate principal amount of 6% senior notes maturingAugust 2024 for$522.5 million . Gain (Loss) on Foreign Currency Transactions Remeasurement adjustments resulting from the foreign currency conversion of the intercompany financing notes payable by PCLI net of gains on foreign exchange forward contracts with banks which hedge the foreign currency exposure on these intercompany notes were a loss of$4.2 million for the three months endedMarch 31, 2020 compared to a net gain of$2.3 million for the three months endedMarch 31, 2019 . For the three months endedMarch 31, 2020 and 2019, gain / loss on foreign currency transactions included a gain of$33.5 million and a loss of$7.6 million , respectively, on foreign exchange forward contracts (utilized as an economic hedge). Income Taxes For the three months endedMarch 31, 2020 , we recorded an income tax benefit of$162.2 million compared to income tax expense of$87.5 million for the three months endedMarch 31, 2019 . This decrease was due principally to a pre-tax loss during the three months endedMarch 31, 2020 compared to pre-tax earnings in the same period of 2019. Our effective tax rates were 35.6% and 24.0% for the three months endedMarch 31, 2020 and 2019, respectively. The year-over-year increase in the effective tax rate is due principally to the relationship between the pre-tax loss and the earnings attributable to the noncontrolling interest that is not included in income for tax purposes.
LIQUIDITY AND CAPITAL RESOURCES
HollyFrontier Credit Agreement We have a$1.35 billion senior unsecured revolving credit facility maturing inFebruary 2022 (the "HollyFrontier Credit Agreement"). The HollyFrontier 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. AtMarch 31, 2020 , we were in compliance with all covenants, had no outstanding borrowings and had outstanding letters of credit totaling$4.9 million under theHollyFrontier Credit Agreement. HollyFrontier Financing Arrangements InDecember 2018 , certain of our wholly-owned subsidiaries entered into financing arrangements whereby such subsidiaries sold a portion of their precious metals catalyst to a financial institution and then leased back the precious metals catalyst in exchange for total cash received of$32.5 million . The volume of the precious metals catalyst and the lease rate are fixed over the term of each lease, and the lease payments are recorded as interest expense. The leases mature onFebruary 1, 2021 . Upon maturity, we must either satisfy the obligation at fair market value or refinance to extend the maturity. HEP Credit Agreement HEP has a$1.4 billion senior secured revolving credit facility maturing inJuly 2022 (the "HEP Credit Agreement") and 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 three months endedMarch 31, 2020 , HEP received advances totaling$112.0 million and repaid$67.0 million under the HEP Credit Agreement. AtMarch 31, 2020 , HEP was in compliance with all of its covenants, had outstanding borrowings of$1,010.5 million and no outstanding letters of credit under the HEP Credit Agreement. 41
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HEP Senior Notes OnFebruary 4, 2020 , HEP closed a private placement of$500 million in aggregate principal amount of 5.0% HEP senior unsecured notes maturingFebruary 2028 . OnFebruary 5, 2020 , HEP redeemed its existing$500 million aggregate principal amount of 6.0% senior notes maturingAugust 2024 at a redemption cost of$522.5 million . HEP recognized a$25.9 million early extinguishment loss consisting of a$22.5 million debt redemption premium and unamortized discount and financing costs of$3.4 million . HEP funded the$522.5 million redemption with proceeds from the issuance of its 5.0% senior notes and borrowings under the HEP Credit Agreement.
See Note 9 "Debt" in the Notes to Consolidated Financial Statements for additional information on our debt instruments.
HEP Common Unit Continuous Offering Program InMay 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 three months endedMarch 31, 2020 , HEP did not issue any common units under this program. As ofMarch 31, 2020 , HEP has issued 2,413,153 units under this program, providing$82.3 million in gross proceeds.
Liquidity
We believe our current cash and cash equivalents, along with future internally generated cash flow and funds available under our credit facilities, will provide sufficient resources to fund currently planned capital projects and our liquidity needs for the foreseeable future. In addition, subject to our current cash conservation strategies as discussed above in "Outlook," components of our growth strategy include the expansion of existing units at our facilities and selective acquisition of complementary assets for our refining operations intended to increase earnings and cash flow. We also expect to use cash for payment of cash dividends, which are at the discretion of our Board of Directors, and, once commodity prices and demand for products normalize, for the repurchases of our common stock under our share repurchase program. Our standalone (excluding HEP) liquidity was over$2.2 billion atMarch 31, 2020 , consisting of cash and cash equivalents totaling$889.8 million and an undrawn$1.35 billion credit facility maturing in 2022. Our earliest standalone (excluding HEP) debt maturity is$1.0 billion of senior notes in 2026. We consider all highly-liquid instruments with a maturity of three months or less at the time of purchase to be cash equivalents. Cash equivalents are stated at cost, which approximates market value. These primarily consist of investments in conservative, highly-rated instruments issued by financial institutions, government and corporate entities with strong credit standings and money market funds. InNovember 2019 , our Board of Directors approved a$1.0 billion share repurchase program, which replaced all existing share repurchase programs, authorizing us to repurchase common stock in the open market or through privately negotiated transactions. The timing and amount of stock repurchases will depend on market conditions and corporate, regulatory and other relevant considerations. This program may be discontinued at any time by the Board of Directors. As ofMarch 31, 2020 , we had not repurchased common stock under this stock repurchase program. In addition, we are authorized by our Board of Directors to repurchase shares in an amount sufficient to offset shares issued under our compensation programs. In order to preserve liquidity, we do not intend to repurchase common stock under our$1.0 billion share repurchase program until commodity prices and demand for products normalize. Cash and cash equivalents increased$24.0 million for the three months endedMarch 31, 2020 . Net cash provided by operating activities of$190.1 million exceeded net cash used by investing and financing activities of$86.1 million , and$71.5 million , respectively. 42
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Cash Flows - Operating Activities
Three Months EndedMarch 31, 2020 Compared to Three Months EndedMarch 31, 2019 Net cash flows provided by operating activities were$190.1 million for the three months endedMarch 31, 2020 compared to$216.8 million for the three months endedMarch 31, 2019 , a decrease of$26.7 million . Net loss for the three months endedMarch 31, 2020 of$(293.3) million , was a decrease of$569.8 million compared to net income of$276.5 million for the three months endedMarch 31, 2019 . Non-cash adjustments to net income consisting of depreciation and amortization, lower of cost or market inventory valuation adjustment, earnings of equity method investments, inclusive of distributions, loss on early extinguishment of debt, gain on sale of assets, deferred income taxes, equity-based compensation expense and fair value changes to derivative instruments totaled$539.4 million for the three months endedMarch 31, 2020 compared to$(48.5) million for the same period in 2019. Adjusted for non-cash items, changes in working capital decreased operating cash flows by$65.4 million and increased operating cash flows by$63.9 million , for the three months endedMarch 31, 2020 and 2019, respectively. Additionally, for the three months endedMarch 31, 2020 , turnaround expenditures decreased to$38.7 million from$78.6 million from the same period of 2019.
Cash Flows - Investing Activities and Planned Capital Expenditures
Three Months EndedMarch 31, 2020 Compared to Three Months EndedMarch 31, 2019 Net cash flows used for investing activities were$86.1 million for the three months endedMarch 31, 2020 compared to$726.7 million for the three months endedMarch 31, 2019 , a decrease of$640.6 million . Cash expenditures for properties, plants and equipment for the first three months of 2020 increased to$83.7 million from$63.7 million for the same period in 2019. These include HEP capital expenditures of$18.9 million and$10.7 million for the three months endedMarch 31, 2020 and 2019, respectively. Prior year investing activities reflected a net cash outflow of$663.4 million upon the acquisition of Sonneborn. Planned Capital ExpendituresHollyFrontier Corporation Each year our Board of Directors approves our annual capital budget, which includes specific projects that management is authorized to undertake. Additionally, when conditions warrant or as new opportunities arise, additional projects may be approved. The funds appropriated for a particular capital project may be expended over a period of several years, depending on the time required to complete the project. Therefore, our planned capital expenditures for a given year consist of expenditures appropriated in that year's capital budget plus expenditures for projects appropriated in prior years which have not yet been completed. Refinery turnaround spending is amortized over the useful life of the turnaround. The refining industry is capital intensive and requires on-going investments to sustain our refining operations. This includes replacement of, or rebuilding, refinery units and components that extend the useful life. We also invest in projects that improve operational reliability and profitability via enhancements that improve refinery processing capabilities as well as production yield and flexibility. Our capital expenditures also include projects related to environmental, health and safety compliance and include initiatives as a result of federal and state mandates. Our refinery operations and related emissions are highly regulated at both federal and state levels, and we invest in our facilities as needed to remain in compliance with these standards. Additionally, when faced with new emissions or fuels standards, we seek to execute projects that facilitate compliance and also improve the operating costs and / or yields of associated refining processes.
HEP
Each year theHolly Logistic Services, L.L.C. board of directors approves HEP's annual capital budget, which specifies capital projects that HEP management is authorized to undertake. Additionally, at times when conditions warrant or as new opportunities arise, special projects may be approved. The funds allocated for a particular capital project may be expended over a period in excess of a year, depending on the time required to complete the project. Therefore, HEP's planned capital expenditures for a given year consist of expenditures approved for capital projects included in its current year capital budget as well as, in certain cases, expenditures approved for capital projects in capital budgets for prior years. HEP expects the majority of the expansion capital budget in 2020 to be invested in the Cushing Connect joint venture. In addition, HEP may spend funds periodically to perform capital upgrades or additions to its assets where a customer reimburses HEP for such costs. The upgrades or additions would generally benefit the customer over the remaining life of the related service agreements. 43
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Due to the COVID-19 pandemic and resulting decline in
Expected Cash Spending Range
(In millions)
HollyFrontier Capital Expenditures
Refining $ 222.0 $ 251.0
Renewable Diesel Unit 130.0
150.0
Lubricants and Specialty Products 30.0 45.0 Turnarounds and catalyst 85.0 110.0 Total HollyFrontier 467.0 556.0 HEP Maintenance 8.0 12.0 Expansion and joint venture investment 45.0 50.0 Refining unit turnarounds 5.0 7.0 Total HEP 58.0 69.0 Total $ 525.0$ 625.0
Cash Flows - Financing Activities
Three Months EndedMarch 31, 2020 Compared to Three Months EndedMarch 31, 2019 Net cash flows used for financing activities were$71.5 million for the three months endedMarch 31, 2020 compared to$150.1 million for the three months endedMarch 31, 2019 , a decrease of$78.7 million . During the three months endedMarch 31, 2020 , we purchased$1.1 million of treasury stock and paid$57.2 million in dividends. Also during this period, HEP received$112.0 million and repaid$67.0 million under the HEP Credit Agreement, paid$522.5 million upon the redemption of HEP's 6.0% senior notes and received$491.5 million in net proceeds from issuance of HEP 5.0% senior notes, paid distributions of$33.9 million to noncontrolling interests and received contributions from noncontrolling interests of$7.3 million . During the three months endedMarch 31, 2019 , we purchased$77.8 million of treasury stock and paid$56.8 million in dividends. Also during this period, HEP received$104.0 million and repaid$85.0 million under the HEP Credit Agreement and paid distributions of$33.7 million to noncontrolling interests.
Contractual Obligations and Commitments
There were no significant changes to our long-term contractual obligations
during the three months ended
HEP
InFebruary 2020 , HEP issued$500 million in aggregate principal amount of 5.0% HEP senior notes maturingFebruary 2028 and redeemed its existing$500 million 6.0% senior notes maturingAugust 2024 . During the three months endedMarch 31, 2020 , HEP had net borrowings of$45.0 million resulting in$1,010.5 million of outstanding borrowings under the HEP Credit Agreement atMarch 31, 2020 .
There were no other significant changes to HEP's long-term contractual obligations during this period.
CRITICAL ACCOUNTING POLICIES
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted inthe United States . The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities as of the date of the financial statements. Actual results may differ from these estimates under different assumptions or conditions. 44
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Our significant accounting policies are described in "Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies" in our Annual Report on Form 10-K for the year endedDecember 31, 2019 . Certain critical accounting policies that materially affect the amounts recorded in our consolidated financial statements include the use of the last-in, first-out ("LIFO") method of valuing certain inventories, assessing the possible impairment of certain long-lived assets and goodwill, and assessing contingent liabilities for probable losses. Inventory Valuation: Inventories related to our refining operations are stated at the lower of cost, using the 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. AtMarch 31, 2020 , our lower of cost or market inventory valuation reserve was$800.8 million . This amount, or a portion thereof, is subject to reversal as a reduction to cost of products sold in subsequent periods as inventories giving rise to the reserve are sold, and a new reserve is established. Inventories consisting of process chemicals, materials and maintenance supplies and RINs are stated at the lower of weighted-average cost or net realizable value. Inventories of ourPetro-Canada Lubricants and Sonneborn businesses are stated at the lower of cost, using the FIFO method, or net realizable value.Goodwill and Long-lived Assets: As ofMarch 31, 2020 , our goodwill balance was$2.4 billion , with goodwill assigned to our Refining, Lubricants and Specialty Products and HEP segments of$1,733.5 million ,$327.1 million and$312.9 million , respectively.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 either a quantitative assessment or an optional qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If we determine that based on the qualitative factors that it is more likely than not that the fair value of the reporting unit is greater than its carrying amount, a quantitative test is performed in which we estimate the fair value of the related reporting unit. If the carrying amount of a reporting unit exceeds its fair value, the goodwill of that reporting unit is impaired, and we measure goodwill impairment as the excess of the carrying amount of reporting unit over the related fair value. Our long-lived assets principally consist of our refining assets that are organized as refining asset groups and the assets of our Lubricants and Specialty Products 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. Due to the recent economic slowdown caused by the COVID-19 pandemic, we performed a qualitative analysis of whether it is more likely than not that the fair value of our reporting units that include goodwill balances is less than their carrying amounts as ofMarch 31, 2020 . These effects of this recent economic slowdown on our operating results and financial position include reductions in the prices of our finished goods, raw materials and the related decrease in our gross margins. As ofMarch 31, 2020 , we have concluded that it is more likely than not that the carrying amounts of our reporting units that include goodwill are less than their fair value. A reasonable expectation exists that further deterioration in gross margins or a prolonged economic slowdown due to COVID-19 could result in an impairment of goodwill at some point in the future. Such impairment charges could be material. Our annual goodwill impairment testing is performed onJuly 1 .
Contingencies
We are subject to proceedings, lawsuits and other claims related to environmental, labor, product and other matters. We are required to assess the likelihood of any adverse judgments or outcomes to these matters as well as potential ranges of probable losses. A determination of the amount of reserves required, if any, for these contingencies is made after careful analysis of each individual issue. The required reserves may change in the future due to new developments in each matter or changes in approach such as a change in settlement strategy in dealing with these matters.
RISK MANAGEMENT
We use certain strategies to reduce some commodity price and operational risks. We do not attempt to eliminate all market risk exposures when we believe that the exposure relating to such risk would not be significant to our future earnings, financial position, capital resources or liquidity or that the cost of eliminating the exposure would outweigh the benefit. 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, sales prices of refined products and crude oil costs. Foreign Currency Risk Management We are exposed to market risk related to the volatility in foreign currency exchange rates. We periodically enter into derivative contracts in the form of foreign exchange forward and foreign exchange swap contracts to mitigate the exposure associated with fluctuations on intercompany notes with our foreign subsidiaries that are not denominated in theU.S. dollar. As ofMarch 31, 2020 , we have the following notional contract volumes related to all outstanding derivative instruments used to mitigate commodity price and foreign currency risk: Notional Contract Volumes by Year of Maturity Total Outstanding Unit of Derivative Instrument Notional 2020 2021 Measure Natural gas price swaps - long 3,150,000 1,350,000 1,800,000 MMBTU Crude oil price swaps (basis spread) - long 4,675,000 4,675,000 - Barrels NYMEX futures (WTI) - short 455,000 455,000 - Barrels Forward gasoline contracts - long 1,450,000 1,450,000 - Barrels Foreign currency forward U.S. contracts 426,037,417 319,732,567106,304,850 dollar Forward commodity contracts Troy (platinum) (1) 40,867 - 40,867 ounces
(1) Represents an embedded derivative within our catalyst financing arrangements, which may be refinanced or require repayment under certain conditions. See Note 9 "Debt" in the Notes to Consolidated Financial Statements for additional information on these financing arrangements.
The following sensitivity analysis provides the hypothetical effects of market
price fluctuations to the commodity positions hedged under our derivative
contracts:
Estimated Change in Fair Value at
March 31 ,
Commodity-based Derivative Contracts 2020 2019
(In thousands)
Hypothetical 10% change in underlying commodity prices $ 319$ 2,670 Interest Rate Risk Management The market risk inherent in our fixed-rate debt is the potential change arising from increases or decreases in interest rates as discussed below. For the fixed rateHollyFrontier Senior Notes and HEP Senior Notes, changes in interest rates will generally affect fair value of the debt, but not earnings or cash flows. The outstanding principal, estimated fair value and estimated change in fair value (assuming a hypothetical 10% change in the yield-to-maturity rates) for this debt as ofMarch 31, 2020 is presented below: Estimated Outstanding Estimated Change in Principal Fair Value Fair Value (In thousands) HollyFrontier Senior Notes$ 1,000,000 $ 880,540 $ 37,308 HEP Senior Notes$ 500,000 $ 416,795 $ 20,967 For the variable rate HEP Credit Agreement, changes in interest rates would affect cash flows, but not the fair value. AtMarch 31, 2020 , outstanding borrowings under the HEP Credit Agreement were$1,010.5 million . A hypothetical 10% change in interest rates applicable to the HEP Credit Agreement would not materially affect cash flows. Our operations are subject to hazards of petroleum processing operations, including fire, explosion and weather-related perils. We maintain various insurance coverages, including business interruption insurance, subject to certain deductibles. We are not fully insured against certain risks because such risks are not fully insurable, coverage is unavailable, or premium costs, in our judgment, do not justify such expenditures. Financial information is reviewed on the counterparties in order to review and monitor their financial stability and assess their ongoing ability to honor their commitments under the derivative contracts. We have not experienced, nor do we expect to experience, any difficulty in the counterparties honoring their commitments. We have a risk management oversight committee consisting of members from our senior management. This committee oversees our risk enterprise program, monitors our risk environment and provides direction for activities to mitigate identified risks that may adversely affect the achievement of our goals. 45
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