HOLLYFRONTIER CO. This Item 7 contains "forward-looking" statements. See "Forward-Looking Statements" at the beginning of this Annual Report on Form 10-K. In this document, the words "we," "our," "ours" and "us" refer only toHollyFrontier 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" include 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 an independent petroleum refiner and marketer that produces high-value light products such as gasoline, diesel fuel, jet fuel and other specialty products. We own and operate refineries located inKansas, Oklahoma ,New Mexico ,Wyoming andUtah and 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 of 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 . OnJuly 10, 2018 , we entered into a definitive agreement to acquireRed Giant Oil , a privately-owned lubricants company. The acquisition closed onAugust 1, 2018 . Cash consideration paid was$54.2 million .Red Giant Oil is one of the largest suppliers of locomotive engine oil inNorth America and is headquartered inCouncil Bluffs, Iowa with storage and distribution facilities inIowa ,Kansas ,Utah andWyoming , along with a blending and packaging facility inTexas . HFC acquired 100% of the outstanding capital stock of PCLI onFebruary 1, 2017 . Cash consideration paid was$862.1 million , or$1.125 billion Canadian dollars. PCLI is a Canadian-based producer of base oils with a plant having 15,600 BPD of lubricant production capacity that is located inMississauga, Ontario . The facility is downstream integrated from base oils to finished lubricants and produces a broad spectrum of specialty lubricants and white oils that are distributed to end customers worldwide through a global sales network with locations inCanada ,the United States ,Europe andChina . For the year endedDecember 31, 2019 , net income attributable toHollyFrontier stockholders was$772.4 million compared to net income of$1,098.0 million and$805.4 million for the years endedDecember 31, 2018 , and 2017, respectively. Overall gross refining margins per produced barrel sold for 2019 decreased 10% over the year endedDecember 31, 2018 due to lower crack spreads and crude oil basis differentials. Pursuant to the 2007 Energy Independence and Security Act, theEPA promulgated the RFS regulations, which increased the volume of renewable fuels mandated to be blended into the nation's fuel supply. The regulations, in part, require refiners to add annually increasing amounts of "renewable fuels" to their petroleum products or purchase credits, known as RINs, in lieu of such blending. Compliance with RFS regulations significantly increases our cost of products sold, with RINs costs totaling$110.6 million for the year endedDecember 31, 2019 , which is net of the$36.6 million cost reduction resulting from small refinery RINs waivers granted by theEPA in 2019 as described in Note 9 "Inventories" in the Notes to Consolidated Financial Statements.
OUTLOOK
In 2020, we expect continued global economic growth to fuel increased demand for
transportation fuels, lubricants, specialty products and base oils. Within our
Refining segment, we anticipate healthy utilization rates across our refining
system in 2020 due to light planned maintenance. For the first quarter 2020, we
expect to run between 425,000-435,000 barrels per day of crude oil.
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In our Lubricants and Specialty Products segment, we expect the Rack Forward business to generate$250-$275 million of EBITDA based on an expected steady demand for finished lubricants. Within the Rack Back portion, we expect the base oil market will continue to improve from cyclical lows in 2019 as existing capacity absorbs growing demand for premium base oils. At HEP, we expect contractual tariff escalators and earnings from ourCushing Connect joint venture to offset cost inflation. HEP intends to maintain its quarterly distribution at$0.6725 , while expecting to achieve a distribution coverage ratio of 1.0x for the full year 2020. A more detailed discussion of our financial and operating results for the years endedDecember 31, 2019 and 2018 is presented in the following sections. Discussions of year-over-year comparisons for 2018 and 2017 can be found in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of our Annual Report on Form 10-K for the year endedDecember 31, 2018 . RESULTS OF OPERATIONS Financial Data Years Ended December 31, 2019 2018 2017 (In thousands, except per share data) Sales and other revenues$ 17,486,578 $ 17,714,666 $ 14,251,299 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) 13,918,384 13,940,782 11,467,873 Lower of cost or market inventory valuation adjustment (119,775 )
136,305 (108,685 )
13,798,609 14,077,087 11,359,188
Operating expenses (exclusive of
depreciation and amortization) 1,394,052 1,285,838 1,296,669
Selling, general and administrative expenses
(exclusive of depreciation and amortization) 354,236 290,424 265,721
Depreciation and amortization 509,925 437,324 409,937
Goodwill and asset impairment 152,712 - 19,247
Total operating costs and expenses 16,209,534 16,090,673 13,350,762
Income from operations 1,277,044 1,623,993 900,537
Other income (expense):
Earnings of equity method investments 5,180 5,825 12,510
Interest income 22,139 16,892 3,736
Interest expense (143,321 ) (131,363 ) (117,597 )
Loss on early extinguishment of debt - - (12,225 )
Gain on foreign currency transactions 5,449 6,197 16,921
Gain on foreign currency swap contracts - - 24,545
Remeasurement gain on HEP pipeline interest
acquisitions - - 36,254
Other, net 5,013 2,923 4,182
(105,540 ) (99,526 ) (31,674 )
Income before income taxes 1,171,504 1,524,467 868,863
Income tax expense (benefit) 299,152 347,243 (12,379 )
Net income 872,352 1,177,224 881,242
Less net income attributable to
noncontrolling interest 99,964 79,264 75,847
Net income attributable to HollyFrontier
stockholders $ 772,388 $ 1,097,960 $ 805,395
Earnings per share attributable to
HollyFrontier stockholders:
Basic $ 4.64 $ 6.25 $ 4.54
Diluted $ 4.61 $ 6.19 $ 4.52
Cash dividends declared per common share $ 1.34 $ 1.32 $ 1.32
Average number of common shares outstanding:
Basic 166,287 175,009 176,174
Diluted 167,385 176,661 177,196
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Other Financial Data
Years Ended December 31,
2019 2018 2017
(In thousands)
Net cash provided by operating activities $ 1,548,611 $ 1,554,416 $ 951,390
Net cash used for investing activities $ (972,914 ) $ (360,520 ) $ (959,670 )
Net cash used for financing activities $ (848,255 ) $ (664,328 ) $ (72,630 )
Capital expenditures $ 293,763 $ 311,029 $ 272,259
EBITDA (1) $ 1,702,647 $ 1,996,998 $ 1,316,814 (1) Earnings before interest, taxes, depreciation and amortization, which we
refer to as "EBITDA," is calculated as net income 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 7A of Part II of this Form 10-K.
Supplemental Segment Operating Data Our operations are organized into three reportable segments, Refining, Lubricants and Specialty Products and HEP. See Note 20 "Segment Information" in the Notes to Consolidated Financial Statements for additional information on our reportable segments.
Refining Segment Operating Data
Our refinery operations include the El 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 7A of Part II of this Form 10-K. Years Ended December 31, 2019 2018 2017 Consolidated Crude charge (BPD) (1) 427,600 431,570 438,800 Refinery throughput (BPD) (2) 458,600 463,340 472,010 Sales of produced refined products (BPD) (3) 449,190 452,630 452,270 Refinery utilization (4) 93.6 % 94.4 % 96.0 % Average per produced barrel (5) Refinery gross margin$ 15.96 $ 17.71 $ 11.56 Refinery operating expenses (6) 6.68 6.39 6.11 Net operating margin$ 9.28 $
11.32
Refinery operating expenses per throughput barrel (7)$ 6.54 $ 6.24 $ 5.86
(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 7A of Part II of this Form 10-K.
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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 Segment Operating Data
The following table sets forth information about our lubricants and specialty products operations and includes ourPetro-Canada Lubricants business for the periodFebruary 1, 2017 (date of acquisition) throughDecember 31, 2019 .Red Giant Oil is included for the periodAugust 1, 2018 (date of acquisition) throughDecember 31, 2019 . Sonneborn is included for the periodFebruary 1, 2019 (date of acquisition) throughDecember 31, 2019 . Years Ended December 31, 2019 2018 2017 Lubricants and Specialty Products Throughput (BPD) 20,251 19,590 21,710
Sales of produced barrels sold (BPD) 34,827 30,510 32,910
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)
Year Ended December 31, 2019
Sales and other revenues $ 661,523 $ 1,883,920 $ (452,915 ) $ 2,092,528
Cost of products sold 620,660 1,412,291 (452,915 ) 1,580,036
Operating expenses 116,984 114,539 - 231,523
Selling, general and
administrative expenses 31,854 136,741 - 168,595
Depreciation and amortization 37,001 51,780 - 88,781
Goodwill impairment (4) 152,712 - - 152,712
Income (loss) from operations
- $ (129,119 )
Year Ended December 31, 2018
Sales and other revenues $ 682,892 $ 1,650,056 $ (520,245 ) $ 1,812,703
Cost of products sold 633,459 1,268,326 (520,245 ) 1,381,540
Operating expenses 111,155 56,665 - 167,820
Selling, general and
administrative expenses 32,086 111,664 - 143,750
Depreciation and amortization 26,955 16,300 - 43,255
Income (loss) from operations
- $ 76,338
Year Ended December 31, 2017
Sales and other revenues $ 621,153 $ 1,415,842 $ (442,959 ) $ 1,594,036
Cost of products sold
(exclusive of lower of cost or
market inventory valuation
adjustment) 504,782 1,032,161 (442,959 ) 1,093,984
Lower of cost or market
inventory valuation adjustment - (1,206 ) - (1,206 )
Operating expenses 95,303 127,158 - 222,461
Selling, general and
administrative expenses 27,764 77,902 - 105,666
Depreciation and amortization 23,471 8,423 - 31,894
Income (loss) from operations
- $ 141,237 (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.
Rack back results reflect the increase in feedstock prices from 2017 to
2019 combined with softening market conditions from the increased supply
of base oils.
(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.
(4) During the three months ended
of
Lubricants and Specialty Products segment. We have separately allocated
this charge for purposes of management's discussion and analysis
presentation of Rack Back and Rack Forward results entirely to Rack Back .
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Results of Operations - Year Ended
Summary
Net income attributable toHollyFrontier stockholders for the year endedDecember 31, 2019 was$772.4 million ($4.64 per basic and$4.61 per diluted share), a$325.6 million decrease compared to net income attributable toHollyFrontier stockholders of$1,098.0 million ($6.25 per basic and$6.19 per diluted share) for the year endedDecember 31, 2018 . Net income decreased due principally to a goodwill impairment charge of$152.7 million and lower gross refining margins. For the year endedDecember 31, 2019 , lower of cost or market inventory reserve adjustments increased pre-tax earnings by$119.8 million compared to a decrease of$136.3 million for the year endedDecember 31, 2018 . Refinery gross margins for the year endedDecember 31, 2019 decreased to$15.96 per produced barrel from$17.71 for the year endedDecember 31, 2018 . During 2019, ourCheyenne Refinery andWoods Cross Refinery were each granted a one-year small refinery exemption from theEPA for the 2018 calendar year, at which time we recorded a total$36.6 million reduction to our cost of products sold. During 2018, ourCheyenne Refinery was granted a one-year small refinery exemption from theEPA for the 2015 and 2017 calendar years and ourWoods Cross Refinery was granted a one-year small refinery exemption for 2017. As a result of these exemptions, we recorded reductions totaling$97.0 million to our cost of products sold in 2018. Sales and Other Revenues Sales and other revenues decreased 1% from$17,714.7 million for the year endedDecember 31, 2018 to$17,486.6 million for the year endedDecember 31, 2019 due to a year-over-year decrease in sales prices and lower refined product volumes. Sales and other revenues for the years endedDecember 31, 2019 and 2018 include$121.0 million and$108.4 million , respectively, in HEP revenues attributable to pipeline and transportation services provided to unaffiliated parties. Additionally, sales and other revenues included$2,081.2 million and$1,799.5 million in unaffiliated revenues related to our Lubricants and Specialty Products segment for the years endedDecember 31, 2019 and 2018, respectively. Sonneborn contributed$340.3 million in sales and other revenues for the year endedDecember 31, 2019 . Cost of Products Sold Total cost of products sold decreased 2% from$14,077.1 million for the year endedDecember 31, 2018 to$13,798.6 million for the year endedDecember 31, 2019 , due principally to lower crude oil costs and lower refined product volumes. Additionally, for the year endedDecember 31, 2019 , we recognized a$119.8 million lower of cost or market inventory valuation benefit compared to a charge of$136.3 million for the same period of 2018, resulting in a new$240.4 million inventory reserve atDecember 31, 2019 . The reserve atDecember 31, 2019 is based on market conditions and prices at that time. Cost of products sold included$217.7 million in costs attributable to our Sonneborn operations for the year endedDecember 31, 2019 . During the years endedDecember 31, 2019 and 2018, we recorded$36.6 million and$97.0 million , respectively, RINs cost reduction as a result of ourCheyenne Refinery andWoods Cross Refinery small refinery exemptions. Also, during the year endedDecember 31, 2019 , we recorded an$18.0 million reduction to cost of products sold as a result ofU.S. blender's tax credit legislation that was signed inDecember 2019 and applied retroactively for the years 2019 and 2018. Gross Refinery MarginsGross refinery margin per barrel sold decreased 10% from$17.71 for the year endedDecember 31, 2018 to$15.96 for the year endedDecember 31, 2019 . This was due to the effects of a decrease in the average per barrel sold sales price, partially offset by decreased crude oil and feedstock prices during the current year. Gross refinery margin 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 7A of Part II of this Form 10-K 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, increased 8% from$1,285.8 million for the year endedDecember 31, 2018 to$1,394.1 million for the year endedDecember 31, 2019 due principally to higher repair and maintenance costs related to aFebruary 2019 fire in an FCC unit at ourEl Dorado Refinery . Prior year period operating expenses included higher repair and maintenance costs as a result of theWoods Cross Refinery fire and resulting damage inMarch 2018 . Current year operating expenses include$54.3 million in costs attributable to our Sonneborn operations. 44
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Selling, General and Administrative Expenses Selling, general and administrative expenses increased 22% from$290.4 million for the year endedDecember 31, 2018 to$354.2 million for the year endedDecember 31, 2019 . Current year selling, general and administrative expenses include$29.7 million in costs attributable to our Sonneborn operations. Additionally, direct integration and regulatory costs of our recently acquired Sonneborn operations were$24.2 million for the year endedDecember 31, 2019 . We incurred$3.6 million in integration costs of ourPetro-Canada Lubricants business during the year endedDecember 31, 2018 . Depreciation and Amortization Expenses Depreciation and amortization increased 17% from$437.3 million for the year endedDecember 31, 2018 to$509.9 million for the year endedDecember 31, 2019 . This increase was due principally to depreciation and amortization attributable to capitalized improvement projects and capitalized refinery turnaround costs. Current year depreciation and amortization expenses include$33.6 million in costs attributable to our Sonneborn operations. Goodwill Impairment During the year endedDecember 31, 2019 , we recorded goodwill impairment charges of$152.7 million that relate to PCLI. See Note 11 "Goodwill , Long-lived Assets and Intangibles" in the Notes to Consolidated Financial Statements for additional information on the PCLI impairment. Interest Income Interest income for the year endedDecember 31, 2019 was$22.1 million compared to$16.9 million for the year endedDecember 31, 2018 . This increase was due to higher interest rates during 2019. Interest Expense Interest expense was$143.3 million for the year endedDecember 31, 2019 compared to$131.4 million for the year endedDecember 31, 2018 . This increase was due to interest attributable to higher HEP debt levels during the current year relative to the same period of 2018. For the years endedDecember 31, 2019 and 2018, interest expense included$74.8 million and$71.9 million , respectively, in interest costs attributable to HEP operations. Gain on Foreign Currency Transactions Remeasurement adjustments resulting from the conversion of the intercompany financing structure on our PCLI acquisition from local currencies to theU.S. dollar resulted in gains of$5.4 million and$6.2 million for the years endedDecember 31, 2019 and 2018, respectively. For the years endedDecember 31, 2019 and 2018, gain on foreign currency translation included a loss of$17.4 million and a gain of$41.8 million , respectively, on foreign exchange forward contracts (utilized as an economic hedge). Income Taxes For the year endedDecember 31, 2019 , we recorded an income tax expense of$299.2 million compared to$347.2 million for the year endedDecember 31, 2018 . Our effective tax rates, before consideration of earnings attributable to the noncontrolling interest, were 25.5% and 22.8% for the years endedDecember 31, 2019 and 2018, respectively. Our current year effective tax rate reflects the effects of the$152.7 million goodwill impairment charge that is not deductible for income 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. AtDecember 31, 2019 , we were in compliance with all covenants, had no outstanding borrowings and had outstanding letters of credit totaling$4.9 million under the HollyFrontier 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 one-year 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. 45
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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 year endedDecember 31, 2019 , HEP received advances totaling$365.5 million and repaid$323.0 million under the HEP Credit Agreement. AtDecember 31, 2019 , HEP was in compliance with all of its covenants, had outstanding borrowings of$965.5 million and no outstanding letters of credit under the HEP Credit Agreement. 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 maturing inFebruary 2028 . OnFebruary 5, 2020 , HEP redeemed its existing$500 million 6.0% senior notes at a redemption cost of$522.5 million . HEP will record any early extinguishment losses associated with this redemption during the first quarter of 2020. HEP funded the$522.5 million redemption with proceeds from the issuance of its 5.0% senior notes and borrowing under the HEP Credit Agreement.
See Note 13 "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 year endedDecember 31, 2019 , HEP did not issue any common units under this program. As ofDecember 31, 2019 , HEP has issued 2,413,153 common 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, 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, support of our master limited partnership and repurchases of our common stock under our share repurchase program. As ofDecember 31, 2019 , our cash and cash equivalents totaled$885.2 million . 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 our Board of Directors. As ofDecember 31, 2019 , we had remaining authorization to repurchase up to$1.0 billion 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. Cash and cash equivalents decreased$269.6 million for the year endedDecember 31, 2019 . Net cash used by investing and financing activities of$972.9 million and$848.3 million , respectively, exceeded cash provided by operating activities of$1,548.6 million . 46
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Cash Flows - Operating Activities
Year EndedDecember 31, 2019 Compared to Year EndedDecember 31, 2018 Net cash flows provided by operating activities were$1,548.6 million for the year endedDecember 31, 2019 compared to$1,554.4 million for the year endedDecember 31, 2018 , a decrease of$5.8 million . Net income for the year endedDecember 31, 2019 was$872.4 million , a decrease of$304.9 million compared to$1,177.2 million for the year endedDecember 31, 2018 . Non-cash adjustments to net income consisting of depreciation and amortization, goodwill impairment, lower of cost or market inventory valuation adjustment, earnings of equity method investments, inclusive of distributions, loss on sale of assets, deferred income taxes, equity-based compensation expense and fair value changes to derivative instruments totaled$700.5 million for the year endedDecember 31, 2019 compared to$663.3 million for the same period in 2018. Changes in working capital items increased operating cash flows by$312.8 million and decreased operating cash flows by$87.7 million for the years endedDecember 31, 2019 and 2018, respectively. For the year endedDecember 31, 2019 , turnaround expenditures increased to$318.4 million from$217.2 million for the same period of 2018.
Cash Flows - Investing Activities and Planned Capital Expenditures
Year EndedDecember 31, 2019 Compared to Year EndedDecember 31, 2018 Net cash flows used for investing activities were$972.9 million for the year endedDecember 31, 2019 compared to$360.5 million for the year endedDecember 31, 2018 , an increase of$612.4 million . Current year investing activities reflect a net cash outflow of$662.7 million upon the acquisition of Sonneborn, and prior year investing activities reflect a net cash outflow of$54.2 million upon the acquisition ofRed Giant Oil . HEP invested$17.9 million in theCushing Connect Pipeline & Terminal LLC joint venture. Cash expenditures for properties, plants and equipment for 2019 decreased to$293.8 million from$311.0 million for the same period in 2018. These include HEP capital expenditures of$30.1 million and$54.1 million for the years endedDecember 31, 2019 and 2018, respectively. We received proceeds of$0.2 million and$3.1 million from the sale of assets during the years endedDecember 31, 2019 and 2018, respectively. 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. 47
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Expected capital and turnaround cash spending for 2020 is as follows:
Expected Cash Spending Range
(In millions)
HollyFrontier Capital Expenditures
Refining $ 270.0 $ 300.0
Renewable Diesel Unit 130.0
150.0
Lubricants and Specialty Products 40.0 60.0 Turnarounds and catalyst 125.0 150.0 Total HollyFrontier 565.0 660.0 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 $ 623.0$ 729.0
Cash Flows - Financing Activities
Year EndedDecember 31, 2019 Compared to Year EndedDecember 31, 2018 Net cash flows used for financing activities were$848.3 million for the year endedDecember 31, 2019 compared to$664.3 million for the year endedDecember 31, 2018 , an increase of$183.9 million . During the year endedDecember 31, 2019 , we purchased$533.1 million of treasury stock and paid$225.2 million in dividends. Also during this period, HEP received$365.5 million and repaid$323.0 million under the HEP Credit Agreement, paid distributions of$132.3 million to noncontrolling interests and received a contribution of$3.2 million from a noncontrolling interest. During 2018, we received$32.5 million in proceeds from our financing arrangement related to precious metals, purchased$363.4 million of treasury stock and paid$233.5 million in dividends. HEP received$337.0 million and repaid$426.0 million under the HEP Credit Agreement, received$114.8 million in net proceeds from the issuance of its common units and paid distributions of$125.7 million to noncontrolling interests. 48
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Contractual Obligations and Commitments
The following table presents our long-term contractual obligations as ofDecember 31, 2019 in total and by period due beginning in 2020. The table below does not include our contractual obligations to HEP under our long-term transportation agreements as these related-party transactions are eliminated in the Consolidated Financial Statements. A description of these agreements is provided under "Holly Energy Partners, L.P. " under Items 1 and 2, "Business and Properties." Payments Due by Period Contractual Obligations and Commitments Total 2020 2021 & 2022
2023 & 2024 Thereafter
(In thousands)
HollyFrontier Corporation Long-term debt - principal$ 1,000,000 $ - $ - $ -$ 1,000,000 Long-term debt - interest (1) 367,188 58,750 117,500 117,500 73,438 Financing arrangements 39,971 - 39,971 - - Supply agreements (2) 2,882,811 884,034 1,055,896 648,595 294,286 Transportation and storage agreements (3) 1,274,852 137,457 227,116 224,338 685,941 Operating and finance leases (4) 447,665 115,255 176,889 110,114 45,407 Other long-term obligations 13,296 8,494 2,696 1,106 1,000 6,025,783 1,203,990 1,620,068
1,101,653 2,100,072
Holly Energy Partners Long-term debt - principal (5) 1,465,500 - 965,500 500,000 - Long-term debt - interest (6) 227,200 64,900 114,800 47,500 - Operating and finance leases (4) 119,413 8,383 15,295 14,273 81,462 Other agreements 4,931 1,820 3,111 - - 1,817,044 75,103 1,098,706 561,773 81,462 Total$ 7,842,827 $ 1,279,093 $ 2,718,774 $ 1,663,426 $ 2,181,534
(1) Interest payments consist of interest on our 5.875% senior notes.
(2) We have long-term supply agreements to secure certain quantities of crude
oil, feedstock and other resources used in the production process at
market prices. We have estimated future payments under thesefixed-quantity agreements expiring between 2020 and 2025 using current
market rates. Additionally, commitments include purchases of 20,000 BPD
of crude oil under a 10-year agreement to supply our Woods Cross
Refinery .
(3) Consists of contractual obligations under agreements with third parties
for the transportation of crude oil, natural gas and feedstocks to our
refineries and for terminal and storage services under contracts expiring
between 2020 and 2039.
(4) Operating and finance lease obligations include options to extend terms
that are reasonably certain of being exercised.
(5) HEP's long-term debt consists of the
the 6% HEP senior notes and
under the HEP Credit Agreement. The HEP Credit Agreement expires in 2022.
(6) Interest payments consist of interest on the 6% HEP senior notes and
interest on long-term debt under the HEP Credit Agreement. Interest on
the HEP Credit Agreement debt is based on the weighted average rate of
3.61% at December 31, 2019 .
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. We consider the following policies to be the most critical to understanding the judgments that are involved and the uncertainties that could impact our results of operations, financial condition and cash flows. For additional information, see Note 1 "Description of Business and Summary of Significant Accounting Policies" in the Notes to Consolidated Financial Statements. 49
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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. AtDecember 31, 2019 and 2018, market values had fallen below historical LIFO inventory costs and, as a result, we recorded lower of cost or market inventory valuation reserves of$240.4 million and$360.1 million , respectively. AtDecember 31, 2019 , our lower of cost or market inventory valuation reserve was$240.4 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. Such a reduction to cost of products sold could be significant if inventory values return to historical cost price levels. Additionally, further decreases in overall inventory values could result in additional charges to cost of products sold should the lower of cost or market inventory valuation reserve be increased. 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 ofDecember 31, 2019 , 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 ,$327.6 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 the 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. During the second quarter of 2019, we performed interim goodwill impairment testing of the PCLI reporting unit included in our Lubricants and Specialty Products segment. We elected to perform this interim assessment due to the recent reorganization of our reporting unit structure within the Lubricants and Specialty Products segment, combined with the identification of events and circumstances which were indicators of potential goodwill impairment at PCLI, including recent declines in gross margins to lower than historic levels. These recent lower gross margins are in the base oil market which is largely attributed to the increase in global supply of base oils with a current outlook for continued near-term softness. Our interim goodwill impairment testing was performed as ofMay 31, 2019 . The estimated fair values of our goodwill reporting units within our Lubricants and Specialty Products segment were derived using a combination of both income and market approaches. The income approach reflects expected future cash flows based on estimated future production volumes, selling prices, gross margins, operating costs and capital expenditures. Our market approach includes both the guideline public company and guideline transaction methods. Both methods utilize pricing multiples derived from historical market transactions of other like-kind assets. As a result of our impairment testing, we determined that the carrying value of the PCLI reporting unit's goodwill within our Lubricants and Specialty Products segment was fully impaired and a goodwill impairment charge of$152.7 million was recorded. Our testing did not identify any other impairments. 50
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We performed our annual goodwill impairment testing as of
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 ofDecember 31, 2019 , we have the following notional contract volumes related to all outstanding derivative contracts used to mitigate commodity price and foreign currency risk: Notional Contract Volumes by Year of Maturity Total Outstanding Contract Description Notional 2020 2021 Unit of Measure Natural gas price swaps - long 3,600,000 1,800,000 1,800,000 MMBTU Crude oil price swaps (basis spread) - long 6,222,000 6,222,000 - Barrels NYMEX futures (WTI) - short 1,365,000 1,365,000 - Barrels Forward gasoline and diesel contracts - long 1,251,200 1,251,200 - Barrels Foreign currency forward contracts 434,340,348 434,340,348 - U.S. dollar Forward commodity contracts (platinum) (1) 41,147 - 41,147 Troy ounces
(1) Represents an embedded derivative within our catalyst financing arrangements, which may be refinanced or require repayment under certain conditions. See Note 13 "Debt" in the Notes to Consolidated Financial Statements for additional information on these financing arrangements.
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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 December 31 ,
Commodity-based Derivative Contracts 2019 2018
(In thousands)
Hypothetical 10% change in underlying
commodity prices $ 7,420 $ 1,485
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 rate HollyFrontier 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 of December 31, 2019 is presented below:
Estimated
Outstanding Estimated Change in
Principal Fair Value Fair Value
(In thousands)
HollyFrontier Senior Notes $ 1,000,000 $ 1,127,610 $ 22,552
HEP Senior Notes $ 500,000 $ 522,045 $ 10,892
For the variable rate HEP Credit Agreement, changes in interest rates would
affect cash flows, but not the fair value. At December 31, 2019 , outstanding
borrowings under the HEP Credit Agreement were $965.5 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.
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