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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 ______________________________________________________________________________________
FORM 10-Q
 ______________________________________________________________________________________
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2020
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: 1-32225
  _____________________________________________________________________________________
HOLLY ENERGY PARTNERS, L.P.
(Exact name of registrant as specified in its charter)
 ______________________________________________________________________________________
Delaware
 
20-0833098
(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)
Securities registered pursuant to 12(b) of the Securities Exchange Act of 1934:
Title of each class
 
Trading Symbol(s)
 
Name of each exchange on which registered
Common Limited Partner Units
 
HEP
 
New York Stock Exchange
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      No  
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files).    Yes       No  
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth” company in Rule 12b-2 of the Exchange Act.
Large accelerated filer
Accelerated filer
Non-accelerated filer
Smaller reporting company
Emerging growth company
 
 
 
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act).    Yes   No  
The number of the registrant’s outstanding common units at May 1, 2020, was 105,440,201.




HOLLY ENERGY PARTNERS, L.P.
INDEX
 

- 2 -



FORWARD-LOOKING STATEMENTS

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, statements regarding funding of capital expenditures and distributions, distributable cash flow coverage and leverage targets, and statements under “Results of Operations” and “Liquidity and Capital Resources” in Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part I are forward-looking statements. Forward-looking statements use words such as “anticipate,” “project,” “expect,” “plan,” “goal,” “forecast,” “intend,” “should,” “would,” “could,” “believe,” “may,” and similar expressions and statements regarding our plans and objectives for future operations. These statements are based on our beliefs and assumptions and those of our general partner 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 and our general partner believe that such expectations reflected in such forward-looking statements are reasonable, neither we nor our general partner can give assurance that our expectations will prove to be correct. All statements concerning our expectations for future results of operations are based on forecasts for our existing operations and do not include the potential impact of any future acquisitions. Our forward-looking statements are subject to a variety of risks, uncertainties and assumptions. If one or more of these risks or uncertainties materialize, or if underlying assumptions prove incorrect, our actual results may vary materially from those anticipated, estimated, projected or expected. Certain factors could cause actual results to differ materially from results anticipated in the forward-looking statements. These factors include, but are not limited to:
the extraordinary market environment and effects of the COVID-19 pandemic, including the continuation of a material decline in demand for refined petroleum products in markets we serve;
risks and uncertainties with respect to the actual quantities of petroleum products and crude oil shipped on our pipelines and/or terminalled, stored or throughput in our terminals and refinery processing units;
the economic viability of HollyFrontier Corporation (“HFC”), our other customers and our joint ventures’ other customers, including any refusal or inability of our or our joint ventures’ customers or counterparties to perform their obligations under their contracts;
our ability to purchase and integrate future acquired operations;
our ability to complete previously announced or contemplated acquisitions;
the availability and cost of additional debt and equity financing;
the possibility of reductions in production or shutdowns at refineries utilizing our pipelines, terminal facilities and refinery processing units, whether due to infection in the workforce or in response to reductions in demand;
the effects of current and future government regulations and policies, including the effects of current restrictions on various commercial and economic activities in response to the COVID-19 pandemic;
our and our joint venture partners’ ability to complete and maintain operational efficiency in carrying out routine operations and capital construction projects;
the possibility of terrorist or cyber attacks and the consequences of any such attacks;
general economic conditions, including uncertainty regarding the timing, pace and extent of an economic recovery in the United States;
the impact of recent or proposed changes in the tax laws and regulations that affect master limited partnerships; and
other financial, operational and legal risks and uncertainties detailed from time to time in our Securities and Exchange Commission 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. You should not put any undue reliance on any forward-looking statements. When considering forward-looking statements, you should keep in mind the known material risk factors and other cautionary statements set forth in our Annual Report on Form 10-K for the year ended December 31, 2019, and in this Quarterly Report on Form 10-Q in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in “Risk Factors.” All forward-looking statements included in this Form 10-Q and all subsequent written or oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. The forward-looking statements speak only as of the date made and, other than as required by law, we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

- 3 -


PART I. FINANCIAL INFORMATION

Item 1.
Financial Statements
HOLLY ENERGY PARTNERS, L.P.
CONSOLIDATED BALANCE SHEETS
(In thousands, except unit data)
 
 
March 31, 2020
 
December 31, 2019
 
 
(Unaudited)
 
 
ASSETS
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents (Cushing Connect VIEs: $16,675 and $6,842, respectively)
 
$
19,282

 
$
13,287

Accounts receivable:
 
 
 
 
Trade
 
15,638

 
18,731

Affiliates
 
38,406

 
49,716

 
 
54,044

 
68,447

Prepaid and other current assets
 
7,548

 
7,629

Total current assets
 
80,874

 
89,363

 
 
 
 
 
Properties and equipment, net (Cushing Connect VIEs: $15,087 and $2,916, respectively)
 
1,465,789

 
1,467,099

Operating lease right-of-use assets, net
 
3,587

 
3,255

Net investment in leases
 
134,108

 
134,886

Intangible assets, net
 
97,820

 
101,322

Goodwill
 
270,336

 
270,336

Equity method investments (Cushing Connect VIEs: $39,054 and $37,084, respectively)
 
123,580

 
120,071

Other assets
 
12,190

 
12,900

Total assets
 
$
2,188,284

 
$
2,199,232

 
 
 
 
 
LIABILITIES AND EQUITY
 
 
 
 
Current liabilities:
 
 
 
 
Accounts payable:
 
 
 
 
Trade (Cushing Connect VIEs: $11,417 and $2,082, respectively)
 
$
19,549

 
$
17,818

Affiliates
 
6,393

 
16,737

 
 
25,942

 
34,555

 
 
 
 
 
Accrued interest
 
4,695

 
13,206

Deferred revenue
 
10,810

 
10,390

Accrued property taxes
 
5,707

 
3,799

Current operating lease liabilities
 
1,235

 
1,126

Current finance lease liabilities
 
3,238

 
3,224

Other current liabilities
 
3,065

 
2,305

Total current liabilities
 
54,692

 
68,605

 
 
 
 
 
Long-term debt
 
1,502,154

 
1,462,031

Noncurrent operating lease liabilities
 
2,709

 
2,482

Noncurrent finance lease liabilities
 
70,640

 
70,475

Other long-term liabilities
 
12,450

 
12,808

Deferred revenue
 
45,078

 
45,681

 
 
 
 
 
Class B unit
 
50,227

 
49,392

 
 
 
 
 
Equity:
 
 
 
 
Partners’ equity:
 
 
 
 
Common unitholders (105,440,201 units issued and outstanding
    at March 31, 2020 and December 31, 2019)
 
338,159

 
381,103

Noncontrolling interest
 
112,175

 
106,655

Total equity
 
450,334

 
487,758

Total liabilities and equity
 
$
2,188,284

 
$
2,199,232


See accompanying notes.


- 4 -


HOLLY ENERGY PARTNERS, L.P.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(In thousands, except per unit data)

 
 
Three Months Ended
March 31,
 
 
2020
 
2019
Revenues:
 
 
 
 
Affiliates
 
$
101,428

 
$
103,359

Third parties
 
26,426

 
31,138

 
 
127,854

 
134,497

Operating costs and expenses:
 
 
 
 
Operations (exclusive of depreciation and amortization)
 
34,981

 
37,519

Depreciation and amortization
 
23,978

 
23,824

General and administrative
 
2,702

 
2,620

 
 
61,661

 
63,963

Operating income
 
66,193

 
70,534

 
 
 
 
 
Other income (expense):
 
 
 
 
Equity in earnings of equity method investments
 
1,714

 
2,100

Interest expense
 
(17,767
)
 
(19,022
)
Interest income
 
2,218

 
528

Loss on early extinguishment of debt
 
(25,915
)
 

Gain (loss) on sale of assets and other
 
506

 
(310
)
 
 
(39,244
)
 
(16,704
)
Income before income taxes
 
26,949

 
53,830

State income tax expense
 
(37
)
 
(36
)
Net income
 
26,912

 
53,794

Allocation of net income attributable to noncontrolling interests
 
(2,051
)
 
(2,612
)
Net income attributable to the partners
 
24,861

 
51,182

Limited partners’ per unit interest in earnings—basic and diluted
 
$
0.24

 
$
0.49

Weighted average limited partners’ units outstanding
 
105,440

 
105,440




See accompanying notes.


- 5 -


HOLLY ENERGY PARTNERS, L.P.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
 
 
 
Three Months Ended
March 31,
 
 
2020
 
2019
Cash flows from operating activities
 
 
 
 
Net income
 
$
26,912

 
$
53,794

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Depreciation and amortization
 
23,978

 
23,824

Gain on sale of assets
 
(417
)
 
(9
)
Loss on early extinguishment of debt
 
25,915

 

Amortization of deferred charges
 
799

 
766

Equity-based compensation expense
 
506

 
406

Equity in earnings of equity method investments, net of distributions
 
(1,164
)
 
(112
)
(Increase) decrease in operating assets:
 
 
 
 
Accounts receivable—trade
 
3,093

 
(2,253
)
Accounts receivable—affiliates
 
11,310

 
10,748

Prepaid and other current assets
 
126

 
244

Increase (decrease) in operating liabilities:
 
 
 
 
Accounts payable—trade
 
(10,344
)
 
(2,199
)
Accounts payable—affiliates
 
2,921

 
(7,002
)
Accrued interest
 
(8,511
)
 
(7,616
)
Deferred revenue
 
(184
)
 
(233
)
Accrued property taxes
 
1,908

 
3,757

Other current liabilities
 
760

 
130

Other, net
 
339

 
(3,090
)
Net cash provided by operating activities
 
77,947

 
71,155

 
 
 
 
 
Cash flows from investing activities
 
 
 
 
Additions to properties and equipment
 
(18,942
)
 
(10,718
)
Investment in Cushing Connect
 
(2,345
)
 

Proceeds from sale of assets
 
417

 
9

Distributions in excess of equity in earnings of equity investments
 

 
395

Net cash used for investing activities
 
(20,870
)
 
(10,314
)
 
 
 
 
 
Cash flows from financing activities
 
 
 
 
Borrowings under credit agreement
 
112,000

 
104,000

Repayments of credit agreement borrowings
 
(67,000
)
 
(85,000
)
Redemption of senior notes
 
(522,500
)
 

Proceeds from issuance of debt
 
500,000

 

Contributions from general partner
 
354

 

Contributions from noncontrolling interest
 
7,304

 

Distributions to HEP unitholders
 
(68,519
)
 
(67,975
)
Distributions to noncontrolling interest
 
(3,000
)
 
(3,000
)
Payments on finance leases
 
(1,096
)
 
(252
)
Deferred financing costs
 
(8,478
)
 

Units withheld for tax withholding obligations
 
(147
)
 
(119
)
Net cash used by financing activities
 
(51,082
)
 
(52,346
)
 
 
 
 
 
Cash and cash equivalents
 
 
 
 
Increase for the period
 
5,995

 
8,495

Beginning of period
 
13,287

 
3,045

End of period
 
$
19,282

 
$
11,540


See accompanying notes.

- 6 -


HOLLY ENERGY PARTNERS, L.P.
CONSOLIDATED STATEMENTS OF EQUITY
(Unaudited)
(In thousands)
 
 
 
Common
Units
 
Noncontrolling Interest
 
Total Equity
 
 
 
Balance December 31, 2019
 
$
381,103

 
$
106,655

 
$
487,758

Capital contribution-Cushing Connect

 

 
7,304

 
7,304

Distributions to HEP unitholders
 
(68,519
)
 

 
(68,519
)
Distributions to noncontrolling interest
 

 
(3,000
)
 
(3,000
)
Equity-based compensation
 
506

 

 
506

Class B unit accretion
 
(835
)
 

 
(835
)
   Other
 
208

 

 
208

Net income
 
25,696

 
1,216

 
26,912

Balance March 31, 2020
 
338,159

 
112,175

 
450,334


 
 
Common
Units
 
Noncontrolling Interest
 
Total Equity
 
 
 
Balance December 31, 2018
 
$
427,435

 
$
88,126

 
$
515,561

Distributions to HEP unitholders
 
(67,975
)
 

 
(67,975
)
Distributions to noncontrolling interest
 

 
(3,000
)
 
(3,000
)
Equity-based compensation
 
406

 

 
406

Class B unit accretion
 
(780
)
 

 
(780
)
Other
 
1,069

 

 
1,069

Net income
 
51,962

 
1,832

 
53,794

Balance March 31, 2019
 
412,117

 
86,958

 
499,075



See accompanying notes.



- 7 -


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1:
Description of Business and Presentation of Financial Statements

Holly Energy Partners, L.P. (“HEP”), together with its consolidated subsidiaries, is a publicly held master limited partnership. As of March 31, 2020, HollyFrontier Corporation (“HFC”) and its subsidiaries own a 57% limited partner interest and the non-economic general partner interest in HEP. We commenced operations on July 13, 2004, upon the completion of our initial public offering. In these consolidated financial statements, the words “we,” “our,” “ours” and “us” refer to HEP unless the context otherwise indicates.

On October 31, 2017, we closed on an equity restructuring transaction with HEP Logistics Holdings, L.P. (“HEP Logistics”), a wholly-owned subsidiary of HFC and the general partner of HEP, pursuant to which the incentive distribution rights ("IDRs") held by HEP Logistics were canceled, and HEP Logistics' 2% general partner interest in HEP was converted into a non-economic general partner interest in HEP. In consideration, we issued 37,250,000 of our common units to HEP Logistics. In addition, HEP Logistics agreed to waive $2.5 million of limited partner cash distributions for each of twelve consecutive quarters beginning with the first quarter the units issued as consideration were eligible to receive distributions. This waiver of limited partner cash distributions will expire after the cash distribution for the second quarter of 2020, which will be made during the third quarter of 2020. As a result of this transaction, no distributions were made on the general partner interest after October 31, 2017.

We own and operate petroleum product and crude oil pipelines, terminal, tankage and loading rack facilities and refinery processing units that support refining and marketing operations of HFC and other refineries in the Mid-Continent, Southwest and Northwest regions of the United States and Delek US Holdings, Inc.’s (“Delek”) refinery in Big Spring, Texas. Additionally, we own a 75% interest in UNEV Pipeline, LLC (“UNEV”), a 50% interest in Osage Pipe Line Company, LLC (“Osage”), a 50% interest in Cheyenne Pipeline LLC, and a 50% interest in Cushing Connect Pipeline & Terminal LLC.

We operate in two reportable segments, a Pipelines and Terminals segment and a Refinery Processing Unit segment. Disclosures around these segments are discussed in Note 15.

We generate revenues by charging tariffs for transporting petroleum products and crude oil through our pipelines, by charging fees for terminalling and storing refined products and other hydrocarbons, providing other services at our storage tanks and terminals and by charging fees for processing hydrocarbon feedstocks through our refinery processing units. We do not take ownership of products that we transport, terminal, store or process, and therefore, we are not exposed directly to changes in commodity prices.

The consolidated financial statements included herein have been prepared without audit, pursuant to the rules and regulations of the United States Securities and Exchange Commission (the “SEC”). The interim financial statements reflect all adjustments, which, in the opinion of management, are necessary for a fair presentation of our results for the interim periods. Such adjustments are considered to be of a normal recurring nature. Although certain notes and other information required by U.S. generally accepted accounting principles (“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, 2019. Results of operations for interim periods are not necessarily indicative of the results of operations that will be realized for the year ending December 31, 2020.

Principles of Consolidation and Common Control Transactions
The consolidated financial statements include our accounts and those of subsidiaries and joint ventures that we control. All significant intercompany transactions and balances have been eliminated.

Most of our acquisitions from HFC occurred while we were a consolidated variable interest entity (“VIE”) of HFC. Therefore, as an entity under common control with HFC, we recorded these acquisitions on our balance sheets at HFC's historical basis instead of our purchase price or fair value.


- 8 -


Accounting Pronouncements Adopted During the Periods Presented

Goodwill Impairment Testing
In January 2017, Accounting Standard Update (“ASU”) 2017-04, “Simplifying the Test for Goodwill Impairment,” was issued amending the testing for goodwill impairment by eliminating Step 2 from the goodwill impairment test. Step 2 measures a goodwill impairment loss by comparing the implied fair value of a reporting unit’s goodwill with the carrying amount of that goodwill. Under this standard, goodwill impairment is measured as the excess of the carrying amount of the reporting unit over the related fair value. We adopted this standard effective in the second quarter of 2019, and the adoption of this standard had no effect on our financial condition, results of operations or cash flows.

Leases
In February 2016, ASU No. 2016-02, “Leases” (“ASC 842”) was issued requiring leases to be measured and recognized as a lease liability, with a corresponding right-of-use asset on the balance sheet. We adopted this standard effective January 1, 2019, and we elected to adopt using the modified retrospective transition method, whereby comparative prior period financial information will not be restated and will continue to be reported under the lease accounting standard in effect during those periods. We also elected practical expedients provided by the new standard, including the package of practical expedients and the short-term lease recognition practical expedient, which allow an entity to not recognize on the balance sheet leases with a term of 12 months or less. Upon adoption of this standard, we recognized $78.4 million of lease liabilities and corresponding right-of-use assets on our consolidated balance sheet. Adoption of this standard did not have a material impact on our results of operations or cash flows. See Notes 3 and 4 for additional information on our lease policies.

Credit Losses Measurement
In June 2016, ASU 2016-13, “Measurement of Credit Losses on Financial Instruments,” was issued requiring measurement of all expected credit losses for certain types of financial instruments, including trade receivables, held at the reporting date based on historical experience, current conditions and reasonable and supportable forecasts. We adopted this standard effective January 1, 2020, and adoption of the standard did not have a material impact on our financial condition, results of operations or cash flows.


Note 2:
Investment in Joint Venture

On October 2, 2019, HEP Cushing LLC (“HEP Cushing”), a wholly-owned subsidiary of HEP, and Plains Marketing, L.P. (“PMLP”), a wholly-owned subsidiary of Plains All American Pipeline, L.P. (“Plains”), formed a 50/50 joint venture, Cushing Connect Pipeline & Terminal LLC (the “Cushing Connect Joint Venture”), for (i) the development and construction of a new 160,000 barrel per day common carrier crude oil pipeline (the “Cushing Connect Pipeline”) that will connect the Cushing, Oklahoma crude oil hub to the Tulsa, Oklahoma refining complex owned by a subsidiary of HFC and (ii) the ownership and operation of 1.5 million barrels of crude oil storage in Cushing, Oklahoma (the “ Cushing Connect JV Terminal”). The Cushing Connect JV Terminal was partially in service in the first quarter of 2020 and is expected to be fully in service during the second quarter of 2020. The Cushing Connect Pipeline is expected to be in service during the first quarter of 2021. Long-term commercial agreements have been entered into to support the Cushing Connect Joint Venture assets.

The Cushing Connect Joint Venture contracted with an affiliate of HEP to manage the construction and operation of the Cushing Connect Pipeline and with an affiliate of Plains to manage the operation of the Cushing Connect JV Terminal. The total Cushing Connect Joint Venture investment will be shared proportionately among the partners, and HEP estimates its share of the cost of the Cushing Connect JV Terminal contributed by Plains and Cushing Connect Pipeline construction costs will be approximately $65 million.

The Cushing Connect Joint Venture legal entities are variable interest entities ("VIEs") as defined under GAAP. A VIE is a legal entity if it has any one of the following characteristics: (i) the entity does not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support; (ii) the at risk equity holders, as a group, lack the characteristics of a controlling financial interest; or (iii) the entity is structured with non-substantive voting rights. The Cushing Connect Joint Venture legal entities do not have sufficient equity at risk to finance their activities without additional financial support. Since HEP is constructing and will operate the Cushing Connect Pipeline, HEP has more ability to direct the activities that most significantly impact the financial performance of the Cushing Connect Joint Venture and Cushing Connect Pipeline legal entities. Therefore, HEP consolidates those legal entities. We do not have the ability to direct the activities that most significantly impact the Cushing Connect JV Terminal legal entity, and therefore, we account for our interest in the Cushing Connect JV Terminal legal entity using the equity method of accounting.

- 9 -




Note 3:
Revenues

Revenues are generally recognized as products are shipped through our pipelines and terminals, feedstocks are processed through our refinery processing units or other services are rendered. The majority of our contracts with customers meet the definition of a lease since (1) performance of the contracts is dependent on specified property, plant, or equipment and (2) it is remote that one or more parties other than the customer will take more than a minor amount of the output associated with the specified property, plant, or equipment. Prior to the adoption of the new lease standard (see Note 1), we bifurcated the consideration received between lease and service revenue. The new lease standard allows the election of a practical expedient whereby a lessor does not have to separate non-lease (service) components from lease components under certain conditions. The majority of our contracts meet these conditions, and we have made this election for those contracts. Under this practical expedient, we treat the combined components as a single performance obligation in accordance with Accounting Standards Codification (“ASC”) 606, which largely codified ASU 2014-09, if the non-lease (service) component is the dominant component. If the lease component is the dominant component, we treat the combined components as a lease in accordance with ASC 842, which largely codified ASU 2016-02.
Several of our contracts include incentive or reduced tariffs once a certain quarterly volume is met. Revenue from the variable element of these transactions is recognized based on the actual volumes shipped as it relates specifically to rendering the services during the applicable quarter.
The majority of our long-term transportation contracts specify minimum volume requirements, whereby, we bill a customer for a minimum level of shipments in the event a customer ships below their contractual requirements. If there are no future performance obligations, we will recognize these deficiency payments in revenue.
In certain of these throughput agreements, a customer may later utilize such shortfall billings as credit towards future volume shipments in excess of its minimum levels within its respective contractual shortfall make-up period. Such amounts represent an obligation to perform future services, which may be initially deferred and later recognized as revenue based on estimated future shipping levels, including the likelihood of a customer’s ability to utilize such amounts prior to the end of the contractual shortfall make-up period. We recognize the service portion of these deficiency payments in revenue when we do not expect we will be required to satisfy these performance obligations in the future based on the pattern of rights exercised by the customer. During the three months ended March 31, 2020, we recognized $7.5 million of these deficiency payments in revenue, of which $0.7 million related to deficiency payments billed in prior periods. As of March 31, 2020, deferred revenue reflected in our consolidated balance sheet related to shortfalls billed was $0.3 million.
A contract liability exists when an entity is obligated to perform future services to a customer for which the entity has received consideration. Since HEP may be required to perform future services for these deficiency payments received, the deferred revenues on our balance sheets were considered contract liabilities. A contract asset exists when an entity has a right to consideration in exchange for goods or services transferred to a customer. Our consolidated balance sheets included the contract assets and liabilities in the table below:
 
 
March 31,
2020
 
December 31,
2019
 
 
(In thousands)
Contract assets
 
$
5,870

 
$
5,675

Contract liabilities
 
$
(300
)
 
$
(650
)


The contract assets and liabilities include both lease and service components. We recognized $0.7 million of revenue, during the three months ended March 31, 2020, that was previously included in contract liability as of December 31, 2019, and we recognized $0.6 million of revenue during the three months ended March 31, 2019, that was previously included in contract liability as of December 31, 2018. During the three months ended March 31, 2020, we also recognized $0.2 million of revenue included in contract assets at March 31, 2020.

As of March 31, 2020, we expect to recognize $2.3 billion in revenue related to our unfulfilled performance obligations under the terms of our long-term throughput agreements and operating leases expiring in 2021 through 2036. These agreements generally provide for changes in the minimum revenue guarantees annually for increases or decreases in the Producer Price Index (“PPI”) or Federal Energy Regulatory Commission (“FERC”) index, with certain contracts having provisions that limit the level of the rate increases or decreases. We expect to recognize revenue for these unfulfilled performance obligations as shown in the table below (amounts shown in table include both service and lease revenues):

- 10 -


Years Ending December 31,
 
(In millions)
Remainder of 2020
 
$
277

2021
 
359

2022
 
331

2023
 
295

2024
 
257

2025
 
186

Thereafter
 
639

Total
 
$
2,344


Payment terms under our contracts with customers are consistent with industry norms and are typically payable within 10 to 30 days of the date of invoice.
Disaggregated revenues were as follows:
 
 
Three Months Ended
March 31,
 
 
2020
 
2019
 
 
(In thousands)
Pipelines
 
$
70,472

 
$
75,100

Terminals, tanks and loading racks
 
37,498

 
37,578

Refinery processing units
 
19,884

 
21,819

 
 
$
127,854

 
$
134,497


During the three months ended March 31, 2020 and March 31, 2019, lease revenues amounted to $93.2 million and $94.3 million, respectively, and service revenues amounted to $34.7 million and $40.2 million, respectively. Both of these revenues were recorded within affiliates and third parties revenues on our consolidated statement of income.

Note 4:
Leases

We adopted ASC 842 effective January 1, 2019, and elected to adopt using the modified retrospective transition method and practical expedients, both of which are provided as options by the standard and further defined in Note 1.

Lessee Accounting
At inception, we determine if an arrangement is or contains a lease. Right-of-use assets represent our right to use an underlying asset for the lease term, and lease liabilities represent our payment obligation under the leasing arrangement. Right-of-use assets and lease liabilities are recognized at the commencement date based on the present value of lease payments over the lease term. We use our estimated incremental borrowing rate (“IBR”) to determine the present value of lease payments as most of our leases do not contain an implicit rate. Our IBR represents the interest rate which we would pay to borrow, on a collateralized basis, an amount equal to the lease payments over a similar term in a similar economic environment. We use the implicit rate when readily determinable.

As a lessee, we lease land, buildings, pipelines, transportation and other equipment to support our operations. These leases can be categorized into operating and finance leases. Operating leases are recorded in operating lease right-of-use assets and current and noncurrent operating lease liabilities on our consolidated balance sheet. Finance leases are included in properties and equipment, current finance lease liabilities and noncurrent finance lease liabilities on our consolidated balance sheet.

When renewal options are defined in a lease, our lease term includes an option to extend the lease when it is reasonably certain we will exercise that option. Leases with a term of 12 months or less are not recorded on our balance sheet, and lease expense is accounted for on a straight-line basis. In addition, as a lessee, we separate non-lease components that are identifiable and exclude them from the determination of net present value of lease payment obligations.

Our leases have remaining terms of 1 to 25 years, some of which include options to extend the leases for up to 10 years.


- 11 -


Finance Lease Obligations
We have finance lease obligations related to vehicle leases with initial terms of 33 to 48 months. The total cost of assets under finance leases was $7.4 million and $7.0 million as of March 31, 2020 and December 31, 2019, respectively, with accumulated depreciation of $3.9 million and $4.5 million as of March 31, 2020 and December 31, 2019, respectively. We include depreciation of finance leases in depreciation and amortization in our consolidated statements of income.

In addition, we have a finance lease obligation related to a pipeline lease with an initial term of 10 years with one remaining subsequent renewal option for an additional 10 years.

Supplemental balance sheet information related to leases was as follows (in thousands, except for lease term and discount rate):
 
 
March 31, 2020
 
December 31, 2019
 
 
 
 
 
Operating leases:
 
 
 
 
   Operating lease right-of-use assets, net
 
$
3,587

 
3,255

 
 
 
 
 
   Current operating lease liabilities
 
1,235

 
1,126

   Noncurrent operating lease liabilities
 
2,709

 
2,482

      Total operating lease liabilities
 
$
3,944

 
3,608

 
 
 
 
 
Finance leases:
 
 
 
 
   Properties and equipment
 
$
7,388

 
6,968

   Accumulated amortization
 
(3,934
)
 
(4,547
)
      Properties and equipment, net
 
$
3,454

 
2,421

 
 
 
 
 
   Current finance lease liabilities
 
$
3,238

 
3,224

   Noncurrent finance lease liabilities
 
70,640

 
70,475

      Total finance lease liabilities
 
$
73,878

 
73,699

 
 
 
 
 
Weighted average remaining lease term (in years)
 
 
 
 
   Operating leases
 
6.2
 
6.5
   Finance leases
 
16.6
 
17.0
 
 
 
 
 
Weighted average discount rate
 
 
 
 
   Operating leases
 
4.8%
 
5.0%
   Finance leases
 
5.6%
 
6.0%



Supplemental cash flow and other information related to leases were as follows:
 
 
Three Months Ended
March 31,
 
 
2020
 
2019
 
 
(In thousands)
Cash paid for amounts included in the measurement of lease liabilities:
 
 
 
 
Operating cash flows on operating leases
 
$
282

 
$
1,795

Operating cash flows on finance leases
 
$
1,077

 
$
27

Financing cash flows on finance leases
 
$
1,096

 
$
252



- 12 -


Maturities of lease liabilities were as follows:
 
 
March 31, 2020
 
 
Operating
 
Finance
 
 
(In thousands)
2020
 
$
722

 
$
5,430

2021
 
963

 
7,333

2022
 
628

 
7,207

2023
 
544

 
7,254

2024
 
494

 
6,774

2025 and thereafter
 
1,184

 
80,313

   Total lease payments
 
4,535

 
114,311

Less: Imputed interest
 
(591
)
 
(40,433
)
   Total lease obligations
 
3,944

 
73,878

Less: Current obligations
 
(1,235
)
 
(3,238
)
   Long-term lease obligations
 
$
2,709

 
$
70,640




The components of lease expense were as follows:
 
 
Three Months Ended
March 31, 2020
 
Three Months Ended March 31, 2019
 
 
(In thousands)
Operating lease costs
 
$
273

 
1,770

Finance lease costs
 
 
 
 
   Amortization of assets
 
242

 
244

   Interest on lease liabilities
 
1,037

 
27

Variable lease cost
 
49

 
35

Total net lease cost
 
$
1,601

 
2,076


Lessor Accounting
As discussed in Note 3, the majority of our contracts with customers meet the definition of a lease. See Note 3 for further discussion of the impact of adoption of this standard on our activities as a lessor.

Customer contracts that contain leases are generally classified as either operating leases, direct finance leases or sales-type leases. We consider inputs such as the lease term, fair value of the underlying asset and residual value of the underlying assets when assessing the classification.

Substantially all of the assets supporting contracts meeting the definition of a lease have long useful lives, and we believe these assets will continue to have value when the current agreements expire due to our risk management strategy for protecting the residual fair value of the underlying assets by performing ongoing maintenance during the lease term. HFC generally has the option to purchase assets located within HFC refinery boundaries, including refinery tankage, truck racks and refinery processing units, at fair market value when the related agreements expire.

Lease income recognized was as follows:
 
 
Three Months Ended
March 31, 2020
 
Three Months Ended March 31, 2019
 
 
(In thousands)
Operating lease revenues
 
$
91,388

 
$
94,295

Direct financing lease interest income
 
$
524

 
$
509

Sales-type lease interest income
 
$
1,655

 
$

Lease revenues relating to variable lease payments not included in measurement of the sales-type lease receivable
 
$
1,797

 
$



- 13 -


For our sales-type leases, we included customer obligations related to minimum volume requirements in guaranteed minimum lease payments. Portions of our minimum guaranteed pipeline tariffs for assets subject to sales-type lease accounting are recorded as interest income with the remaining amounts recorded as a reduction in net investment in leases. We recognized any billings for throughput volumes in excess of minimum volume requirements as variable lease payments, and these variable lease payments were recorded in lease revenues.

As discussed in Note 3, prior to the adoption of ASC 842, contract consideration was bifurcated between operating lease and service revenues.

Annual minimum undiscounted lease payments under our leases were as follows as of March 31, 2020:
 
 
Operating
 
Finance
 
Sales-type
Years Ending December 31,
 
(In thousands)
Remainder of 2020
 
$
233,353

 
$
1,586

 
$
7,126

2021
 
305,811

 
2,128

 
9,501

2022
 
303,468

 
2,145

 
9,501

2023
 
272,784

 
2,162

 
9,501

2024
 
235,009

 
2,179

 
9,501

Thereafter
 
728,110

 
40,787

 
42,754

Total
 
$
2,078,535

 
$
50,987

 
$
87,884



Net investments in leases recorded on our balance sheet were composed of the following:
 
 
March 31, 2020
 
December 31, 2019
 
 
Sales-type Leases
 
Direct Financing Leases
 
Sales-type Leases
 
Direct Financing Leases
 
 
(In thousands)
 
(In thousands)
Lease receivables (1)
 
$
67,092

 
$
16,499

 
$
68,457

 
$
16,511

Unguaranteed residual assets
 
53,577

 

 
52,933

 

Net investment in leases
 
$
120,669

 
$
16,499

 
$
121,390

 
$
16,511


(1)
Current portion of lease receivables included in prepaid and other current assets on the balance sheet.


Note 5:
Fair Value Measurements

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. 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.

Financial Instruments
Our financial instruments consist of cash and cash equivalents, accounts receivable, accounts payable, and debt. The carrying amounts of cash equivalents, accounts receivable and accounts payable approximate fair value due to the short-term maturity of these instruments. Debt consists of outstanding principal under our revolving credit agreement (which approximates fair value as interest rates are reset frequently at current interest rates) and our fixed interest rate senior notes.


- 14 -


The carrying amounts and estimated fair values of our senior notes were as follows:
 
 
 
 
March 31, 2020
 
December 31, 2019
Financial Instrument
 
Fair Value Input Level
 
Carrying
Value
 
Fair Value
 
Carrying
Value
 
Fair Value
 
 
 
 
(In thousands)
Liabilities:
 
 
 
 
 
 
 
 
 
 
6% Senior Notes
 
Level 2
 

 

 
496,531

 
522,045

5% Senior Notes
 
Level 2
 
491,654

 
416,795

 

 



Level 2 Financial Instruments
Our senior notes are measured at fair value using Level 2 inputs. The fair value of the senior notes is based on market values provided by a third-party bank, which were derived using market quotes for similar type debt instruments. See Note 9 for additional information.


Note 6:
Properties and Equipment 

The carrying amounts of our properties and equipment are as follows:
 
 
March 31,
2020
 
December 31,
2019
 
 
(In thousands)
Pipelines, terminals and tankage
 
$
1,602,189

 
$
1,602,231

Refinery assets
 
349,030

 
348,093

Land and right of way
 
87,076

 
86,190

Construction in progress
 
26,894

 
10,930

Other
 
14,501

 
14,110

 
 
2,079,690

 
2,061,554

Less accumulated depreciation
 
613,901

 
594,455

 
 
$
1,465,789

 
$
1,467,099



We capitalized $23.0 thousand and $46.0 thousand during the three months ended March 31, 2020 and 2019, respectively, in interest attributable to construction projects.

Depreciation expense was $20.3 million and $20.7 million for the three months ended March 31, 2020 and 2019, respectively, and includes depreciation of assets acquired under capital leases.


Note 7:
Intangible Assets

Intangible assets include transportation agreements and customer relationships that represent a portion of the total purchase price of certain assets acquired from Delek in 2005, from HFC in 2008 prior to HEP becoming a consolidated VIE of HFC, from Plains in 2017, and from other minor acquisitions in 2018.


- 15 -


The carrying amounts of our intangible assets are as follows:
 
 
Useful Life
 
March 31,
2020
 
December 31,
2019
 
 
 
 
(In thousands)
Delek transportation agreement
 
30 years
 
$
59,933

 
$
59,933

HFC transportation agreement
 
10-15 years
 
75,131

 
75,131

Customer relationships
 
10 years
 
69,683

 
69,683

Other
 
 
 
50

 
50

 
 
 
 
204,797

 
204,797

Less accumulated amortization
 
 
 
106,977

 
103,475

 
 
 
 
$
97,820

 
$
101,322


Amortization expense was $3.5 million for both of the three months ended March 31, 2020 and 2019. We estimate amortization expense to be $14.0 million for each of the next two years, $9.9 million in 2023, and $9.1 million in 2024 and 2025.

We have additional transportation agreements with HFC resulting from historical transactions consisting of pipeline, terminal and tankage assets contributed to us or acquired from HFC. These transactions occurred while we were a consolidated variable interest entity of HFC; therefore, our basis in these agreements is zero and does not reflect a step-up in basis to fair value.


Note 8:
Employees, Retirement and Incentive Plans

Direct support for our operations is provided by Holly Logistic Services, L.L.C. (“HLS”), an HFC subsidiary, which utilizes personnel employed by HFC who are dedicated to performing services for us. Their costs, including salaries, bonuses, payroll taxes, benefits and other direct costs, are charged to us monthly in accordance with an omnibus agreement that we have with HFC (the “Omnibus Agreement”). These employees participate in the retirement and benefit plans of HFC. Our share of retirement and benefit plan costs was $2.2 million and $1.9 million for the three months ended March 31, 2020 and 2019, respectively.

Under HLS’s secondment agreement with HFC (the “Secondment Agreement”), certain employees of HFC are seconded to HLS to provide operational and maintenance services for certain of our processing, refining, pipeline and tankage assets, and HLS reimburses HFC for its prorated portion of the wages, benefits, and other costs related to these employees.
We have a Long-Term Incentive Plan for employees and non-employee directors who perform services for us. The Long-Term Incentive Plan consists of four components: restricted or phantom units, performance units, unit options and unit appreciation rights. Our accounting policy for the recognition of compensation expense for awards with pro-rata vesting (a significant proportion of our awards) is to expense the costs ratably over the vesting periods.

As of March 31, 2020, we had two types of incentive-based awards outstanding, which are described below. The compensation cost charged against income was $0.5 million and $0.7 million for the three months ended March 31, 2020 and 2019, respectively. We currently purchase units in the open market instead of issuing new units for settlement of all unit awards under our Long-Term Incentive Plan. As of March 31, 2020, 2,500,000 units were authorized to be granted under our Long-Term Incentive Plan, of which 1,116,919 have not yet been granted, assuming no forfeitures of the unvested units and full achievement of goals for the unvested performance units.

Restricted and Phantom Units
Under our Long-Term Incentive Plan, we grant restricted units to non-employee directors and phantom units to selected employees who perform services for us, with most awards vesting over a period of one to three years. Although full ownership of the units does not transfer to the recipients until the units vest, the recipients have distribution rights on these units from the date of grant, and the recipients of the restricted units have voting rights on the restricted units from the date of grant.

The fair value of each restricted or phantom unit award is measured at the market price as of the date of grant and is amortized on a straight-line basis over the requisite service period for each separately vesting portion of the award.


- 16 -


A summary of restricted and phantom unit activity and changes during the three months ended March 31, 2020, is presented below:
Restricted and Phantom Units
 
Units
 
Weighted Average Grant-Date Fair Value
Outstanding at January 1, 2020 (nonvested)
 
145,205

 
$
26.22

Vesting and transfer of full ownership to recipients
 
(4,397
)
 
30.29

Forfeited
 
(3,267
)
 
24.44

Outstanding at March 31, 2020 (nonvested)
 
137,541

 
$
26.14



The grant date fair values of phantom units that were vested and transferred to recipients during the three months ended March 31, 2020 were $0.1 million. No restricted or phantom units were vested and transferred to recipients during the three months ended March 31, 2019. As of March 31, 2020, there was $1.9 million of total unrecognized compensation expense related to unvested restricted and phantom unit grants, which is expected to be recognized over a weighted-average period of 1.4 years.

Performance Units
Under our Long-Term Incentive Plan, we grant performance units to selected officers who perform services for us. Performance units granted are payable in common units at the end of a three-year performance period based upon meeting certain criteria over the performance period. Under the terms of our performance unit grants, some awards are subject to the growth in our distributable cash flow per common unit over the performance period while other awards are subject to "financial performance" and "market performance." Financial performance is based on meeting certain earnings before interest, taxes, depreciation and amortization ("EBITDA") targets, while market performance is based on the relative standing of total unitholder return achieved by HEP compared to peer group companies. The number of units ultimately issued under these awards can range from 50% to 150% or 0% to 200%. As of March 31, 2020, estimated unit payouts for outstanding nonvested performance unit awards ranged between 100% and 150% of the target number of performance units granted.

We did not grant any performance units during the three months ended March 31, 2020. Although common units are not transferred to the recipients until the performance units vest, the recipients have distribution rights with respect to the target number of performance units subject to the award from the date of grant at the same rate as distributions paid on our common units.

A summary of performance unit activity and changes for the three months ended March 31, 2020, is presented below:
Performance Units
 
Units
Outstanding at January 1, 2020 (nonvested)
 
53,445

Vesting and transfer of common units to recipients
 
(11,634
)
Outstanding at March 31, 2020 (nonvested)
 
41,811



The grant date fair value of performance units vested and transferred to recipients during the three months ended March 31, 2020 and 2019 was $0.4 million and $0.3 million, respectively. Based on the weighted-average fair value of performance units outstanding at March 31, 2020, of $1.2 million, there was $0.5 million of total unrecognized compensation expense related to nonvested performance units, which is expected to be recognized over a weighted-average period of 1.8 years.

During the three months ended March 31, 2020, we did not purchase any of our common units in the open market for the issuance and settlement of unit awards under our Long-Term Incentive Plan.


Note 9:
Debt

Credit Agreement
We have a $1.4 billion senior secured revolving credit facility (the “Credit Agreement”) expiring in July 2022. The Credit Agreement is available to fund capital expenditures, investments, acquisitions, distribution payments and working capital and for general partnership purposes. The Credit Agreement is also available to fund letters of credit up to a $50 million sub-limit, and it contains an accordion feature giving us the ability to increase the size of the facility by up to $300 million with additional lender commitments.


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Our obligations under the Credit Agreement are collateralized by substantially all of our assets, and indebtedness under the Credit Agreement is guaranteed by our material, wholly-owned subsidiaries.  The Credit Agreement requires us to maintain compliance with certain financial covenants consisting of total leverage, senior secured leverage, and interest coverage.  It also limits or restricts our ability to engage in certain activities.  If, at any time prior to the expiration of the Credit Agreement, HEP obtains two investment grade credit ratings, the Credit Agreement will become unsecured and many of the covenants, limitations, and restrictions will be eliminated.

We may prepay all loans at any time without penalty, except for tranche breakage costs.  If an event of default exists under the Credit Agreement, the lenders will be able to accelerate the maturity of all loans outstanding and exercise other rights and remedies.  We were in compliance with the covenants as of March 31, 2020.

Senior Notes
As of December 31, 2019, we had $500 million aggregate principal amount of 6% senior unsecured notes due in 2024 (the "6% Senior Notes") outstanding. The 6% Senior Notes were unsecured and imposed certain restrictive covenants, including limitations on our ability to incur additional indebtedness, make investments, sell assets, incur certain liens, pay distributions, enter into transactions with affiliates and enter into mergers.

On February 4, 2020, we closed a private placement of $500 million in aggregate principal amount of 5% senior unsecured notes due in 2028 (the "5% Senior Notes"). On February 5, 2020, we redeemed the existing $500 million 6% Senior Notes at a redemption cost of $522.5 million, at which time we recognized a $25.9 million early extinguishment loss consisting of a $22.5 million debt redemption premium and unamortized financing costs of $3.4 million. We funded the $522.5 million redemption with net proceeds from the issuance of our 5% Senior Notes and borrowings under our Credit Agreement.

The 5% Senior Notes are unsecured and impose certain restrictive covenants, including limitations on our ability to incur additional indebtedness, make investments, sell assets, incur certain liens, pay distributions, enter into transactions with affiliates, and enter into mergers. We were in compliance with the restrictive covenants for the 5% Senior Notes as of March 31, 2020. At any time when the 5% Senior Notes are rated investment grade by either Moody’s or Standard & Poor’s and no default or event of default exists, we will not be subject to many of the foregoing covenants. Additionally, we have certain redemption rights at varying premiums over face value under the 5% Senior Notes.

Indebtedness under the 5% Senior Notes is guaranteed by all of our existing wholly-owned subsidiaries (other than Holly Energy Finance Corp. and certain immaterial subsidiaries).

Long-term Debt
The carrying amounts of our long-term debt was as follows:
 
 
March 31,
2020
 
December 31,
2019
 
 
(In thousands)
Credit Agreement
 
 
 
 
Amount outstanding
 
1,010,500

 
$
965,500

 
 
 
 
 
6% Senior Notes
 
 
 
 
Principal
 

 
500,000

Unamortized premium and debt issuance costs
 

 
(3,469
)
 
 

 
496,531

 
 
 
 
 
5% Senior Notes
 
 
 
 
Principal
 
500,000

 

Unamortized premium and debt issuance costs
 
(8,346
)
 

 
 
491,654

 

 
 
 
 
 
Total long-term debt
 
1,502,154

 
$
1,462,031




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Interest Expense and Other Debt Information
Interest expense consists of the following components:
 
 
Three Months Ended March 31,
 
 
2020
 
2019
 
 
(In thousands)
Interest on outstanding debt:
 
 
 
 
Credit Agreement
 
$
8,601

 
$
10,372

6% Senior Notes
 
2,833

 
7,500

5% Senior Notes
 
4,167

 

Amortization of discount and deferred debt issuance costs
 
799

 
766

Commitment fees
 
353

 
403

Interest on finance leases
 
1,037

 
27

Total interest incurred
 
17,790

 
19,068

Less capitalized interest
 
23

 
46

Net interest expense
 
$
17,767

 
$
19,022

Cash paid for interest
 
$
25,168

 
$
25,918




Note 10:
Related Party Transactions

We serve HFC’s refineries under long-term pipeline, terminal and tankage throughput agreements, and refinery processing unit tolling agreements expiring from 2021 to 2036, and revenues from these agreements accounted for 79% of our total revenues for the three months ended March 31, 2020. Under these agreements, HFC agrees to transport, store and process throughput volumes of refined product, crude oil and feedstocks on our pipelines, terminals, tankage, loading rack facilities and refinery processing units that result in minimum annual payments to us. These minimum annual payments or revenues are subject to annual rate adjustments on July 1st each year generally based on increases or decreases in PPI or the FERC index. As of March 31, 2020, these agreements with HFC require minimum annualized payments to us of $348.2 million.

If HFC fails to meet its minimum volume commitments under the agreements in any quarter, it will be required to pay us the amount of any shortfall in cash by the last day of the month following the end of the quarter. Under certain of these agreements, a shortfall payment may be applied as a credit in the following four quarters after its minimum obligations are met.

Under certain provisions of the Omnibus Agreement, we pay HFC an annual administrative fee (currently $2.6 million) for the provision by HFC or its affiliates of various general and administrative services to us. This fee does not include the salaries of personnel employed by HFC who perform services for us on behalf of HLS or the cost of their employee benefits, which are charged to us separately by HFC. Also, we reimburse HFC and its affiliates for direct expenses they incur on our behalf.

Related party transactions with HFC are as follows:
Revenues received from HFC were $101.4 million and $103.4 million for the three months ended March 31, 2020 and 2019, respectively.
HFC charged us general and administrative services under the Omnibus Agreement of $0.7 million and $0.6 million for the three months ended March 31, 2020 and 2019, respectively.
We reimbursed HFC for costs of employees supporting our operations of $14.1 million and $13.6 million for the three months ended March 31, 2020 and 2019, respectively.
HFC reimbursed us $3.1 million and $2.1 million for the three months ended March 31, 2020 and 2019, respectively, for expense and capital projects.
We distributed $37.6 million and $37.3 million in the three months ended March 31, 2020 and 2019, respectively, to HFC as regular distributions on its common units.
Accounts receivable from HFC were $38.4 million and $49.7 million at March 31, 2020, and December 31, 2019, respectively.
Accounts payable to HFC were $6.4 million and $16.7 million at March 31, 2020, and December 31, 2019, respectively.

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Deferred revenue in the consolidated balance sheets at March 31, 2020 and December 31, 2019, included $0.2 million and $0.5 million, respectively, relating to certain shortfall billings to HFC.
We received direct financing lease payments from HFC for use of our Artesia and Tulsa railyards of $0.5 million for the three months ended March 31, 2020 and 2019.
We received sales-type lease payments of $2.4 million from HFC that were not included in revenues for the three months ended March 31, 2020.
On October 31, 2017, we closed on an equity restructuring transaction with HEP Logistics, a wholly-owned subsidiary of HFC and the general partner of HEP, pursuant to which the incentive distribution rights held by HEP Logistics were canceled, and HEP Logistics' 2% general partner interest in HEP was converted into a non-economic general partner interest in HEP. In consideration, we issued 37,250,000 of our common units to HEP Logistics. In addition, HEP Logistics agreed to waive $2.5 million of limited partner cash distributions for each of twelve consecutive quarters beginning with the first quarter the units issued as consideration were eligible to receive distributions. This waiver of limited partner cash distributions will expire after the cash distribution for the second quarter of 2020, which will be made during the third quarter of 2020.

Note 11:
Partners’ Equity, Income Allocations and Cash Distributions

As of March 31, 2020, HFC held 59,630,030 of our common units, constituting a 57% limited partner interest in us, and held the non-economic general partner interest.

Continuous Offering Program
We have a continuous offering program under which we may issue and sell common units from time to time, representing limited partner interests, up to an aggregate gross sales amount of $200 million. As of March 31, 2020, HEP has issued 2,413,153 units under this program, providing $82.3 million in gross proceeds.
 
Allocations of Net Income
Net income attributable to HEP is allocated to the partners based on their weighted-average ownership percentage during the period.

Cash Distributions
On April 23, 2020, we announced our cash distribution for the first quarter of 2020 of $0.35 per unit. The distribution is payable on all common units and will be paid May 14, 2020, to all unitholders of record on May 4, 2020. However, HEP Logistics waived $2.5 million in limited partner cash distributions due to them as discussed in Note 1.

Our regular quarterly cash distribution to the limited partners will be $34.5 million for the three months ended March 31, 2020 and was $68.2 million for the three months ended March 31, 2019. Our distributions are declared subsequent to quarter end; therefore, these amounts do not reflect distributions paid during the respective period.

As a master limited partnership, we distribute our available cash, which historically has exceeded our net income attributable to HEP because depreciation and amortization expense represents a non-cash charge against income. The result is a decline in our partners’ equity since our regular quarterly distributions have exceeded our quarterly net income attributable to HEP. Additionally, if the asset contributions and acquisitions from HFC had occurred while we were not a consolidated VIE of HFC, our acquisition cost, in excess of HFC’s historical basis in the transferred assets, would have been recorded in our financial statements at the time of acquisition as increases to our properties and equipment and intangible assets instead of decreases to our partners’ equity.


Note 12:
Net Income Per Limited Partner Unit

Basic net income per unit applicable to the limited partners is calculated as net income attributable to the partners divided by the weighted average limited partners’ units outstanding. Diluted net income per unit assumes, when dilutive, the issuance of the net incremental units from restricted units, phantom units and performance units.To the extent net income attributable to the partners exceeds or is less than cash distributions, this difference is allocated to the partners based on their weighted-average ownership percentage during the period, after consideration of any priority allocations of earnings. Our dilutive securities are immaterial for all periods presented.
  

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Net income per limited partner unit is computed as follows:

 
 
Three Months Ended
March 31,
 
 
2020
 
2019
 
 
(In thousands, except per unit data)
Net income attributable to the partners
 
$
24,861

 
$
51,182

Weighted average limited partners' units outstanding
 
105,440

 
105,440

Limited partners' per unit interest in earnings - basic and diluted
 
$
0.24

 
$
0.49




Note 13:
Environmental

We expensed $0.2 million for the three months ended March 31, 2020, for environmental remediation obligations, and we incurred no expenses for the three months ended March 31, 2019. The accrued environmental liability, net of expected recoveries from indemnifying parties, reflected in our consolidated balance sheets was $5.5 million at both March 31, 2020 and December 31, 2019, of which $3.3 million and $3.5 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.

Under the Omnibus Agreement and certain transportation agreements and purchase agreements with HFC, HFC has agreed to indemnify us, subject to certain monetary and time limitations, for environmental noncompliance and remediation liabilities associated with certain assets transferred to us from HFC and occurring or existing prior to the date of such transfers. Our consolidated balance sheets included additional accrued environmental liabilities of $0.4 million and $0.5 million for HFC indemnified liabilities for the periods ending March 31, 2020 and December 31, 2019, respectively, and other assets included equal and offsetting balances representing amounts due from HFC related to indemnifications for environmental remediation liabilities.


Note 14:
Contingencies

We are a party to various legal and regulatory proceedings, none of which we believe will have a material adverse impact on our financial condition, results of operations or cash flows.


Note 15:
Segment Information

Although financial information is reviewed by our chief operating decision makers from a variety of perspectives, they view the business in two reportable operating segments: pipelines and terminals, and refinery processing units. These operating segments adhere to the accounting polices used for our consolidated financial statements.

Pipelines and terminals have been aggregated as one reportable segment as both pipeline and terminals (1) have similar economic characteristics, (2) similarly provide logistics services of transportation and storage of petroleum products, (3) similarly support the petroleum refining business, including distribution of its products, (4) have principally the same customers and (5) are subject to similar regulatory requirements.

We evaluate the performance of each segment based on its respective operating income. Certain general and administrative expenses and interest and financing costs are excluded from segment operating income as they are not directly attributable to a specific reportable segment. Identifiable assets are those used by the segment, whereas other assets are principally equity method investments, cash, deposits and other assets that are not associated with a specific reportable reportable segment.

- 21 -


 
 
Three Months Ended
March 31,
 
 
2020
 
2019
 
 
(In thousands)
Revenues:
 
 
 
 
Pipelines and terminals - affiliate
 
$
81,544

 
$
81,540

Pipelines and terminals - third-party
 
26,426

 
31,138

Refinery processing units - affiliate
 
19,884

 
21,819

Total segment revenues
 
$
127,854

 
$
134,497

 
 
 
 
 
Segment operating income:
 
 
 
 
Pipelines and terminals
 
$
58,903

 
$
63,232

Refinery processing units
 
9,992

 
9,922

Total segment operating income
 
68,895

 
73,154

Unallocated general and administrative expenses
 
(2,702
)
 
(2,620
)
Interest and financing costs, net
 
(15,549
)
 
(18,494
)
Loss on early extinguishment of debt
 
(25,915
)
 

Equity in earnings of equity method investments
 
1,714

 
2,100

Gain (loss) on sale of assets and other
 
506

 
(310
)
Income before income taxes
 
$
26,949

 
$
53,830