Holly Energy Partners, L.P.
HOLLY ENERGY PARTNERS LP (Form: 10-Q, Received: 08/03/2016 15:54:18)


                    
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 June 30, 2016
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)
________________________________________________________________
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 by Rule 12b-2 of the Exchange Act).    Yes   ¨    No   ý
The number of the registrant’s outstanding common units at July 29, 2016 was 59,101,847.


Table of Contents ril 19,

HOLLY ENERGY PARTNERS, L.P.
INDEX
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
 
 
Item 3.
 
 
 
 
 
Item 4.
 
 
 
 
 
 
 
Item 1.
 
 
 
 
 
Item 1A.
 
 
 
 
 
Item 6.
 
 
 
 
 
 
 
 
 
 
 
 

- 2 -

Table of Contents ril 19,


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, those 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:
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;
the economic viability of HollyFrontier Corporation, Alon USA, Inc. and our other customers;
the demand for refined petroleum products in markets we serve;
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 pipeline and terminal facilities;
the effects of current and future government regulations and policies;
our operational efficiency in carrying out routine operations and capital construction projects;
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 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. 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, 2015 , 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 -

Table of Contents ril 19,

PART I. FINANCIAL INFORMATION


Item 1.
Financial Statements
HOLLY ENERGY PARTNERS, L.P.
CONSOLIDATED BALANCE SHEETS
(Unaudited)  
(in thousands, except unit data)
 
 
June 30, 2016
 
December 31, 2015 (1)
ASSETS
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
4,882

 
$
15,013

Accounts receivable:
 
 
 
 
Trade
 
7,288

 
8,593

Affiliates
 
42,845

 
32,482

 
 
50,133

 
41,075

Prepaid and other current assets
 
4,638

 
5,054

Total current assets
 
59,653

 
61,142

 
 
 
 
 
Properties and equipment, net
 
1,054,162

 
1,059,179

Transportation agreements, net
 
70,330

 
73,805

Goodwill
 
256,498

 
256,498

Equity method investments
 
165,362

 
79,438

Other assets
 
11,324

 
13,703

Total assets
 
$
1,617,329

 
$
1,543,765

 
 
 
 
 
LIABILITIES AND EQUITY
 
 
 
 
Current liabilities:
 
 
 
 
Accounts payable:
 
 
 
 
Trade
 
$
12,245

 
$
10,948

Affiliates
 
9,182

 
11,635

 
 
21,427

 
22,583

 
 
 
 
 
Accrued interest
 
6,661

 
6,752

Deferred revenue
 
9,553

 
12,016

Accrued property taxes
 
5,174

 
3,764

Other current liabilities
 
3,298

 
3,809

Total current liabilities
 
46,113

 
48,924

 
 
 
 
 
Long-term debt
 
1,083,136

 
1,008,752

Other long-term liabilities
 
17,190

 
20,744

Deferred revenue
 
42,474

 
39,063

 
 
 
 
 
Class B unit
 
37,705

 
33,941

 
 
 
 
 
Equity:
 
 
 
 
Partners’ equity:
 
 
 
 
Common unitholders (59,101,847 and 58,657,048 units issued and outstanding
    at June 30, 2016 and December 31, 2015, respectively)
 
433,551

 
428,019

General partner interest (2% interest)
 
(137,882
)
 
(130,297
)
Accumulated other comprehensive income (loss)
 
(405
)
 
190

Total partners’ equity
 
295,264

 
297,912

Noncontrolling interest
 
95,447

 
94,429

Total equity
 
390,711

 
392,341

Total liabilities and equity
 
$
1,617,329

 
$
1,543,765

(1) Retrospectively adjusted as described in Note 1.
See accompanying notes.


- 4 -

Table of Contents ril 19,

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

 
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
 
2016
 
2015 (1)
 
2016
 
2015 (1)
Revenues:
 
 
 
 
 
 
 
 
Affiliates
 
$
79,179

 
$
68,297

 
$
162,025

 
$
140,552

Third parties
 
15,718

 
15,182

 
34,882

 
32,683

 
 
94,897

 
83,479

 
196,907

 
173,235

Operating costs and expenses:
 
 
 
 
 
 
 
 
Operations (exclusive of depreciation and amortization)
 
27,255

 
25,400

 
54,177

 
53,465

Depreciation and amortization
 
15,709

 
15,179

 
32,260

 
29,977

General and administrative
 
2,863

 
2,696

 
5,954

 
5,986

 
 
45,827

 
43,275

 
92,391

 
89,428

Operating income
 
49,070

 
40,204

 
104,516

 
83,807

 
 
 
 
 
 
 
 
 
Other income (expense):
 
 
 
 
 
 
 
 
Equity in earnings of equity method investments
 
3,623

 
631

 
6,388

 
1,365

Interest expense
 
(11,276
)
 
(9,056
)
 
(21,811
)
 
(17,824
)
Interest income
 
112

 
3

 
224

 
3

Gain (loss) on sale of assets
 
(5
)
 
50

 
(5
)
 
209

Other income (expense)
 
5

 
21

 
(3
)
 
21

 
 
(7,541
)
 
(8,351
)
 
(15,207
)
 
(16,226
)
Income before income taxes
 
41,529

 
31,853

 
89,309

 
67,581

State income tax benefit (expense)
 
(54
)
 
64

 
(149
)
 
(37
)
Net income
 
41,475

 
31,917

 
89,160

 
67,544

Allocation of net income attributable to noncontrolling interests
 
(2,355
)
 
(1,743
)
 
(7,282
)
 
(5,770
)
Net income attributable to Holly Energy Partners
 
39,120

 
30,174

 
81,878

 
61,774

General partner interest in net income, including incentive distributions
 
(12,677
)
 
(9,969
)
 
(24,562
)
 
(19,576
)
Limited partners’ interest in net income
 
$
26,443

 
$
20,205

 
$
57,316

 
$
42,198

Limited partners’ per unit interest in earnings—basic and diluted
 
$
0.45

 
$
0.34

 
$
0.96

 
$
0.71

Weighted average limited partners’ units outstanding
 
58,865

 
58,657

 
58,761

 
58,657


(1) Retrospectively adjusted as described in Note 1.

See accompanying notes.


- 5 -


HOLLY ENERGY PARTNERS, L.P.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(In thousands)

 
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
 
2016
 
2015 (1)
 
2016
 
2015 (1)
Net income
 
$
41,475

 
$
31,917

 
$
89,160

 
$
67,544

Other comprehensive income:
 
 
 
 
 
 
 
 
Change in fair value of cash flow hedging instruments
 
(255
)
 
(306
)
 
(938
)
 
(1,586
)
Reclassification adjustment to net income on partial settlement of cash flow hedge
 
113

 
528

 
343

 
1,059

Other comprehensive income (loss)
 
(142
)
 
222

 
(595
)
 
(527
)
Comprehensive income before noncontrolling interest
 
41,333

 
32,139

 
88,565

 
67,017

Allocation of comprehensive income to noncontrolling interests
 
(2,355
)
 
(1,743
)
 
(7,282
)
 
(5,770
)
Comprehensive income attributable to Holly Energy Partners
 
$
38,978

 
$
30,396

 
$
81,283

 
$
61,247


(1) Retrospectively adjusted as described in Note 1.
 
See accompanying notes.


- 6 -

Table of Contents ril 19,

HOLLY ENERGY PARTNERS, L.P.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
 
 
 
Six Months Ended June 30,
 
 
2016
 
2015 (1)
Cash flows from operating activities
 
 
 
 
Net income
 
$
89,160

 
$
67,544

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Depreciation and amortization
 
32,260

 
29,977

(Gain) loss on sale of assets
 
5

 
(209
)
Amortization of deferred charges
 
1,376

 
930

Amortization of restricted and performance units
 
1,193

 
1,762

Distributions less than income from equity investments
 
(414
)
 

(Increase) decrease in operating assets:
 
 
 
 
Accounts receivable—trade
 
2,564

 
(4,514
)
Accounts receivable—affiliates
 
(10,183
)
 
5,064

Prepaid and other current assets
 
416

 
(311
)
Increase (decrease) in operating liabilities:
 
 
 
 
Accounts payable—trade
 
(637
)
 
(1,610
)
Accounts payable—affiliates
 
(2,454
)
 
2,573

Accrued interest
 
(91
)
 
168

Deferred revenue
 
948

 
3,600

Accrued property taxes
 
1,409

 
1,632

Other current liabilities
 
(979
)
 
(242
)
Other, net
 
(381
)
 
3,890

Net cash provided by operating activities
 
114,192

 
110,254

 
 
 
 
 
Cash flows from investing activities
 
 
 
 
Additions to properties and equipment
 
(32,667
)
 
(42,343
)
Purchase of El Dorado crude tanks
 

 
(27,500
)
Purchase of interest in Cheyenne Pipeline
 
(42,500
)
 

Proceeds from sale of assets and other
 
18

 
965

Distributions in excess of equity in earnings of equity investments
 
1,496

 
198

Net cash used for investing activities
 
(73,653
)
 
(68,680
)
 
 
 
 
 
Cash flows from financing activities
 
 
 
 
Borrowings under credit agreement
 
239,000

 
254,100

Repayments of credit agreement borrowings
 
(165,000
)
 
(221,100
)
Contributions from HFC for El Dorado Operating acquisition
 

 
18,888

Contributions from general partner
 
120

 

Distribution to HFC for Osage acquisition
 
(1,245
)
 

Proceeds from issuance of common units
 
13,690

 

Distributions to HEP unitholders
 
(91,109
)
 
(82,614
)
Distributions to noncontrolling interest
 
(2,500
)
 
(2,875
)
Distribution to HFC for Tulsa tank acquisition
 
(39,500
)
 

Contributions from HFC for Tulsa tank expenditures
 
99

 
722

Purchase of units for incentive grants
 
(784
)
 
(247
)
Deferred financing costs
 
(3,084
)
 

Other
 
(357
)
 
(854
)
Net cash used by financing activities
 
(50,670
)
 
(33,980
)
 
 
 
 
 
Cash and cash equivalents
 
 
 
 
Increase (decrease) for the period
 
(10,131
)
 
7,594

Beginning of period
 
15,013

 
2,830

End of period
 
$
4,882

 
$
10,424

     
(1) Retrospectively adjusted as described in Note 1.

See accompanying notes.

- 7 -

Table of Contents ril 19,

HOLLY ENERGY PARTNERS, L.P.
CONSOLIDATED STATEMENTS OF EQUITY
(Unaudited)
(In thousands)
 
 
 
Common
Units
 
General
Partner
Interest
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Noncontrolling Interest
 
Total Equity
 
 
 
Balance December 31, 2015 (1)
 
$
428,019

 
$
(130,297
)
 
$
190

 
$
94,429

 
$
392,341

Contribution from HFC for Osage transaction
 

 
31,285

 

 

 
31,285

Contribution from HFC
 

 
299

 

 

 
299

Distribution to HFC for Tulsa tank acquisition

 

 
(39,500
)
 

 

 
(39,500
)
Contribution from HFC for Tulsa tank expenditures
 

 
99

 

 

 
99

Distributions to HEP unitholders
 
(66,854
)
 
(24,255
)
 

 

 
(91,109
)
Distributions to noncontrolling interest
 

 

 

 
(2,500
)
 
(2,500
)
Issuance of common units
 
14,586

 

 

 

 
14,586

Purchase of units for incentive grants
 
(784
)
 

 

 

 
(784
)
Amortization of restricted and performance units
 
1,193

 

 

 

 
1,193

Class B unit accretion
 
(3,689
)
 
(75
)
 

 

 
(3,764
)
Net income
 
61,080

 
24,562

 

 
3,518

 
89,160

Other comprehensive loss
 

 

 
(595
)
 

 
(595
)
Balance June 30, 2016
 
$
433,551

 
$
(137,882
)
 
$
(405
)
 
$
95,447

 
$
390,711


(1) Retrospectively adjusted as described in Note 1.

See accompanying notes.



- 8 -

Table of Contents ril 19,

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 which is 39% owned (including the 2% general partner interest) by HollyFrontier Corporation (“HFC”) and its subsidiaries. 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.

We operate in one reportable segment which represents the aggregation of our petroleum product and crude pipelines business and terminals, tankage, loading rack facilities and refinery processing units.

We own and operate petroleum product and crude oil pipelines, terminals, tankage and loading rack facilities and refinery processing units that support HFC’s 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, we own a 75% interest in UNEV Pipeline, LLC (“UNEV”), a 50% interest in Frontier Aspen, LLC, a 50% interest in Osage Pipe Line Company, LLC (“Osage”), a 50% interest in Cheyenne Pipeline LLC and a 25% interest in SLC Pipeline LLC.

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, 2015 . 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, 2016 .

On July 19, 2016, we closed a private placement of $400 million in aggregate principal amount of 6.0% senior unsecured notes due in 2024 (the “6.0% Senior Notes”). We used the net proceeds to repay indebtedness under our revolving credit agreement.

On May 10, 2016, we established a continuous offering program under which HEP may issue and sell common units from time to time, representing limited partner interests, up to an aggregate gross sales amount of $200 million . We intend to use our net proceeds for general partnership purposes.

Acquisitions

Cheyenne Pipeline
On June 3, 2016, we acquired a 50% interest in Cheyenne Pipeline LLC, owner of the Cheyenne Pipeline, in exchange for a contribution of $42.5 million in cash to Cheyenne Pipeline LLC. Cheyenne Pipeline LLC will continue to be operated by an affiliate of Plains All American Pipeline, L.P. (“Plains”), which owns the remaining 50% interest. The 87-mile crude oil pipeline runs from Fort Laramie to Cheyenne, Wyoming and has an 80,000 barrel per day capacity.

Tulsa Tanks
On March 31, 2016, we acquired crude oil tanks located at HFC’s Tulsa refinery from an affiliate of Plains for $39.5 million . In 2009, HFC sold these tanks to Plains and leased them back, and due to HFC’s continuing interest in the tanks, HFC accounted for the transaction as a financing arrangement. Accordingly, the tanks remained on HFC’s balance sheet and were depreciated for accounting purposes.

As we are a consolidated variable interest entity (“VIE”) of HFC, this transaction was recorded as a transfer between entities under common control and reflects HFC’s carrying basis in the net assets acquired. We have retrospectively adjusted our financial position and operating results as if these crude oil tanks were owned for all periods while we were under common control of HFC. The 2015 consolidated income statement was adjusted to reflect a $0.2 million and a $0.4 million increase in operating costs and expenses for the three and six months ended June 30, 2015 , respectively. The consolidated balance sheet was adjusted to reflect

- 9 -


HOLLY ENERGY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Continued



increases of $9.3 million in net properties and equipment, $0.1 million in other long-term liabilities and $9.2 million in general partner interest at December 31, 2015 . The consolidated statement of cash flows for the six months ended June 30, 2015 , reflects these changes in cash flows from investing and financing activities.

Osage
On February 22, 2016, HFC obtained a 50% membership interest in Osage in a non-monetary exchange for a 20-year terminalling services agreement, whereby a subsidiary of Magellan Midstream Partners (“Magellan”) will provide terminalling services for all HFC products originating in Artesia, New Mexico requiring terminalling in or through El Paso, Texas. Osage is the owner of the Osage Pipeline, a 135-mile pipeline that transports crude oil from Cushing, Oklahoma to HFC’s El Dorado Refinery in Kansas and also connects to the Jayhawk pipeline serving the CHS Inc. refinery in McPherson, Kansas. The Osage Pipeline is the primary pipeline supplying HFC’s El Dorado refinery with crude oil.

Concurrent with this transaction, we entered into a non-monetary exchange with HFC, whereby we received HFC’s interest in Osage in exchange for our El Paso terminal. Under this exchange, we agreed to build two connections on our south products pipeline system that will permit HFC access to Magellan’s El Paso terminal. Effective upon the closing of this exchange, we are the named operator of the Osage Pipeline and are working to transition into that role. Since we are a consolidated VIE of HFC, this transaction was recorded as a transfer between entities under common control and reflects HFC’s carrying basis of its 50% membership interest in Osage of $44.5 million offset by our net carrying basis in the El Paso terminal of $12.1 million with the difference treated as a contribution from HFC. The carrying value of our 50% membership interest in Osage of $44.5 million exceeds the amount of the underlying equity in net assets recorded by Osage by $33.1 million .

El Dorado Operating
On November 1, 2015 , we acquired from a wholly owned subsidiary of HFC, all the outstanding membership interests in El Dorado Operating LLC (“El Dorado Operating”), which owns the newly constructed naphtha fractionation and hydrogen generation units at HFC’s El Dorado refinery, for cash consideration of $62.0 million . In connection with this transaction, we entered into 15-year tolling agreements containing minimum quarterly throughput commitments from HFC that provide minimum annualized revenues of $15.3 million .

As we are a consolidated VIE of HFC, this transaction was recorded as a transfer between entities under common control and reflects HFC’s carrying basis in El Dorado Operating’s assets and liabilities. We have retrospectively adjusted our financial position and operating results as if El Dorado Operating were a consolidated subsidiary for all periods while we were under common control of HFC. The consolidated statement of cash flows for the six months ending June 30, 2015 , reflects a $18.9 million recast between investing activities and financing activities.

New Accounting Pronouncements

Revenue Recognition
In May 2014, an accounting standard update was issued requiring revenue to be recognized when promised goods or services are transferred to customers in an amount that reflects the expected consideration for these goods or services. This standard has an effective date of January 1, 2018. We are evaluating the impact of this standard.

Consolidation
In February 2015, the FASB issued a standard that modifies existing consolidation guidance for reporting organizations that are required to evaluate whether they should consolidate certain legal entities. We adopted the new standard effective January 1, 2016. This standard had no impact on the entities we consolidate.

Financial Assets and Liabilities
In January 2016, an accounting standard update was issued requiring changes in the accounting and disclosures for financial instruments. This standard will become effective beginning with our 2018 reporting year. We are evaluating the impact of this standard.

Leases
In February 2016, an accounting standard update was issued requiring leases to be measured and recognized as a lease liability, with a corresponding right-of-use asset on the balance sheet. This standard has an effective date of January 1, 2019, and we are evaluating the impact of this standard.


- 10 -


HOLLY ENERGY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Continued



Earnings Per Unit
In April 2015, an accounting standard update was issued requiring changes to the allocation of the earnings or losses of a transferred business for periods before the date of a dropdown of net assets accounted for as a common control transaction entirely to the general partner for purposes of calculating historical earnings per unit. We adopted this standard as of January 1, 2016. In connection with the dropdown of assets from HFC’s Tulsa refinery on March 31, 2016, we reduced net income by $0.2 million and $0.4 million for the three and six months ended June 30, 2015 , respectively. This reduction had no impact on the historical earnings per unit.


Note 2:
Financial Instruments

Our financial instruments consist of cash and cash equivalents, accounts receivable, accounts payable, debt and interest rate swaps. The carrying amounts of cash and 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.

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.

The carrying amounts and estimated fair values of our senior notes and interest rate swaps were as follows:
 
 
 
 
June 30, 2016
 
December 31, 2015
Financial Instrument
 
Fair Value Input Level
 
Carrying
Value
 
Fair Value
 
Carrying
Value
 
Fair Value
 
 
 
 
(In thousands)
Assets:
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
 
Level 2
 
$

 
$

 
$
304

 
$
304

 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
 
6.5% Senior notes
 
Level 2
 
$
297,136

 
$
301,500

 
$
296,752

 
$
295,500

Interest rate swaps
 
Level 2
 
405

 
405

 
114

 
114

 
 
 
 
$
297,541

 
$
301,905

 
$
296,866

 
$
295,614


Level 2 Financial Instruments
Our senior notes and interest rate swaps 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. The fair value of our interest rate swaps is based on the net present value of expected future cash flows related to both variable and fixed-rate legs of the swap agreement. This measurement is computed using the forward London Interbank Offered Rate (“LIBOR”) yield curve, a market-based observable input.

See Note 6 for additional information on these instruments.



- 11 -


HOLLY ENERGY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Continued



Note 3:
Properties and Equipment  

The carrying amounts of our properties and equipment are as follows:
 
 
June 30,
2016
 
December 31, 2015 (1)
 
 
(In thousands)
Pipelines, terminals and tankage
 
$
1,199,857

 
$
1,231,597

Land and right of way
 
65,273

 
66,215

Refinery assets
 
64,371

 
63,336

Construction in progress
 
52,759

 
28,249

Other
 
24,524

 
22,200

 
 
1,406,784

 
1,411,597

Less accumulated depreciation
 
352,622

 
352,418

 
 
$
1,054,162

 
$
1,059,179

(1) Retrospectively adjusted as described in Note 1.

We capitalized $0.3 million and $0.6 million in interest attributable to construction projects during the six months ended June 30, 2016 and 2015 , respectively.

Depreciation expense was $28.5 million and $26.2 million for the six months ended June 30, 2016 and 2015 , respectively.


Note 4:
Transportation Agreements

Our transportation agreements represent a portion of the total purchase price of certain assets acquired from Alon in 2005 and from HFC in 2008 . The Alon agreement is being amortized over 30 years ending 2035 (the initial 15 -year term of the agreement plus an expected 15 -year extension period), and the HFC agreement is being amortized over 15 years ending 2023 (the term of the HFC agreement).

The carrying amounts of our transportation agreements are as follows:
 
 
June 30,
2016
 
December 31,
2015
 
 
(In thousands)
Alon transportation agreement
 
$
59,933

 
$
59,933

HFC transportation agreement
 
74,231

 
74,231

Other
 
50

 
50

 
 
134,214

 
134,214

Less accumulated amortization
 
63,884

 
60,409

 
 
$
70,330

 
$
73,805


Amortization expense was $3.5 million for each of the six months ended June 30, 2016 and 2015 .

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 VIE of HFC; therefore, our basis in these agreements is zero and does not reflect a step-up in basis to fair value.



- 12 -


HOLLY ENERGY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Continued



Note 5:
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. These employees participate in the retirement and benefit plans of HFC. Our share of retirement and benefit plan costs was $1.3 million and $1.7 million for the three months ended June 30, 2016 and 2015 , respectively, and $2.9 million and $3.1 million for the six months ended June 30, 2016 and 2015 , 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.

As of June 30, 2016 , we have two types of incentive-based awards outstanding, which are described below. The compensation cost charged against income was $0.5 million and $0.9 million for the three months ended June 30, 2016 and 2015 , respectively, and $1.2 million and $1.6 million for the six months ended June 30, 2016 and 2015 , 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 June 30, 2016 , 2,500,000 units were authorized to be granted under our Long-Term Incentive Plan, of which 1,487,498 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 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 and voting rights on these units from the date of grant.

In addition, we previously granted phantom units to certain employees. All outstanding phantom units vested in 2015, and no phantom units are currently outstanding. Vested units were paid in common units. Full ownership of the units transferred to the recipients at vesting, and the recipients did not have voting or distribution rights on these units until they vested.

The fair value of each restricted 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.

A summary of restricted unit activity and changes during the six months ended June 30, 2016 , is presented below:
Restricted Units
 
Units
 
Weighted Average Grant-Date Fair Value
Outstanding at January 1, 2016 (nonvested)
 
101,408

 
$
33.63

Granted
 
10,725

 
24.48

Forfeited
 
(3,030
)
 
34.21

Outstanding at June 30, 2016 (nonvested)
 
109,103

 
$
32.71


As of June 30, 2016 , there was $1.6 million of total unrecognized compensation expense related to nonvested restricted unit grants, which is expected to be recognized over a weighted-average period of 1.1 years.


- 13 -


HOLLY ENERGY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Continued



Performance Units
Under our Long-Term Incentive Plan, we grant performance units to selected executives who perform services for us. Performance units granted are payable in common units at the end of a three-year performance period based upon the growth in our distributable cash flow per common unit over the performance period. As of June 30, 2016 , estimated unit payouts for outstanding nonvested performance unit awards ranged between 100% and 150% of the target number of performance units granted.

We granted 10,725 performance units during the six months ended June 30, 2016 . Performance units granted in 2015 and during the six months ended June 30, 2016 , vest over a three-year performance period ending December 31, 2018 and are payable in HEP common units. The number of units actually earned will be based on the growth of our distributable cash flow per common unit over the performance period, and can range from 50% to 150% of the target number of performance units granted. Although common units are not transferred to the recipients until the performance units vest, the recipients have distribution rights with respect to the common units from the date of grant.

A summary of performance unit activity and changes during the six months ended June 30, 2016 , is presented below:
Performance Units
 
Units
Outstanding at January 1, 2016 (nonvested)
 
45,494

Granted
 
10,725

Vesting and transfer of common units to recipients
 
(26,157
)
Forfeited
 
(2,679
)
Outstanding at June 30, 2016 (nonvested)
 
27,383


The grant-date fair value of performance units vested and transferred to recipients during the six months ended June 30, 2016 , was $1.1 million . Based on the weighted average fair value of performance units outstanding at June 30, 2016 , of $0.8 million , there was $0.6 million of total unrecognized compensation expense related to nonvested performance units, which is expected to be recognized over a weighted-average period of 2.4 years.


Note 6:
Debt

Credit Agreement
In March 2016, we amended our senior secured revolving credit facility (the “Credit Agreement”) expiring in November 2018, increasing the size of the Credit Agreement from $850 million to $1.2 billion . The Credit Agreement 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.

Our obligations under the Credit Agreement are collateralized by substantially all of our assets. Indebtedness under the Credit Agreement involves recourse to HEP Logistics Holdings, L.P. (“HEP Logistics”), our general partner, and is guaranteed by our material, wholly-owned subsidiaries. Any recourse to HEP Logistics would be limited to the extent of its assets, which other than its investment in us are not significant. We may prepay all loans at any time without penalty, except for payment of certain breakage and related costs.

The Credit Agreement imposes certain requirements on us with which we were in compliance as of June 30, 2016 , including: a prohibition against distribution to unitholders if, before or after the distribution, a potential default or an event of default as defined in the agreement would occur; limitations on our ability to incur debt, make loans, acquire other companies, change the nature of our business, enter into a merger or consolidation, or sell assets; and covenants that require maintenance of a specified EBITDA to interest expense ratio, total debt to EBITDA ratio and senior debt to EBITDA ratio. If an event of default exists under the Credit Agreement, the lenders will be able to accelerate the maturity of the debt and exercise other rights and remedies.

Senior Notes
We have $300 million in aggregate principal amount outstanding of 6.5% senior notes (the “6.5% Senior Notes”) maturing March 2020.



- 14 -


HOLLY ENERGY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Continued



On July 19, 2016, we closed a private placement of $400 million in aggregate principal amount of 6.0% senior unsecured notes due in 2024 (the “6.0% Senior Notes” and together with the 6.5 % Senior Notes, the “Senior Notes”). We used the net proceeds to repay indebtedness under our revolving credit agreement.

The 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 6.5% Senior Notes as of June 30, 2016 . At any time when the Senior Notes are rated investment grade by both Moody’s and 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 Senior Notes.

Indebtedness under the Senior Notes is guaranteed by our wholly-owned subsidiaries.

Long-term Debt
The carrying amounts of our long-term debt are as follows:
 
 
June 30,
2016
 
December 31,
2015
 
 
(In thousands)
Credit Agreement
 
 
 
 
Amount outstanding
 
$
786,000

 
$
712,000

 
 
 
 
 
6.5% Senior Notes
 
 
 
 
Principal
 
300,000

 
300,000

Unamortized discount and debt issuance costs
 
(2,864
)
 
(3,248
)
 
 
297,136

 
296,752

 
 
 
 
 
Total long-term debt
 
$
1,083,136

 
$
1,008,752


Interest Rate Risk Management
We use interest rate swaps (derivative instruments) to manage our exposure to interest rate risk.

As of June 30, 2016 , we have two interest rate swaps with identical terms that hedge our exposure to the cash flow risk caused by the effects of LIBOR changes on $150 million of Credit Agreement advances. The swaps effectively convert $150 million of our LIBOR based debt to fixed rate debt having an interest rate of 0.74% plus an applicable margin of 2.25% as of June 30, 2016 , which equaled an effective interest rate of 2.99% . Both of these swap contracts mature in July 2017.

We have designated these interest rate swaps as cash flow hedges. Based on our assessment of effectiveness using the change in variable cash flows method, we have determined these interest rate swaps are effective in offsetting the variability in interest payments on $150 million of our variable rate debt resulting from changes in LIBOR. Under hedge accounting, we adjust our cash flow hedges on a quarterly basis to their fair values with the offsetting fair value adjustments to accumulated other comprehensive income (loss). Also on a quarterly basis, we measure hedge effectiveness by comparing the present value of the cumulative change in the expected future interest to be paid or received on the variable leg of our swaps against the expected future interest payments on $150 million of our variable rate debt. Any ineffectiveness is recorded directly to interest expense. As of June 30, 2016 , we had no ineffectiveness on our cash flow hedges.

At June 30, 2016 , we have accumulated other comprehensive loss of $0.4 million that relates to our current cash flow hedging instruments. Approximately $0.4 million will be transferred from accumulated other comprehensive loss into interest expense as interest is paid on the underlying swap agreement over the next twelve-month period, assuming interest rates remain unchanged.


- 15 -


HOLLY ENERGY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Continued



Additional information on our interest rate swaps is as follows:
Derivative Instrument
 
Balance Sheet Location
 
Fair Value
 
Location of Offsetting Balance
 
Offsetting
Amount
 
 
(In thousands)
June 30, 2016
 
 
 
 
 
 
 
 
Interest rate swaps designated as cash flow hedging instrument:
 
 
 
 
 
 
Variable-to-fixed interest rate swap contracts ($150 million of LIBOR-based debt interest)
 
Other long-term   liabilities
 
$
(405
)
 
Accumulated other
    comprehensive income
 
$
(405
)
 
 
 
 
$
(405
)
 
 
 
$
(405
)
 
 
 
 
 
 
 
 
 
December 31, 2015
 
 
 
 
 
 
 
 
Interest rate swaps designated as cash flow hedging instrument:
 
 
 
 
 
 
Variable-to-fixed interest rate swap contract ($150 million of LIBOR-based debt interest)
 
Other long-term   assets
 
$
304

 
Accumulated other
    comprehensive loss
 
$
304

Variable-to-fixed interest rate swap contracts ($155 million of LIBOR-based debt interest)
 
Other long-term   liabilities
 
(114
)
 
Accumulated other
    comprehensive income
 
(114
)
 
 
 
 
$
190

 
 
 
$
190


Interest Expense and Other Debt Information
Interest expense consists of the following components:
 
 
Six Months Ended June 30,
 
 
2016
 
2015
 
 
(In thousands)
Interest on outstanding debt:
 
 
 
 
Credit Agreement, net of interest on interest rate swaps
 
$
10,284

 
$
7,488

6.5% Senior Notes
 
9,757

 
9,757

Amortization of discount and deferred debt issuance costs
 
1,376

 
930

Commitment fees and other
 
679

 
261

Total interest incurred
 
22,096

 
18,436

Less capitalized interest
 
285

 
612

Net interest expense
 
$
21,811

 
$
17,824

Cash paid for interest
 
$
20,736

 
$
17,280


Capital Lease Obligations
Our capital lease obligations, which relate to vehicle leases with initial terms of 0 to 36 months, are $3.0 million and $1.8 million as of June 30, 2016 and December 31, 2015, respectively. The total cost of assets under capital leases was $4.6 million and $3.0 million as of June 30, 2016 and December 31, 2015 , respectively, with accumulated depreciation of $1.6 million and $1.1 million as of June 30, 2016 and December 31, 2015 , respectively. We include depreciation of capital leases in depreciation and amortization in our consolidated statements of income.


Note 7:
Significant Customers

All revenues are domestic revenues, of which 92% are currently generated from our two largest customers: HFC and Alon.

The following table presents the percentage of total revenues generated by each of these customers:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2016
 
2015
 
2016
 
2015
HFC
 
83
%
 
82
%
 
82
%
 
81
%
Alon
 
9
%
 
10
%
 
8
%
 
10
%

- 16 -


HOLLY ENERGY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Continued





Note 8:
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 2019 to 2036. 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 based on the Producer Price Index (“PPI”) or Federal Energy Regulatory Commission (“FERC”) index. As of June 30, 2016 , these agreements with HFC require minimum annualized payments to us of $261.4 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 an omnibus agreement we have with HFC (the “Omnibus Agreement”), we pay HFC an annual administrative fee (currently $2.5 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 $79.2 million and $68.3 million for the three months ended June 30, 2016 and 2015 , respectively, and $162.0 million and $140.6 million for the six months ended June 30, 2016 and 2015 , respectively.
HFC charged us general and administrative services under the Omnibus Agreement of $0.6 million for each of the three months ended June 30, 2016 and 2015 and $1.2 million for each of the six months ended June 30, 2016 and 2015 .
We reimbursed HFC for costs of employees supporting our operations of $9.5 million and $7.5 million for the three months ended June 30, 2016 and 2015 , respectively, and $19.4 million and $16.2 million for the six months ended June 30, 2016 and 2015 , respectively.
HFC reimbursed us $5.0 million and $4.4 million for the three months ended June 30, 2016 and 2015 , respectively, for reimbursable expense and capital projects and $6.7 million and $7.0 million for the six months ended June 30, 2016 and 2015 , respectively.
We distributed $25.3 million and $22.3 million for the three months ended June 30, 2016 and 2015 , respectively, and $49.8 million and $43.9 million for the six months ended June 30, 2016 and 2015 , respectively, to HFC as regular distributions on its common units and general partner interest, including general partner incentive distributions.
Accounts receivable from HFC were $42.8 million and $32.5 million at June 30, 2016 , and December 31, 2015 , respectively.
Accounts payable to HFC were $9.2 million and $11.6 million at June 30, 2016 , and December 31, 2015 , respectively.
Revenues for the six months ended June 30, 2016 and 2015 , include $5.5 million and $6.0 million , respectively, of shortfall payments billed in 2015 and 2014, respectively. Deferred revenue in the consolidated balance sheets at June 30, 2016 , and December 31, 2015 , includes $3.2 million and $6.4 million , respectively, relating to certain shortfall billings. It is possible that HFC may not exceed its minimum obligations to receive credit for any of the $3.2 million deferred at June 30, 2016 .
On February 22, 2016, HFC obtained a 50% membership interest in Osage in a non-monetary exchange, whereby a subsidiary of Magellan will provide terminalling services for all HFC products originating in Artesia, New Mexico that require terminalling in or through El Paso, Texas. Concurrent with this transaction, we entered into a non-monetary exchange with HFC, whereby we received HFC’s interest in Osage in exchange for our El Paso terminal. See Note 1 for a description of this transaction.
On March 31, 2016, we acquired crude oil tanks located at HFC’s Tulsa refinery from an affiliate of Plains for $39.5 million . See Note 1 for a description of this transaction.


- 17 -


HOLLY ENERGY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Continued




Note 9:
Partners’ Equity

As of June 30, 2016 , HFC held 22,380,030 of our common units and the 2% general partner interest, which together constituted a 39% ownership interest in us. Additionally, HFC owned all incentive distribution rights in us.

Continuous Offering Program
On May 10, 2016, we established a continuous offering program under which HEP may issue and sell common units from time to time, representing limited partner interests, up to an aggregate gross sales amount of $200 million . As of June 30, 2016, HEP has issued 444,799 units under this program, providing $14.9 million in gross proceeds. We accrued sales commissions of $0.3 million associated with the issuance of these units. In connection with this program and to maintain the 2% general partner interest, HFC made capital contributions totaling $0.3 million as of June 30, 2016.

We intend to use our net proceeds for general partnership purposes, which may include funding working capital, repayment of debt, acquisitions and capital expenditures. Amounts repaid under our credit facility may be reborrowed from time to time.

Allocations of Net Income
Net income attributable to HEP is allocated between limited partners and the general partner interest in accordance with the provisions of the partnership agreement. HEP net income allocated to the general partner includes incentive distributions that are declared subsequent to quarter end. After the amount of incentive distributions is allocated to the general partner, the remaining net income attributable to HEP is allocated to the partners based on their weighted-average ownership percentage during the period.

The following table presents the allocation of the general partner interest in net income for the periods presented below:  
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2016
 
2015
 
2016
 
2015
 
 
(In thousands)
General partner interest in net income
 
$
540

 
$
185

 
$
953

 
$
431

General partner incentive distribution
 
12,137

 
9,784

 
23,609

 
19,145

Total general partner interest in net income
 
$
12,677

 
$
9,969

 
$
24,562

 
$
19,576


Cash Distributions
Our general partner, HEP Logistics, is entitled to incentive distributions if the amount we distribute with respect to any quarter exceeds specified target levels.

On July 22, 2016 , we announced our cash distribution for the second quarter of 2016 of $0.585 per unit. The distribution is payable on all common and general partner units and will be paid August 12, 2016 , to all unitholders of record on August 1, 2016 .

The following table presents the allocation of our regular quarterly cash distributions to the general and limited partners for the periods in which they apply. Our distributions are declared subsequent to quarter end; therefore, the amounts presented do not reflect distributions paid during the periods presented below.
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2016
 
2015
 
2016
 
2015
 
 
(In thousands, except per unit data)
General partner interest in distribution
 
$
978

 
$
877

 
$
1,927

 
$
1,738

General partner incentive distribution
 
12,137

 
9,784

 
23,609

 
19,145

Total general partner distribution
 
13,115

 
10,661

 
25,536

 
20,883

Limited partner distribution
 
34,575

 
31,968

 
68,302

 
63,496

Total regular quarterly cash distribution
 
$
47,690

 
$
42,629

 
$
93,838

 
$
84,379

Cash distribution per unit applicable to limited partners
 
$
0.5850

 
$
0.5450

 
$
1.1600

 
$
1.0825



- 18 -


HOLLY ENERGY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Continued



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 variable interest entity 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 10:
Net Income Per Limited Partner Unit

Net income per unit applicable to the limited partners is computed using the two-class method, because we have more than one class of participating securities.  The classes of participating securities as of June 30, 2016 , included common units, general partner units and incentive distribution rights (IDRs). To the extent net income attributable to the partnership exceeds or is less than cash distributions, this difference is allocated based on the unitholders’ respective ownership percentages, after consideration of any priority allocations of earnings. 

When our financial statements are retrospectively adjusted after a dropdown transaction, the earnings of the acquired business or asset, prior to the closing of the transaction, are allocated entirely to our general partner and presented as net income (loss) attributable to predecessors as shown below. The earnings per unit of our limited partners prior to the close of the transaction do not change as a result of the dropdown. After the closing of a dropdown transaction, the earnings of the acquired business are allocated in accordance with our partnership agreement as previously described.

For purposes of applying the two-class method including the allocation of cash distributions in excess of earnings, net income per limited partner unit is computed as follows:

 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2016
 
2015
 
2016
 
2015
 
 
(In thousands)
Net income attributable to Holly Energy Partners
 
$
39,120

 
$
30,174

 
$
81,878

 
$
61,774

Net loss attributable to predecessors
 

 
227

 
239

 
430

Net Income attributable to partnership
 
39,120

 
30,401

 
82,117

 
62,204

Less: General partner’s distribution declared (including IDRs)
 
(13,115
)
 
(10,661
)
 
(25,536
)
 
(20,883
)
Limited partner’s distribution declared on common units
 
(34,575
)
 
(31,968
)
 
(68,302
)
 
(63,496
)
Distributions in excess of net income attributable to partnership
 
(8,570
)
 
(12,228
)
 
(11,721
)
 
(22,175
)



- 19 -


HOLLY ENERGY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Continued



 
 
General Partner (including IDRs)
 
Limited Partners’ Common Units
 
Total
 
 
(In thousands, except per unit data)
Three Months Ended June 30, 2016
 
 
 
 
 
 
Net income attributable to partnership:
 
 
 
 
 
 
Distributions declared
 
$
13,115

 
$
34,575

 
$
47,690

Distributions in excess of net income attributable to partnership
 
(171
)
 
(8,399
)
 
(8,570
)
Net income attributable to partnership
 
$
12,944

 
$
26,176

 
$
39,120

Weighted average limited partners' units outstanding
 
 
 
58,865

 
 
Limited partners' per unit interest in earnings - basic and diluted
 
 
 
$
0.45

 
 
 
 
 
 
 
 
 
Three Months Ended June 30, 2015
 
 
 
 
 
 
Net income attributable to partnership:
 
 
 
 
 
 
Distributions declared
 
$
10,661

 
$
31,968

 
$
42,629

Distributions in excess of net income attributable to partnership
 
(245
)
 
(11,983
)
 
(12,228
)
Net income attributable to partnership
 
$
10,416

 
$
19,985

 
$
30,401

Weighted average limited partners' units outstanding
 
 
 
58,657

 
 
Limited partners' per unit interest in earnings - basic and diluted
 
 
 
$
0.34

 
 
Six Months Ended June 30, 2016
 
 
 
 
 
 
Net income attributable to partnership:
 
 
 
 
 
 
Distributions declared
 
$
25,536

 
$
68,302

 
$
93,838

Distributions in excess of net income attributable to partnership
 
(234
)
 
(11,487
)
 
(11,721
)
Net income attributable to partnership
 
$
25,302

 
$
56,815

 
$
82,117

Weighted average limited partners' units outstanding
 
 
 
58,761

 
 
Limited partners' per unit interest in earnings - basic and diluted
 
 
 
$
0.96

 
 
 
 
 
 
 
 
 
Six Months Ended June 30, 2015
 
 
 
 
 
 
Net income attributable to partnership:
 
 
 
 
 
 
Distributions declared
 
$
20,883

 
$
63,496

 
$
84,379

Distributions in excess of net income attributable to partnership
 
(444
)
 
(21,731
)
 
(22,175
)
Net income attributable to partnership
 
$
20,439

 
$
41,765

 
$
62,204

Weighted average limited partners' units outstanding
 
 
 
58,657

 
 
Limited partners' per unit interest in earnings - basic and diluted
 
 
 
$
0.71

 
 



- 20 -


HOLLY ENERGY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Continued



Note 11:
Environmental

We incurred $0.2 million for environmental remediation obligations for the three months ended June 30, 2016 and no expense for the three months ended June 30, 2015 . For the six months ended June 30, 2016 , we incurred $0.2 million for environmental expense, and we incurred $4.2 million for the six months ended June 30, 2015. The accrued environmental liability, net of expected recoveries from indemnifying parties, reflected in our consolidated balance sheets was $7.2 million and $7.7 million at June 30, 2016 , and December 31, 2015 , respectively, of which $5.7 million and $6.1 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. As of June 30, 2016 , and December 31, 2015 , our accrued environmental liability included $0.9 million and $6.4 million , respectively, for HFC indemnified liabilities, and other assets included equal and offsetting balances representing amounts due from HFC related to indemnifications for environmental remediation liabilities.


Note 12:
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 operation or cash flows.


Note 13:
Supplemental Guarantor/Non-Guarantor Financial Information

Obligations of HEP (“Parent”) under the Senior Notes have been jointly and severally guaranteed by each of its direct and indirect 100% owned subsidiaries (“Guarantor Subsidiaries”). These guarantees are full and unconditional, subject to certain customary release provisions. These circumstances include (i) when a Guarantor Subsidiary is sold or sells all or substantially all of its assets, (ii) when a Guarantor Subsidiary is declared “unrestricted” for covenant purposes, (iii) when a Guarantor Subsidiary’s guarantee of other indebtedness is terminated or released and (iv) when the requirements for legal defeasance or covenant defeasance or to discharge the Senior Notes have been satisfied.

The following financial information presents condensed consolidating balance sheets, statements of comprehensive income, and statements of cash flows of the Parent, the Guarantor Subsidiaries and the Non-Guarantor Subsidiaries. The information has been presented as if the Parent accounted for its ownership in the Guarantor Subsidiaries, and the Guarantor Restricted Subsidiaries accounted for the ownership of the Non-Guarantor Non-Restricted Subsidiaries, using the equity method of accounting.


- 21 -


HOLLY ENERGY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Continued




Condensed Consolidating Balance Sheet
June 30, 2016
 
Parent
 
Guarantor
Restricted Subsidiaries
 
Non-Guarantor Non-Restricted Subsidiaries
 
Eliminations
 
Consolidated
 
 
(In thousands)
ASSETS
 
 
 
 
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
2

 
$
393

 
$
4,487

 
$

 
$
4,882

Accounts receivable
 

 
44,951

 
5,345

 
(163
)
 
50,133

Prepaid and other current assets
 
86

 
3,284

 
1,268

 

 
4,638

Total current assets
 
88

 
48,628

 
11,100

 
(163
)
 
59,653

 
 
 
 
 
 
 
 
 
 
 
Properties and equipment, net
 

 
675,929

 
378,233

 

 
1,054,162

Investment in subsidiaries

 
598,391

 
286,340

 

 
(884,731
)
 

Transportation agreements, net
 

 
70,330

 

 

 
70,330

Goodwill
 

 
256,498

 

 

 
256,498

Equity method investments
 

 
165,362

 

 

 
165,362

Other assets
 
677

 
10,647

 

 

 
11,324

Total assets
 
$
599,156

 
$
1,513,734

 
$
389,333

 
$
(884,894
)
 
$
1,617,329

 
 
 
 
 
 
 
 
 
 
 
LIABILITIES AND EQUITY
 
 
 
 
 
 
 
 
 
 
Current liabilities:
 
 
 
 
 
 
 
 
 
 
Accounts payable
 
$

 
$
18,837

 
$
2,753

 
$
(163
)
 
$
21,427

Accrued interest
 
6,500

 
161

 

 

 
6,661

Deferred revenue
 

 
7,931

 
1,622

 

 
9,553

Accrued property taxes
 

 
2,205

 
2,969

 

 
5,174

Other current liabilities
 
11

 
3,263

 
24

 

 
3,298

Total current liabilities
 
6,511

 
32,397

 
7,368

 
(163
)
 
46,113


 
 
 
 
 
 
 
 
 
 
Long-term debt
 
297,136

 
786,000

 

 

 
1,083,136

Other long-term liabilities
 
245

 
16,767

 
178

 

 
17,190

Deferred revenue
 

 
42,474

 

 

 
42,474

Class B unit
 

 
37,705

 

 

 
37,705

Equity - partners
 
295,264

 
598,391

 
381,787

 
(980,178
)
 
295,264

Equity - noncontrolling interest
 

 

 

 
95,447

 
95,447

Total liabilities and equity
 
$
599,156

 
$
1,513,734

 
$
389,333

 
$
(884,894
)
 
$
1,617,329



- 22 -


HOLLY ENERGY PARTNERS, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Continued




Condensed Consolidating Balance Sheet
December 31, 2015 (1)
 
Parent
 
Guarantor
Restricted Subsidiaries
 
Non-Guarantor Non-Restricted Subsidiaries
 
Eliminations
 
Consolidated
 
 
(In thousands)
ASSETS
 
 
 
 
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
2

 
$
5,452

 
$
9,559

 
$

 
$
15,013

Accounts receivable
 

 
35,558

 
5,715

 
(198
)
 
41,075

Prepaid and other current assets
 
174

 
3,634

 
1,246

 

 
5,054

Total current assets
 
176

 
44,644

 
16,520

 
(198
)
 
61,142

 
 
 
 
 
 
 
 
 
 
 
Properties and equipment, net
 

 
687,336

 
371,843

 

 
1,059,179

Investment in subsidiaries
 
600,563

 
283,287

 

 
(883,850
)
 

Transportation agreements, net
 

 
73,805

 

 

 
73,805

Goodwill
 

 
256,498

 

 

 
256,498

Equity method investments
 

 
79,438