HFC 9-30-2013 10Q




UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_________________________________________________________________
FORM 10-Q
_________________________________________________________________
(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2013
OR

¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from    __________   to   ____________         
Commission File Number 1-3876
 _________________________________________________________________
HOLLYFRONTIER CORPORATION
(Exact name of registrant as specified in its charter)
_________________________________________________________________
Delaware
 
75-1056913
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
2828 N. Harwood, Suite 1300
Dallas, Texas
 
75201
(Address of principal executive offices)
 
(Zip Code)
(214) 871-3555
(Registrant’s telephone number, including area code)
_________________________________________________________________
(Former name, former address and former fiscal year, if changed since last report)
_________________________________________________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes  ý    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
ý
Accelerated filer
¨
Non-accelerated filer
¨
Smaller reporting company
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  ý
199,022,042 shares of Common Stock, par value $.01 per share, were outstanding on October 31, 2013.



Table of Content

HOLLYFRONTIER CORPORATION
INDEX
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


Table of Content

FORWARD-LOOKING STATEMENTS

References herein to HollyFrontier Corporation (“HollyFrontier”) include HollyFrontier and its consolidated subsidiaries. In accordance with the Securities and Exchange Commission’s (“SEC”) “Plain English” guidelines, this Quarterly Report on Form 10-Q has been written in the first person. In this document, the words “we,” “our,” “ours” and “us” refer only to HollyFrontier and its consolidated subsidiaries or to HollyFrontier or an individual subsidiary and not to any other person with certain exceptions. Generally, the words “we,” “our,” “ours” and “us” include Holly Energy Partners, L.P. (“HEP”) and its subsidiaries as consolidated subsidiaries of HollyFrontier, unless when used in disclosures of transactions or obligations between HEP and HollyFrontier or its other subsidiaries. This document contains certain disclosures of agreements that are specific to HEP and its consolidated subsidiaries and do not necessarily represent obligations of HollyFrontier. When used in descriptions of agreements and transactions, “HEP” refers to HEP and its consolidated subsidiaries.

This Quarterly Report on Form 10-Q contains certain “forward-looking statements” within the meaning of the federal securities laws. All statements, other than statements of historical fact included in this Form 10-Q, including, but not limited to, those under “Results of Operations,” “Liquidity and Capital Resources” and “Risk Management” in Part I, Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and those in Part II, Item 1 “Legal Proceedings” are forward-looking statements. These statements are based on management’s beliefs and assumptions using currently available information and expectations as of the date hereof, are not guarantees of future performance and involve certain risks and uncertainties. Although we believe that the expectations reflected in these forward-looking statements are reasonable, we cannot assure you that our expectations will prove to be correct. Therefore, actual outcomes and results could materially differ from what is expressed, implied or forecast in these statements. Any differences could be caused by a number of factors including, but not limited to:

risks and uncertainties with respect to the actions of actual or potential competitive suppliers of refined petroleum products in our markets;
the demand for and supply of crude oil and refined products;
the spread between market prices for refined products and market prices for crude oil;
the possibility of constraints on the transportation of refined products;
the possibility of inefficiencies, curtailments or shutdowns in refinery operations or pipelines;
effects of governmental and environmental regulations and policies;
the availability and cost of our financing;
the effectiveness of our capital investments and marketing strategies;
our efficiency in carrying out construction projects;
our ability to acquire refined product operations or pipeline and terminal operations on acceptable terms and to integrate any existing or future acquired operations;
the possibility of terrorist attacks and the consequences of any such attacks;
general economic conditions; and
other financial, operational and legal risks and uncertainties detailed from time to time in our SEC filings.

Cautionary statements identifying important factors that could cause actual results to differ materially from our expectations are set forth in this Form 10-Q, including without limitation, the forward-looking statements that are referred to above. This summary discussion should be read in conjunction with the discussion of the known material risk factors and other cautionary statements under the heading “Risk Factors” included in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2012 and in Item 1A of our Quarterly Report on Form 10-Q for the quarter ended March 31, 2013 and in conjunction with the discussion in this Form 10-Q in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the heading “Liquidity and Capital Resources.” All forward-looking statements included in this Form 10-Q and all subsequent written or oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. The forward-looking statements speak only as of the date made and, other than as required by law, we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

3

Table of Content


PART I. FINANCIAL INFORMATION

DEFINITIONS

Within this report, the following terms have these specific meanings:

Alkylation” means the reaction of propylene or butylene (olefins) with isobutane to form an iso-paraffinic gasoline (inverse of cracking).

Aromatic oil” is long chain oil that is highly aromatic in nature and is used to manufacture tires and industrial rubber products and in the production of specialty asphalt.

BPD” means the number of barrels per calendar day of crude oil or petroleum products.

BPSD” means the number of barrels per stream day (barrels of capacity in a 24 hour period) of crude oil or petroleum products.

“Biodiesel” means a clean alternative fuel produced from renewable biological resources.

Black wax crude oil” is a low sulfur, low gravity crude oil produced in the Uintah Basin in Eastern Utah that has certain characteristics that require specific facilities to transport, store and refine into transportation fuels.

Catalytic reforming” means a refinery process which uses a precious metal (such as platinum) based catalyst to convert low octane naphtha to high octane gasoline blendstock and hydrogen. The hydrogen produced from the reforming process is used to desulfurize other refinery oils and is a primary source of hydrogen for the refinery.

Cracking” means the process of breaking down larger, heavier and more complex hydrocarbon molecules into simpler and lighter molecules.

Crude distillation” means the process of distilling vapor from liquid crudes, usually by heating, and condensing the vapor slightly above atmospheric pressure turning it back to liquid in order to purify, fractionate or form the desired products.

Ethanol” means a high octane gasoline blend stock that is used to make various grades of gasoline.

FCC,” or fluid catalytic cracking, means a refinery process that breaks down large complex hydrocarbon molecules into smaller more useful ones using a circulating bed of catalyst at relatively high temperatures.

Hydrodesulfurization” means to remove sulfur and nitrogen compounds from oil or gas in the presence of hydrogen and a catalyst at relatively high temperatures.

Hydrogen plant” means a refinery unit that converts natural gas and steam to high purity hydrogen, which is then used in the hydrodesulfurization, hydrocracking and isomerization processes.

HF alkylation,” or hydrofluoric alkylation, means a refinery process which combines isobutane and C3/C4 olefins using HF acid as a catalyst to make high octane gasoline blend stock.

Isomerization” means a refinery process for rearranging the structure of C5/C6 molecules without changing their size or chemical composition and is used to improve the octane of C5/C6 gasoline blendstocks.

LPG” means liquid petroleum gases.

Lubricant” or “lube” means a solvent neutral paraffinic product used in commercial heavy duty engine oils, passenger car oils and specialty products for industrial applications such as heat transfer, metalworking, rubber and other general process oil.

“MSAT2” means Control of Hazardous Air Pollutants from Mobile Sources, a rule issued by the U.S. Environmental Protection Agency to reduce hazardous emissions from motor vehicles and motor vehicle fuels.


4

Table of Content

MEK” means a lube process that separates waxy oil from non-waxy oils using methyl ethyl ketone as a solvent.

MMBTU” means one million British thermal units.

Natural gasoline” means a low octane gasoline blend stock that is purchased and used to blend with other high octane stocks produced to make various grades of gasoline.

Paraffinic oil” is a high paraffinic, high gravity oil produced by extracting aromatic oils and waxes from gas oil and is used in producing high-grade lubricating oils.

Refinery gross margin” means the difference between average net sales price and average product costs per produced barrel of refined products sold. This does not include the associated depreciation and amortization costs.

Reforming” means the process of converting gasoline type molecules into aromatic, higher octane gasoline blend stocks while producing hydrogen in the process.

Roofing flux” is produced from the bottom cut of crude oil and is the base oil used to make roofing shingles for the housing industry.

ROSE,” or “Solvent deasphalter / residuum oil supercritical extraction,” means a refinery unit that uses a light hydrocarbon like propane or butane to extract non-asphaltene heavy oils from asphalt or atmospheric reduced crude. These deasphalted oils are then further converted to gasoline and diesel in the FCC process. The remaining asphaltenes are either sold, blended to fuel oil or blended with other asphalt as a hardener.

Scanfiner” is a refinery unit that removes sulfur from gasoline to produce low sulfur gasoline blendstock.

Sour crude oil” means crude oil containing quantities of sulfur greater than 0.4 percent by weight, while “sweet crude oil” means crude oil containing quantities of sulfur equal to or less than 0.4 percent by weight.

Vacuum distillation” means the process of distilling vapor from liquid crudes, usually by heating, and condensing the vapor below atmospheric pressure turning it back to a liquid in order to purify, fractionate or form the desired products.

“WCS” means Western Canada Select crude oil and is made up of Canadian heavy conventional and bitumen crude oils blended with sweet synthetic and condensate diluents.

“WTI” means West Texas Intermediate and is a grade of crude oil used as a common benchmark in oil pricing. WTI is a sweet crude oil and has a relatively low density.

“WTS” means West Texas Sour, a medium sour crude oil.


5

Table of Content

Item 1.
Financial Statements
HOLLYFRONTIER CORPORATION
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
 
September 30,
2013
 
December 31, 2012
 
(Unaudited)
 
 
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents (HEP: $11,220 and $5,237, respectively)
$
1,294,484

 
$
1,757,699

Marketable securities
656,749

 
630,586

Accounts receivable: Product and transportation (HEP: $35,876 and $38,097, respectively)
676,797

 
587,728

Crude oil resales
78,875

 
46,502

 
755,672

 
634,230

Inventories: Crude oil and refined products
1,461,310

 
1,238,678

Materials, supplies and other (HEP: $1,638 and $1,259, respectively)
86,863

 
80,954

 
1,548,173

 
1,319,632

Income taxes receivable
74,287

 
74,957

Prepayments and other (HEP: $2,701 and $2,360, respectively)
80,770

 
53,161

Total current assets
4,410,135

 
4,470,265

 
 
 
 
Properties, plants and equipment, at cost (HEP: $1,177,772 and $1,155,710, respectively)
4,207,876

 
3,943,114

Less accumulated depreciation (HEP: $(179,215) and $(141,154), respectively)
(895,621
)
 
(748,414
)
 
3,312,255

 
3,194,700

Marketable securities (long-term)
5,415

 
5,116

Other assets: Turnaround costs
257,086

 
151,764

Goodwill (HEP: $288,991 and $288,991, respectively)
2,338,302

 
2,338,302

Intangibles and other (HEP: $74,385 and $76,300, respectively)
175,451

 
168,850

 
2,770,839

 
2,658,916

Total assets
$
10,498,644

 
$
10,328,997

 
 
 
 
LIABILITIES AND EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable (HEP: $13,001 and $12,030, respectively)
$
1,615,970

 
$
1,314,151

Accrued liabilities (HEP: $22,324 and $23,705, respectively)
144,038

 
195,077

Deferred income tax liabilities
133,940

 
145,216

Total current liabilities
1,893,948

 
1,654,444

 
 
 
 
Long-term debt (HEP: $809,391 and $864,673, respectively)
999,884

 
1,336,238

Deferred income taxes (HEP: $5,287 and $4,951, respectively)
658,143

 
536,670

Other long-term liabilities (HEP: $33,139 and $28,683, respectively)
150,519

 
158,987

 
 
 
 
Equity:
 
 
 
HollyFrontier stockholders’ equity:
 
 
 
Preferred stock, $1.00 par value – 5,000,000 shares authorized; none issued

 

Common stock $.01 par value – 320,000,000 shares authorized; 255,962,866 shares issued as of September 30, 2013 and December 31, 2012
2,560

 
2,560

Additional capital
3,991,159

 
3,911,353

Retained earnings
3,241,694

 
3,054,769

Accumulated other comprehensive income (loss)
36,174

 
(8,425
)
Common stock held in treasury, at cost – 56,516,027 and 52,411,370 shares as of September 30, 2013 and December 31, 2012, respectively
(1,097,428
)
 
(907,303
)
Total HollyFrontier stockholders’ equity
6,174,159

 
6,052,954

Noncontrolling interest
621,991

 
589,704

Total equity
6,796,150

 
6,642,658

Total liabilities and equity
$
10,498,644

 
$
10,328,997


Parenthetical amounts represent asset and liability balances attributable to Holly Energy Partners, L.P. (“HEP”) as of September 30, 2013 and December 31, 2012. HEP is a consolidated variable interest entity.

See accompanying notes.

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Table of Content

HOLLYFRONTIER CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(In thousands, except per share data)
 
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2013
 
2012
 
2013
 
2012
 
 
 
 
 
 
 
 
 
Sales and other revenues
 
$
5,327,122

 
$
5,204,798

 
$
15,333,759

 
$
14,943,217

Operating costs and expenses:
 
 
 
 
 
 
 
 
Cost of products sold (exclusive of depreciation and amortization)
 
4,809,990

 
3,898,736

 
13,059,333

 
11,767,417

Operating expenses (exclusive of depreciation and amortization)
 
256,318

 
233,859

 
798,959

 
698,212

General and administrative expenses (exclusive of depreciation and amortization)
 
28,937

 
28,787

 
92,135

 
88,421

Depreciation and amortization
 
82,127

 
65,112

 
224,381

 
178,162

Total operating costs and expenses
 
5,177,372

 
4,226,494

 
14,174,808

 
12,732,212

Income from operations
 
149,750

 
978,304

 
1,158,951

 
2,211,005

Other income (expense):
 
 
 
 
 
 
 
 
Earnings (loss) of equity method investments
 
159

 
852

 
(871
)
 
2,455

Interest income
 
1,482

 
2,219

 
3,791

 
3,360

Interest expense
 
(13,954
)
 
(21,103
)
 
(55,068
)
 
(81,360
)
Loss on early extinguishment of debt
 

 

 
(22,109
)
 

Gain on sale of marketable equity securities
 

 

 

 
326

 
 
(12,313
)
 
(18,032
)
 
(74,257
)
 
(75,219
)
Income before income taxes
 
137,437

 
960,272

 
1,084,694

 
2,135,786

Income tax provision:
 
 
 
 
 
 
 
 
Current
 
(10,454
)
 
324,211

 
339,612

 
753,018

Deferred
 
58,982

 
25,411

 
47,053

 
22,728

 
 
48,528

 
349,622

 
386,665

 
775,746

Net income
 
88,909

 
610,650

 
698,029

 
1,360,040

Less net income attributable to noncontrolling interest
 
6,619

 
10,277

 
25,089

 
24,472

Net income attributable to HollyFrontier stockholders
 
$
82,290

 
$
600,373

 
$
672,940

 
$
1,335,568

Earnings per share attributable to HollyFrontier stockholders:
 
 
 
 
 
 
 
 
Basic
 
$
0.41

 
$
2.95

 
$
3.33

 
$
6.46

Diluted
 
$
0.41

 
$
2.94

 
$
3.33

 
$
6.44

Cash dividends declared per common share
 
$
0.80

 
$
1.15

 
$
2.40

 
$
2.40

Average number of common shares outstanding:
 
 
 
 
 
 
 
 
Basic
 
199,098

 
202,655

 
201,109

 
205,768

Diluted
 
199,509

 
203,532

 
201,486

 
206,654


See accompanying notes.

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Table of Content

HOLLYFRONTIER CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(In thousands)
 
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2013
 
2012
 
2013
 
2012
 
 
 
 
 
 
 
 
 
Net income
 
$
88,909

 
$
610,650

 
$
698,029

 
$
1,360,040

Other comprehensive income (loss):
 
 
 
 
 
 
 
 
Securities available-for-sale:
 
 
 
 
 
 
 
 
Unrealized gain (loss) on available-for-sale securities
 
44

 
(2
)
 
18

 
189

Reclassification adjustments to net income on sale or maturity of marketable securities
 
(10
)
 
15

 
(13
)
 
(392
)
Net unrealized gain (loss) on available-for-sale securities
 
34

 
13

 
5

 
(203
)
Hedging instruments:
 
 
 
 
 
 
 
 
Change in fair value of cash flow hedging instruments
 
25,423

 
(146,437
)
 
42,739

 
(261,893
)
Reclassification adjustments to net income on settlement of cash flow hedging instruments
 
(21,478
)
 
33,830

 
153

 
21,925

Amortization of unrealized loss attributable to discontinued cash flow hedges
 
270

 
1,274

 
1,479

 
3,821

Net unrealized gain (loss) on hedging instruments
 
4,215

 
(111,333
)
 
44,371

 
(236,147
)
Settlement of pension plan obligations
 

 

 
28,986

 

Actuarial loss on post-retirement healthcare plan reclassified to net income upon partial plan settlement
 

 

 
1,726

 

Pension plan curtailment adjustment
 

 

 

 
7,102

Other comprehensive income (loss) before income taxes
 
4,249

 
(111,320
)
 
75,088

 
(229,248
)
Income tax expense (benefit)
 
1,946

 
(43,353
)
 
28,421

 
(89,383
)
Other comprehensive income (loss)
 
2,303

 
(67,967
)
 
46,667

 
(139,865
)
Total comprehensive income
 
91,212

 
542,683

 
744,696

 
1,220,175

Less noncontrolling interest in comprehensive income
 
5,954

 
10,406

 
27,156

 
25,001

Comprehensive income attributable to HollyFrontier stockholders
 
$
85,258

 
$
532,277

 
$
717,540

 
$
1,195,174


See accompanying notes.


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Table of Content

HOLLYFRONTIER CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
 
 
Nine Months Ended September 30,
 
 
2013
 
2012
Cash flows from operating activities:
 
 
 
 
Net income
 
$
698,029

 
$
1,360,040

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Depreciation and amortization
 
224,381

 
178,162

Distributions in excess of earnings of equity method investments
 
3,184

 
169

Loss on early extinguishment of debt attributable to unamortized discount
 
7,948

 

Gain on sale of marketable equity securities
 

 
(326
)
Deferred income taxes
 
47,053

 
22,728

Equity-based compensation expense
 
25,239

 
25,399

Change in fair value – derivative instruments
 
(39,745
)
 
(10,977
)
(Increase) decrease in current assets:
 
 
 
 
Accounts receivable
 
(110,402
)
 
(29,474
)
Inventories
 
(228,541
)
 
(370,831
)
Income taxes receivable
 
670

 
53,465

Prepayments and other
 
18,983

 
16,690

Increase (decrease) in current liabilities:
 
 
 
 
Accounts payable
 
298,916

 
(96,263
)
Income taxes payable
 

 
110,533

Accrued liabilities
 
(7,888
)
 
(6,166
)
Turnaround expenditures
 
(170,468
)
 
(74,612
)
Other, net
 
34,804

 
(6,749
)
Net cash provided by operating activities
 
802,163

 
1,171,788

 
 
 
 
 
Cash flows from investing activities:
 
 
 
 
Additions to properties, plants and equipment
 
(255,090
)
 
(178,235
)
Additions to properties, plants and equipment – HEP
 
(31,099
)
 
(29,302
)
Acquisition of trucking operations
 
(11,301
)
 

Proceeds from sale of property and equipment
 
5,802

 

Investment in Sabine Biofuels
 
(3,000
)
 
(2,000
)
Net advances to Sabine Biofuels
 
(11,040
)
 

Purchases of marketable securities
 
(672,701
)
 
(236,315
)
Sales and maturities of marketable securities
 
646,301

 
212,216

Net cash used for investing activities
 
(332,128
)
 
(233,636
)
 
 
 
 
 
Cash flows from financing activities:
 
 
 
 
Borrowings under credit agreement – HEP
 
256,500

 
523,000

Repayments under credit agreement – HEP
 
(312,500
)
 
(292,000
)
Net proceeds from issuance of senior notes – HEP
 

 
294,750

Redemption of senior notes – HFC
 
(286,812
)
 
(205,000
)
Redemption premium on early extinguishment of debt
 
(14,161
)
 

Principal tender on senior notes – HEP
 

 
(185,000
)
Proceeds from sale of HEP common units
 
73,444

 

Proceeds from common unit offerings - HEP
 
73,444

 

Purchase of treasury stock
 
(184,947
)
 
(190,307
)
Structured stock repurchase arrangement
 

 
8,620

Contribution from joint venture partner
 

 
6,000

Dividends
 
(485,411
)
 
(382,610
)
Distributions to noncontrolling interest
 
(52,835
)
 
(43,749
)
Excess tax benefit from equity-based compensation
 
2,739

 
16,021

Purchase of units for incentive grants – HEP
 
(3,379
)
 
(4,919
)
Deferred financing costs and other
 
668

 
(4,454
)
Net cash used for financing activities
 
(933,250
)
 
(459,648
)
 
 
 
 
 
Cash and cash equivalents:
 
 
 
 
Increase (decrease) for the period
 
(463,215
)
 
478,504

Beginning of period
 
1,757,699

 
1,578,904

End of period
 
$
1,294,484

 
$
2,057,408

 
 
 
 
 
Supplemental disclosure of cash flow information:
 
 
 
 
Cash paid during the period for:
 
 
 
 
Interest
 
$
67,822

 
$
77,184

Income taxes
 
$
336,588

 
$
622,314


See accompanying notes.

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Table of Content

HOLLYFRONTIER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


NOTE 1:
Description of Business and Presentation of Financial Statements

References herein to HollyFrontier Corporation (“HollyFrontier”) include HollyFrontier and its consolidated subsidiaries. In accordance with the Securities and Exchange Commission’s (“SEC”) “Plain English” guidelines, this Quarterly Report on Form 10-Q has been written in the first person. In these financial statements, the words “we,” “our,” “ours” and “us” refer only to HollyFrontier and its consolidated subsidiaries or to HollyFrontier or an individual subsidiary and not to any other person, with certain exceptions. Generally, the words “we,” “our,” “ours” and “us” include Holly Energy Partners, L.P. (“HEP”) and its subsidiaries as consolidated subsidiaries of HollyFrontier, unless when used in disclosures of transactions or obligations between HEP and HollyFrontier or its other subsidiaries. These financial statements contain certain disclosures of agreements that are specific to HEP and its consolidated subsidiaries and do not necessarily represent obligations of HollyFrontier. When used in descriptions of agreements and transactions, “HEP” refers to HEP and its consolidated subsidiaries.

We are principally an independent petroleum refiner that produces high-value light products such as gasoline, diesel fuel, jet fuel, specialty lubricant products, and specialty and modified asphalt. We own and operate petroleum refineries that serve markets throughout the Mid-Continent, Southwest and Rocky Mountain regions of the United States. As of September 30, 2013, we:

owned and operated a petroleum refinery in El Dorado, Kansas (the “El Dorado Refinery”), two refinery facilities located in Tulsa, Oklahoma (collectively, the “Tulsa Refineries”), a refinery in Artesia, New Mexico that is operated in conjunction with crude oil distillation and vacuum distillation and other facilities situated 65 miles away in Lovington, New Mexico (collectively, the “Navajo Refinery”), a refinery located in Cheyenne, Wyoming (the “Cheyenne Refinery”) and a refinery in Woods Cross, Utah (the “Woods Cross Refinery”);
owned and operated NK Asphalt Partners (“NK Asphalt”) which operates various asphalt terminals in Arizona and New Mexico;
owned a 50% interest in Sabine Biofuels II, LLC (“Sabine Biofuels”), a biodiesel production facility located in Port Arthur, Texas; and
owned a 39% interest in HEP, a consolidated variable interest entity (“VIE”), which includes our 2% general partner interest. HEP owns and operates logistic assets consisting of petroleum product and crude oil pipelines and terminal, tankage and loading rack facilities that principally support our refining and marketing operations in the Mid-Continent, Southwest and Rocky Mountain regions of the United States and Alon USA, Inc.'s (“Alon”) refinery in Big Spring, Texas. Additionally, HEP owns a 75% interest in UNEV Pipeline, LLC (“UNEV”), which owns a 12-inch refined products pipeline from Salt Lake City, Utah to Las Vegas, Nevada, together with terminal facilities in the Cedar City, Utah and North Las Vegas areas (the “UNEV Pipeline”), and a 25% interest in SLC Pipeline LLC (the “SLC Pipeline”), a 95-mile intrastate pipeline system that serves refineries in the Salt Lake City area.

We have prepared these consolidated financial statements without audit. In management’s opinion, these consolidated financial statements include all normal recurring adjustments necessary for a fair presentation of our consolidated financial position as of September 30, 2013, the consolidated results of operations and comprehensive income for the three and nine months ended September 30, 2013 and 2012 and consolidated cash flows for the nine months ended September 30, 2013 and 2012 in accordance with the rules and regulations of the SEC. Although certain notes and other information required by generally accepted accounting principles in the United States (“GAAP”) have been condensed or omitted, we believe that the disclosures in these consolidated financial statements are adequate to make the information presented not misleading. These consolidated financial statements should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2012 that has been filed with the SEC.

Our results of operations for the nine months ended September 30, 2013 are not necessarily indicative of the results of operations to be realized for the year ending December 31, 2013.

Balance Sheet Offsetting: We purchase and sell inventories of crude oil with certain same-parties that are net settled in accordance with contractual net settlement provisions. Our policy is to present such balances on a net basis because it more appropriately presents our economic resources (accounts receivable) and claims against us (accounts payable) and the future cash flows associated with such assets and liabilities.


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HOLLYFRONTIER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Continued


Accounts Receivable: Our accounts receivable consist of amounts due from customers that are primarily companies in the petroleum industry. Credit is extended based on our evaluation of the customer’s financial condition, and in certain circumstances collateral, such as letters of credit or guarantees, is required. We reserve for doubtful accounts based on our historical loss experience as well as specific accounts identified as high risk, which historically have been minimal. Credit losses are charged to the allowance for doubtful accounts when an account is deemed uncollectible. Our allowance for doubtful accounts was $2.5 million at September 30, 2013 and December 31, 2012.

Inventories: We use the last-in, first-out (“LIFO”) method of valuing inventory. Under the LIFO method, an actual valuation of inventory can only be 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.

Goodwill: 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 events or circumstances indicate the possibility of impairment. As of September 30, 2013, there have been no impairments to goodwill.


NOTE 2:
Variable Interest Entities

Holly Energy Partners

HEP, a consolidated VIE, is a publicly held master limited partnership that was formed to acquire, own and operate the petroleum product and crude oil pipeline and terminal, tankage and loading rack facilities that support our refining and marketing operations in the Mid-Continent, Southwest and Rocky Mountain regions of the United States. HEP also owns and operates refined product pipelines and terminals, located primarily in Texas, that serve Alon's refinery in Big Spring, Texas.

As of September 30, 2013, we owned a 39% interest in HEP, including the 2% general partner interest. We are the primary beneficiary of HEP's earnings and cash flows and therefore we consolidate HEP. See Note 16 for supplemental guarantor/non-guarantor financial information, including HEP balances included in these consolidated financial statements. All intercompany transactions with HEP are eliminated in our consolidated financial statements.

HEP has two primary customers (including us) and generates revenues by charging tariffs for transporting petroleum products and crude oil though its pipelines, by charging fees for terminalling refined products and other hydrocarbons, and storing and providing other services at its storage tanks and terminals. Under our long-term transportation agreements with HEP (discussed further below), we accounted for 84% of HEP’s total revenues for the nine months ended September 30, 2013. We do not provide financial or equity support through any liquidity arrangements and / or debt guarantees to HEP.

HEP has outstanding debt under a senior secured revolving credit agreement and its senior notes. With the exception of the assets of HEP Logistics Holdings, L.P., one of our wholly-owned subsidiaries and HEP’s general partner, HEP’s creditors have no recourse to our assets. Any recourse to HEP’s general partner would be limited to the extent of HEP Logistics Holdings, L.P.’s assets, which other than its investment in HEP are not significant. Furthermore, our creditors have no recourse to the assets of HEP and its consolidated subsidiaries. See Note 9 for a description of HEP’s debt obligations.

HEP has risk associated with its operations. If a major customer of HEP were to terminate its contracts or fail to meet desired shipping or throughput levels for an extended period of time, revenue would be reduced and HEP could suffer substantial losses to the extent that a new customer is not found. In the event that HEP incurs a loss, our operating results will reflect HEP’s loss, net of intercompany eliminations, to the extent of our ownership interest in HEP at that point in time.


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HOLLYFRONTIER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Continued


Transportation Agreements
HEP serves our refineries under long-term pipeline and terminal, tankage and throughput agreements expiring from 2019 through 2026. Under these agreements, we pay HEP fees to transport, store and throughput volumes of refined product and crude oil on HEP's pipeline and terminal, tankage and loading rack facilities that result in minimum annual payments to HEP including UNEV (a consolidated subsidiary of HEP). Under these agreements, the agreed upon tariff rates are subject to annual tariff rate adjustments on July 1 at a rate based upon the percentage change in Producer Price Index (“PPI”) or Federal Energy Regulatory Commission (“FERC”) index. As of September 30, 2013, these agreements result in minimum annualized payments to HEP of $225.5 million.

Since HEP is a consolidated VIE, our transactions with HEP including fees paid under our transportation agreements with HEP are eliminated and have no impact on our consolidated financial statements.

HEP Common Unit Offering
In March 2013, HEP closed on a public offering of 1,875,000 of its common units. Additionally, our wholly-owned subsidiary, HollyFrontier Holdings LLC, as a selling unitholder, closed on a public sale of 1,875,000 HEP common units held by it. HEP used net proceeds of $73.4 million to repay indebtedness incurred under its credit facility and for general partnership purposes. As a result of these transactions and resulting HEP ownership changes, we adjusted additional capital and equity attributable to HEP's noncontrolling interest holders to reallocate HEP's equity among its unitholders.

Sabine Biofuels

We have a 50% ownership interest in Sabine Biofuels, a biofuels production facility that is a VIE. We do not hold a controlling financial interest, nor are we its primary beneficiary. Accordingly, we account for our investment using the equity method of accounting which had a carrying amount of $10.3 million at September 30, 2013 and is classified as a noncurrent asset under “Intangibles and other” in our consolidated balance sheets. Also, we have extended a working capital facility to Sabine Biofuels having an outstanding balance of $15.2 million at September 30, 2013.

NOTE 3:
Financial Instruments

Our financial instruments consist of cash and cash equivalents, investments in marketable securities, accounts receivable, accounts payable, debt and derivative instruments. The carrying amounts of cash and cash equivalents, accounts receivable and accounts payable approximate fair value. HEP's outstanding credit agreement borrowings also approximate fair value as interest rates are reset frequently at current interest rates.

Fair value measurements are derived using inputs (assumptions that market participants would use in pricing an asset or liability, including assumptions about risk). GAAP categorizes inputs used in fair value measurements into three broad levels as follows:

(Level 1) Quoted prices in active markets for identical assets or liabilities.
(Level 2) Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets, similar assets and liabilities in markets that are not active or can be corroborated by observable market data.
(Level 3) Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. This includes valuation techniques that involve significant unobservable inputs.


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HOLLYFRONTIER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Continued


The carrying amounts and related estimated fair values of our investments in marketable securities, derivative instruments and senior notes at September 30, 2013 and December 31, 2012 were as follows:
 
 
 
 
 
 
Fair Value by Input Level
Financial Instrument
 
Carrying Amount
 
Fair Value
 
Level 1
 
Level 2
 
Level 3
 
 
(In thousands)
September 30, 2013
 
 
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
 
 
Marketable debt securities
 
$
662,164

 
$
662,164

 
$

 
$
662,164

 
$

NYMEX futures contracts
 
7,405

 
7,405

 
7,405

 

 

Commodity price swaps
 
84,762

 
84,762

 

 
58,450

 
26,312

HEP interest rate swaps
 
1,424

 
1,424

 

 
1,424

 

Total assets
 
$
755,755

 
$
755,755

 
$
7,405

 
$
722,038

 
$
26,312

 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
 
NYMEX futures contracts
 
$
1,934

 
$
1,934

 
$
1,934

 
$

 
$

Commodity price swaps
 
79,764

 
79,764

 

 
65,106

 
14,658

HollyFrontier senior notes
 
155,272

 
161,062

 

 
161,062

 

HEP senior notes
 
444,391

 
465,375

 

 
465,375

 

HEP interest rate swaps
 
1,976

 
1,976

 

 
1,976

 

Total liabilities
 
$
683,337

 
$
710,111

 
$
1,934

 
$
693,519

 
$
14,658

December 31, 2012
 
 
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
 
 
Marketable debt securities
 
$
635,702

 
$
635,702

 
$

 
$
635,702

 
$

Commodity price swaps
 
17,383

 
17,383

 

 
6,151

 
11,232

Total assets
 
$
653,085

 
$
653,085

 
$

 
$
641,853

 
$
11,232

 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
 
NYMEX futures contracts
 
$
5,563

 
$
5,563

 
$
5,563

 
$

 
$

Commodity price swaps
 
83,982

 
83,982

 

 
39,092

 
44,890

HollyFrontier senior notes
 
435,254

 
470,990

 

 
470,990

 

HEP senior notes
 
443,673

 
484,125

 

 
484,125

 

HEP interest rate swaps
 
3,430

 
3,430

 

 
3,430

 

Total liabilities
 
$
971,902

 
$
1,048,090

 
$
5,563

 
$
997,637

 
$
44,890


Level 1 Financial Instruments
Our NYMEX futures contracts are exchange traded and are measured and recorded at fair value using quoted market prices, a Level 1 input.

Level 2 Financial Instruments
Investments in marketable debt securities and derivative instruments consisting of commodity price swaps and HEP's interest rate swaps are measured and recorded at fair value using Level 2 inputs. The fair values of the commodity price and interest rate swap contracts are based on the net present value of expected future cash flows related to both variable and fixed rate legs of the respective swap agreements. The measurements are computed using market-based observable inputs, quoted forward commodity prices with respect to our commodity price swaps and the forward London Interbank Offered Rate (“LIBOR”) yield curve with respect to HEP's interest rate swaps. The fair value of the marketable debt securities and senior notes is based on values provided by a third-party, which were derived using market quotes for similar type instruments, a Level 2 input.


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HOLLYFRONTIER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Continued


Level 3 Financial Instruments
We have commodity price swap contracts that relate to forecasted sales of diesel and forecasted purchases of WCS and WTS for which quoted forward market prices are not readily available. The forward rate used to value these price swaps is derived using a projected forward rate using quoted market rates for similar products, adjusted for regional pricing and grade differentials, a Level 3 input.

The following table presents the changes in fair value of the Level 3 assets and liabilities (all related to derivative instruments) for the three and nine months ended September 30, 2013 and 2012:

 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
Level 3 Financial Instruments
 
2013
 
2012
 
2013
 
2012
 
 
(In thousands)
Asset (liability) balance at beginning of period
 
$
37,126

 
$
119,461

 
$
(33,658
)
 
$
31,616

Change in fair value:
 
 
 
 
 
 
 
 
Recognized in other comprehensive income
 
(9,956
)
 
(192,446
)
 
(8,542
)
 
(158,893
)
Recognized in cost of products sold
 
(17,194
)
 

 
30,027

 

Settlement date fair value of contractual maturities:
 
 
 
 
 
 
 
 
Recognized in sales and other revenues
 
10,138

 
44,937

 
25,454

 
99,229

Recognized in cost of products sold
 
(8,460
)
 

 
(1,627
)
 

Asset (liability) balance at end of period
 
$
11,654

 
$
(28,048
)
 
$
11,654

 
$
(28,048
)

A hypothetical change of 10% to the estimated future cash flows attributable to our Level 3 derivative instruments would result in an estimated fair value change of approximately $1.2 million.


NOTE 4:
Earnings Per Share

Basic earnings per share is calculated as net income attributable to HollyFrontier stockholders divided by the average number of shares of common stock outstanding. Diluted earnings per share assumes, when dilutive, the issuance of the net incremental shares from variable restricted and variable performance shares. The following is a reconciliation of the denominators of the basic and diluted per share computations for net income attributable to HollyFrontier stockholders:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2013
 
2012
 
2013
 
2012
 
 
(In thousands, except per share data)
Net income attributable to HollyFrontier stockholders
 
$
82,290

 
$
600,373

 
$
672,940

 
$
1,335,568

Participating securities' share in earnings
 
285

 
2,657

 
2,447

 
5,745

Net income attributable to common shares
 
$
82,005

 
$
597,716

 
$
670,493

 
$
1,329,823

Average number of shares of common stock outstanding
 
199,098

 
202,655

 
201,109

 
205,768

Effect of dilutive variable restricted shares and performance share units (1)
 
411

 
877

 
377

 
886

Average number of shares of common stock outstanding assuming dilution
 
199,509

 
203,532

 
201,486

 
206,654

Basic earnings per share
 
$
0.41

 
$
2.95

 
$
3.33

 
$
6.46

Diluted earnings per share
 
$
0.41

 
$
2.94

 
$
3.33

 
$
6.44

 
 
 
 
 
 
 
 
 
(1) Excludes anti-dilutive restricted and performance share units of:
 
251

 

 
1

 
3




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HOLLYFRONTIER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Continued


NOTE 5:
Stock-Based Compensation

As of September 30, 2013, we have two principal share-based compensation plans (collectively, the “Long-Term Incentive Compensation Plan”).

The compensation cost charged against income for these plans was $7.3 million for both the three months ended September 30, 2013 and 2012, and $22.6 million and $23.2 million for the nine months ended September 30, 2013 and 2012, respectively. Our accounting policy for the recognition of compensation expense for awards with pro-rata vesting (substantially all of our awards) is to expense the costs ratably over the vesting periods.

Additionally, HEP maintains a share-based compensation plan for Holly Logistic Services, L.L.C.'s non-employee directors and certain executives and employees. Compensation cost attributable to HEP’s share-based compensation plan was $0.7 million and $0.5 million for the three months ended September 30, 2013 and 2012, respectively, and $2.6 million and $2.1 million for the nine months ended September 30, 2013 and 2012, respectively.

Restricted Stock and Restricted Stock Units
Under our Long-Term Incentive Compensation Plan, we grant certain officers and other key employees restricted stock awards with awards generally vesting over a period of three years. Award recipients are generally entitled to all the rights of absolute ownership of the restricted shares from the date of grant (unless a recipient's tax election requires otherwise) including the right to vote the shares and to receive dividends. Upon vesting, restrictions on the restricted shares lapse at which time they convert to common shares. In addition, we grant non-employee directors restricted stock unit awards, which typically vest over a period of one year and are payable in stock. The fair value of each restricted stock and restricted stock unit award is measured based on the market price as of the date of grant and is amortized over the respective vesting period.

A summary of restricted stock and restricted stock unit activity and changes during the nine months ended September 30, 2013 is presented below:
Restricted Stock and Restricted Stock Units
 
Grants
 
Weighted Average Grant Date Fair Value
 
Aggregate Intrinsic Value ($000)
 
 
 
 
 
 
 
Outstanding at January 1, 2013 (non-vested)
 
843,527

 
$
34.52

 
 
Granted
 
33,181

 
46.09

 
 
Vesting (transfer/conversion to common stock)
 
(125,600
)
 
23.53

 
 
Forfeited
 
(14,661
)
 
35.78

 
 
Outstanding at September 30, 2013 (non-vested)
 
736,447

 
$
36.89

 
$
31,012


For the nine months ended September 30, 2013, 125,600 restricted stock and restricted stock units vested having a grant date fair value of $3.0 million. As of September 30, 2013, there was $8.3 million of total unrecognized compensation cost related to non-vested restricted stock and restricted stock unit grants. That cost is expected to be recognized over a weighted-average period of 1.0 years.

Performance Share Units
Under our Long-Term Incentive Compensation Plan, we grant certain officers and other key employees performance share units, which are payable in stock upon meeting certain criteria over the service period, and generally vest over a period of three years. Under the terms of our performance share unit grants, awards are subject to either a “financial performance” or “market performance” criteria, or both.

The fair value of performance share unit awards subject to financial performance criteria is computed using the grant date closing stock price of each respective award grant and will apply to the number of units ultimately awarded. The number of shares ultimately issued for each award will be based on our financial performance as compared to peer group companies over the performance period and can range from zero to 200%. As of September 30, 2013, estimated share payouts for outstanding non-vested performance share unit awards ranged from 110% to 170%.


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Table of Contents
HOLLYFRONTIER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Continued


For the performance share units subject to market performance criteria, performance is calculated as the total shareholder return achieved by HollyFrontier stockholders compared with the average shareholder return achieved by an equally-weighted peer group of independent refining companies over a three-year period. These share unit awards are valued using a Monte Carlo valuation model, which simulates future stock price movements using key inputs including grant date stock prices, expected stock price performance, expected rate of return and volatility. These units are payable in stock based on share price performance relative to the defined peer group and can range from zero to 200% of the initial target award.

A summary of performance share unit activity and changes during the nine months ended September 30, 2013 is presented below:
Performance Share Units
 
Grants
 
 
 
Outstanding at January 1, 2013 (non-vested)
 
875,574

Granted
 
528

Vesting and transfer of ownership to recipients
 

Forfeited
 
(19,382
)
Outstanding at September 30, 2013 (non-vested)
 
856,720


Based on the weighted-average grant date fair value of $35.41 per share, there was $18.4 million of total unrecognized compensation cost related to non-vested performance share units as of September 30, 2013. That cost is expected to be recognized over a weighted-average period of 1.2 years.


NOTE 6:
Cash and Cash Equivalents and Investments in Marketable Securities

Our investment portfolio at September 30, 2013 consisted of cash, cash equivalents and investments in marketable debt securities.

We invest in highly-rated marketable debt securities that have maturities at the date of purchase of greater than three months. We also invest in other marketable debt securities with the maximum maturity or put date of any individual issue generally not greater than two years from the date of purchase, which are usually held until maturity. All of these instruments are classified as available-for-sale. As a result, they are reported at fair value using quoted market prices. Interest income is recorded as earned. Unrealized gains and losses, net of related income taxes, are reported as a component of accumulated other comprehensive income. Upon sale or maturity, realized gains on our marketable debt securities are recognized as interest income. These gains are computed based on the specific identification of the underlying cost of the securities, net of unrealized gains and losses previously reported in other comprehensive income. Unrealized gains and losses on our available-for-sale securities are due to changes in market prices and are considered temporary.

The following is a summary of our available-for-sale securities:
 
 
Amortized Cost
 
Gross Unrealized Gain
 
Gross Unrealized Loss
 
Fair Value
(Net Carrying Amount)
 
 
(In thousands)
September 30, 2013
 
 
 
 
 
 
 
 
Certificates of deposit
 
$
69,756

 
$
16

 
$
(4
)
 
$
69,768

Commercial paper
 
40,237

 
10

 

 
40,247

Corporate debt securities
 
66,791

 
8

 
(16
)
 
66,783

State and political subdivisions debt securities
 
485,394

 
34

 
(62
)
 
485,366

Total marketable securities
 
$
662,178

 
$
68

 
$
(82
)
 
$
662,164

 
 
 
 
 
 
 
 
 
December 31, 2012
 
 
 
 
 
 
 
 
Certificates of deposit
 
$
82,791

 
$
14

 
$
(6
)
 
$
82,799

Commercial paper
 
45,737

 
17

 

 
45,754

Corporate debt securities
 
49,587

 
2

 
(30
)
 
49,559

State and political subdivisions debt securities
 
457,615

 
26

 
(51
)
 
457,590

Total marketable securities
 
$
635,730

 
$
59

 
$
(87
)
 
$
635,702



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Table of Contents
HOLLYFRONTIER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Continued


Interest income recognized on our marketable debt securities was $0.5 million and $0.2 million for the three months ended September 30, 2013 and 2012, respectively, and $1.6 million and $0.7 million for the nine months ended September 30, 2013 and 2012, respectively.


NOTE 7:
Inventories

Inventory consists of the following components:
 
 
September 30,
2013
 
December 31, 2012
 
 
(In thousands)
Crude oil
 
$
576,672

 
$
502,978

Other raw materials and unfinished products(1)
 
190,635

 
150,090

Finished products(2)
 
694,003

 
585,610

Process chemicals(3)
 
5,682

 
3,514

Repairs and maintenance supplies and other
 
81,181

 
77,440

Total inventory
 
$
1,548,173

 
$
1,319,632


(1)
Other raw materials and unfinished products include feedstocks and blendstocks, other than crude.
(2)
Finished products include gasolines, jet fuels, diesels, lubricants, asphalts, LPG’s and residual fuels.
(3)
Process chemicals include additives and other chemicals.


NOTE 8:
Environmental

We expensed $1.1 million and $1.7 million for the three months ended September 30, 2013 and 2012, respectively, and $1.9 million and $16.9 million for the nine months ended September 30, 2013 and 2012, respectively, for environmental remediation obligations. The accrued environmental liability reflected in our consolidated balance sheets was $82.7 million and $88.9 million at September 30, 2013 and December 31, 2012, respectively, of which $65.0 million and $72.6 million, respectively, were classified as other long-term liabilities. These accruals include remediation and monitoring costs expected to be incurred over an extended period of time (up to 30 years for certain projects).


NOTE 9:
Debt

HollyFrontier Credit Agreement
We have a $1 billion senior secured credit agreement that matures in July 2016 (the “HollyFrontier Credit Agreement”) and may be used to fund working capital requirements, capital expenditures, acquisitions and general corporate purposes. Obligations under the HollyFrontier Credit Agreement are collateralized by our inventory, accounts receivable and certain deposit accounts and guaranteed by our material, wholly-owned subsidiaries. At September 30, 2013, we were in compliance with all covenants, had no outstanding borrowings and had outstanding letters of credit totaling $28.9 million under the HollyFrontier Credit Agreement.

HEP Credit Agreement
HEP has a $550 million senior secured revolving credit facility that matures in June 2017 (the “HEP Credit Agreement”) and is available to fund capital expenditures, investments, acquisitions, distribution payments and working capital and for general partnership purposes. It is also available to fund letters of credit up to a $50 million sub-limit and to fund distributions to unitholders up to a $60 million sub-limit. At September 30, 2013, HEP was in compliance with all of its covenants, had outstanding borrowings of $365.0 million and no outstanding letters of credit under the HEP Credit Agreement.


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Table of Contents
HOLLYFRONTIER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Continued


HEP’s obligations under the HEP Credit Agreement are collateralized by substantially all of HEP’s assets (presented parenthetically in our consolidated balance sheets). Indebtedness under the HEP Credit Agreement involves recourse to HEP Logistics Holdings, L.P., its general partner, and is guaranteed by HEP’s wholly-owned subsidiaries. Any recourse to the general partner would be limited to the extent of HEP Logistics Holdings, L.P.’s assets, which other than its investment in HEP are not significant. HEP’s creditors have no other recourse to our assets. Furthermore, our creditors have no recourse to the assets of HEP and its consolidated subsidiaries.

HollyFrontier Senior Notes
Our 6.875% senior notes ($150 million principal amount maturing November 2018) (the “HollyFrontier Senior Notes”) are unsecured and impose certain restrictive covenants, including limitations on our ability to incur additional debt, incur liens, enter into sale-and-leaseback transactions, pay dividends, enter into mergers, sell assets and enter into certain transactions with affiliates. Additionally, we have certain redemption rights under the HollyFrontier Senior Notes.

At any time, following notice to the trustee, that the HollyFrontier Senior Notes are rated investment grade by both Moody's and Standard & Poor's and no default or event of default exists, we are not subject to many of the foregoing covenants (a "Covenant Suspension"). As of September 30, 2013, the HollyFrontier Senior Notes were rated investment grade (BBB-) by Standard & Poor's. In October 2013, Moody's also upgraded the HollyFrontier Senior Notes to investment grade (Baa3). As a result, we are under the Covenant Suspension pursuant to the terms of the indenture governing the HollyFrontier Senior Notes.

In June 2013, we redeemed our $286.8 million aggregate principal amount of 9.875% senior notes maturing June 2017 at a redemption cost of $301.0 million, at which time we recognized a $22.1 million early extinguishment loss consisting of a $14.2 million debt redemption premium and an unamortized discount of $7.9 million.

HollyFrontier Financing Obligation
We have a financing obligation that relates to a sale and lease-back of certain crude oil tankage that we sold to an affiliate of Plains All American Pipeline, L.P. (“Plains”) in October 2009 for $40.0 million. Monthly lease payments are recorded as a reduction in principal over the 15-year lease term ending in 2024.

HEP Senior Notes
HEP’s senior notes consist of the following:

8.25% HEP senior notes ($150 million principal amount maturing March 2018)
6.5% HEP senior notes ($300 million principal amount maturing March 2020)

The 8.25% and 6.5% HEP senior notes (collectively, the “HEP Senior Notes”) are unsecured and impose certain restrictive covenants, including limitations on HEP’s ability to incur additional indebtedness, make investments, sell assets, incur certain liens, pay distributions, enter into transactions with affiliates, and enter into mergers. At any time when the HEP Senior Notes are rated investment grade by both Moody’s and Standard & Poor’s and no default or event of default exists, HEP will not be subject to many of the foregoing covenants. Additionally, HEP has certain redemption rights under the HEP Senior Notes.

Indebtedness under the HEP Senior Notes involves recourse to HEP Logistics Holdings, L.P., its general partner, and is guaranteed by HEP’s wholly-owned subsidiaries. However, any recourse to the general partner would be limited to the extent of HEP Logistics Holdings, L.P.’s assets, which other than its investment in HEP, are not significant. HEP’s creditors have no other recourse to our assets. Furthermore, our creditors have no recourse to the assets of HEP and its consolidated subsidiaries.


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HOLLYFRONTIER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Continued


The carrying amounts of long-term debt are as follows:
 
 
September 30,
2013
 
December 31,
2012
 
 
(In thousands)
9.875% Senior Notes
 
 
 
 
Principal
 
$

 
$
286,812

Unamortized discount
 

 
(7,468
)
 
 

 
279,344

6.875% Senior Notes
 
 
 
 
Principal
 
150,000

 
150,000

Unamortized premium
 
5,272

 
5,910

 
 
155,272

 
155,910

Financing Obligation
 
35,221

 
36,311

 
 
 
 
 
Total HollyFrontier long-term debt
 
190,493

 
471,565

 
 
 
 
 
HEP Credit Agreement
 
365,000

 
421,000

 
 
 
 
 
HEP 8.25% Senior Notes
 
 
 
 
Principal
 
150,000

 
150,000

Unamortized discount
 
(1,373
)
 
(1,602
)
 
 
148,627

 
148,398

HEP 6.5% Senior Notes
 
 
 
 
Principal
 
300,000

 
300,000

Unamortized discount
 
(4,236
)
 
(4,725
)
 
 
295,764

 
295,275

 
 
 
 
 
Total HEP long-term debt
 
809,391

 
864,673

 
 
 
 
 
Total long-term debt
 
$
999,884

 
$
1,336,238


We capitalized interest attributable to construction projects of $2.8 million and $2.5 million for the three months ended September 30, 2013 and 2012, respectively, and $9.2 million and $6.3 million for the nine months ended September 30, 2013 and 2012, respectively.


NOTE 10: Derivative Instruments and Hedging Activities

Commodity Price Risk Management

Our primary market risk is commodity price risk. We are exposed to market risks related to the volatility in crude oil and refined products, as well as volatility in the price of natural gas used in our refining operations. We periodically enter into derivative contracts in the form of commodity price swaps and futures contracts to mitigate price exposure with respect to:
our inventory positions;
natural gas purchases;
costs of crude oil and related grade differentials;
prices of refined products; and
our refining margins.

Accounting Hedges
We have swap contracts serving as cash flow hedges against price risk on forecasted purchases of natural gas and WTI crude oil and forecasted sales of ultra-low sulfur diesel. These contracts have been designated as accounting hedges and are measured quarterly at fair value with offsetting adjustments (gains/losses) recorded directly to other comprehensive income. These fair value adjustments are later reclassified to earnings as the hedging instruments mature. Also on a quarterly basis, hedge ineffectiveness is measured by comparing the change in fair value of the swap contracts against the expected future cash inflows/outflows on the respective transaction being hedged. Any hedge ineffectiveness is also recognized in earnings.


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HOLLYFRONTIER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Continued


The following table presents the pre-tax effect on other comprehensive income (“OCI”) and earnings due to fair value adjustments and maturities of commodity price swaps under hedge accounting:
 
Unrealized Gain (Loss) Recognized in OCI
 
Gain (Loss) Recognized in Earnings Due to Settlements
 
Gain (Loss) Attributable to Hedge Ineffectiveness Recognized in Earnings
 
 
Location
 
Amount
 
Location
 
Amount
 
(In thousands)
Three Months Ended September 30, 2013
 
 
 
 
 
 
 
 
 
Commodity price swaps
 
 
 
 
 
 
 
 
 
Change in fair value
$
27,049

 
Sales and other revenues
 
$
(10,138
)
 
Sales and other revenues
 
$
1,949

Gain reclassified to earnings due to settlements
(22,007
)
 
Cost of products sold
 
32,874

 
Cost of products sold
 
(962
)
Amortization of discontinued hedge reclassified to earnings
270

 
Operating expenses
 
(999
)
 
Operating expenses
 
259

Total
$
5,312

 
 
 
$
21,737

 
 
 
$
1,246

 
 
 
 
 
 
 
 
 
 
Three Months Ended September 30, 2012
 
 
 
 
 
 
 
 
 
Commodity price swaps
 
 
 
 
 
 
 
 
 
Change in fair value
$
(144,635
)
 
Sales and other revenues
 
$
(44,936
)
 
Sales and other revenues
 
$
(3,531
)
Loss reclassified to earnings due to settlements
33,409

 
Cost of products sold
 
11,527

 
Cost of products sold
 
6,208

Total
$
(111,226
)
 
 
 
$
(33,409
)
 
 
 
$
2,677

 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2013
 
 
 
 
 
 
 
 
 
Commodity price swaps
 
 
 
 
 
 
 
 
 
Change in fair value
$
41,410

 
Sales and other revenues
 
$
(25,454
)
 
Sales and other revenues
 
$
2,143

Gain reclassified to earnings due to settlements
(1,396
)
 
Cost of products sold
 
28,271

 
Cost of products sold
 
730

Amortization of discontinued hedge reclassified to earnings
630

 
Operating expenses
 
(2,051
)
 
Operating expenses
 

Total
$
40,644

 
 
 
$
766

 
 
 
$
2,873

 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2012
 
 
 
 
 
 
 
 
 
Commodity price swaps
 
 
 
 
 
 
 
 
 
Change in fair value
$
(257,711
)
 
Sales and other revenues
 
$
(99,228
)
 
Sales and other revenues
 
$
(1,876
)
Loss reclassified to earnings due to settlements
20,986

 
Cost of products sold
 
78,242

 
Cost of products sold
 
(109
)
Total
$
(236,725
)
 
 
 
$
(20,986
)
 
 
 
$
(1,985
)

As of September 30, 2013, we have the following notional contract volumes related to outstanding derivative instruments serving as cash flow hedges against price risk on forecasted purchases of natural gas and crude oil and sales of refined products:
 
 
 
 
Notional Contract Volumes by Year of Maturity
 
 
Derivative Instrument
 
Total Outstanding Notional
 
2013
 
2014
 
2015
 
2016
 
2017
 
Unit of Measure
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commodity Price Swaps:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Natural gas - long
 
40,800,000

 
2,400,000

 
9,600,000

 
9,600,000

 
9,600,000

 
9,600,000

 
MMBTU
WTI crude oil - long
 
11,610,500

 
2,668,000

 
8,942,500

 

 

 

 
Barrels
Ultra-low sulfur diesel - short
 
11,610,500

 
2,668,000

 
8,942,500

 

 

 

 
Barrels


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Table of Contents
HOLLYFRONTIER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Continued


In the first quarter of 2013, we dedesignated certain commodity price swaps (long positions) that previously received hedge accounting treatment. These contracts now serve as economic hedges against price risk on forecasted natural gas purchases totaling 40,800,000 MMBTU's to be purchased ratably through 2017. As of September 30, 2013, we have an unrealized loss of $4.6 million classified as AOCI that relates to the application of hedge accounting prior to dedesignation that will be amortized as a charge to operating expenses as the contracts mature.

Economic Hedges
We also have swap contracts that serve as economic hedges (derivatives used for risk management, but not designated as accounting hedges) to fix our purchase price on forecasted natural gas and crude oil and other feedstock purchases, and to lock in the spread between WCS and WTI crude oil and between WTS and WTI crude oil on forecasted purchases of WCS and WTS. Also, we have NYMEX futures contracts to lock in prices on purchases of inventory. These contracts are measured quarterly at fair value with offsetting adjustments (gains/losses) recorded directly to income.

The following table presents the pre-tax effect on income due to maturities and fair value adjustments of our economic hedges:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
Location of Gain (Loss) Recognized in Income
 
2013
 
2012
 
2013
 
2012
 
 
(In thousands)
Cost of products sold
 
$
(29,515
)
 
$
19,869

 
$
5,916

 
$
55,738

Operating expenses
 
(157
)
 
604

 
(5,458
)
 
446

Total
 
$
(29,672
)
 
$
20,473

 
$
458

 
$
56,184


As of September 30, 2013, we have the following notional contract volumes related to our outstanding derivative contracts serving as economic hedges:
 
 
 
 
Notional Contract Volumes by Year of Maturity
 
 
Derivative Instrument
 
Total Outstanding Notional
 
2013
 
2014
 
2015
 
2016
 
2017
 
Unit of Measure
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commodity price swap (WCS spread) - long
 
3,801,500

 
1,794,000

 
2,007,500

 

 

 

 
Barrels
Commodity price swap (WTS spread) - long
 
736,000

 
736,000

 

 

 

 

 
Barrels
Commodity price swap (natural gas) - long
 
40,800,000

 
2,400,000

 
9,600,000

 
9,600,000

 
9,600,000

 
9,600,000

 
MMBTU
Commodity price swap (natural gas) - short
 
40,800,000

 
2,400,000

 
9,600,000

 
9,600,000

 
9,600,000

 
9,600,000

 
MMBTU
NYMEX futures (WTI) - short
 
2,536,000

 
2,139,000

 
397,000

 

 

 

 
Barrels

Interest Rate Risk Management

HEP uses interest rate swaps to manage its exposure to interest rate risk.

As of September 30, 2013, HEP had three interest rate swap contracts that hedge its exposure to the cash flow risk caused by the effects of LIBOR changes on $305.0 million in credit agreement advances. The first interest rate swap effectively converts $155.0 million of LIBOR based debt to fixed rate debt having an interest rate of 0.99% plus an applicable margin of 2.25% as of September 30, 2013, which equaled an effective interest rate of 3.24%. This swap matures in February 2016. HEP has two additional interest rate swaps with identical terms which effectively convert $150.0 million of LIBOR based debt to fixed rate debt having an interest rate of 0.74% plus an applicable margin of 2.25% as of September 30, 2013, which equaled an effective interest rate of 2.99%. Both of these swap contracts mature in July 2017. All of these swap contracts have been designated as cash flow hedges. To date, there has been no ineffectiveness on these cash flow hedges.


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HOLLYFRONTIER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Continued


The following table presents the pre-tax effect on other comprehensive income and earnings due to fair value adjustments and maturities of HEP's interest rate swaps under cash flow hedge accounting:
 
Unrealized Gain (Loss) Recognized in OCI
 
Loss Recognized in Earnings Due to Settlements
 
 
Location
 
Amount
 
(In thousands)
Three Months Ended September 30, 2013
 
 
 
 
 
Interest rate swaps
 
 
 
 
 
Change in fair value
$
(1,626
)
 
 
 
 
Loss reclassified to earnings due to settlements
529

 
Interest expense
 
$
(529
)
Total
$
(1,097
)
 
 
 
$
(529
)
 
 
 
 
 
 
Three Months Ended September 30, 2012
 
 
 
 
 
Interest rate swaps
 
 
 
 
 
Change in fair value
$
(1,802
)
 
 
 
 
Loss reclassified to earnings due to settlements
421

 
 
 
 
Amortization of discontinued hedge reclassified to earnings
1,274

 
Interest expense
 
$
(1,695
)
Total
$
(107
)
 
 
 
$
(1,695
)
 
 
 
 
 
 
Nine Months Ended September 30, 2013
 
 
 
 
 
Interest rate swaps
 
 
 
 
 
Change in fair value
$
1,329

 
 
 
 
Loss reclassified to earnings due to settlements
1,549

 
 
 
 
Amortization of discontinued hedge reclassified to earnings
849

 
Interest expense
 
$
(2,398
)
Total
$
3,727

 
 
 
$
(2,398
)
 
 
 
 
 
 
Nine Months Ended September 30, 2012
 
 
 
 
 
Interest rate swaps
 
 
 
 
 
Change in fair value
$
(4,182
)
 
 
 
 
Loss reclassified to earnings due to settlements
939

 
 
 
 
Amortization of discontinued hedge reclassified to earnings
3,821

 
Interest expense
 
$
(4,760
)
Total
$
578

 
 
 
$
(4,760
)

The following table presents the fair value and balance sheet locations of our outstanding derivative instruments. These amounts are presented on a gross basis with offsetting balances that reconcile to a net asset or liability position in our consolidated balance sheets. We present on a net basis to reflect the net settlement of these positions in accordance with provisions of our master netting arrangements.

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HOLLYFRONTIER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Continued


 
 
Derivatives in Net Asset Position
 
Derivatives in Net Liability Position
 
 
Gross Assets
 
Gross Liabilities Offset in Balance Sheet
 
Net Assets Recognized in Balance Sheet
 
Gross Liabilities
 
Gross Assets Offset in Balance Sheet
 
Net Liabilities Recognized in Balance Sheet
 
 
 
 
(In thousands)
 
 
September 30, 2013