Holly Energy Partners, L.P.
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HOLLY ENERGY PARTNERS LP (Form: 10-Q, Received: 05/03/2017 14:57:41)


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 March 31, 2017
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
¨

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   ý

The number of the registrant’s outstanding common units at April 28, 2017 was 63,922,861.

Table of Contents ril 19,

HOLLY ENERGY PARTNERS, L.P.
INDEX
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated Statement of Equity
 
 
 
 
 
 
 
 
 
 
 
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, 2016 , 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
(In thousands, except unit data)
 
 
March 31, 2017
 
December 31, 2016
 
 
(Unaudited)
 
 
ASSETS
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
7,007

 
$
3,657

Accounts receivable:
 
 
 
 
Trade
 
10,111

 
7,846

Affiliates
 
35,634

 
42,562

 
 
45,745

 
50,408

Prepaid and other current assets
 
3,170

 
2,888

Total current assets
 
55,922

 
56,953

 
 
 
 
 
Properties and equipment, net
 
1,320,981

 
1,328,395

Transportation agreements, net
 
65,118

 
66,856

Goodwill
 
256,498

 
256,498

Equity method investments
 
162,319

 
165,609

Other assets
 
9,297

 
9,926

Total assets
 
$
1,870,135

 
$
1,884,237

 
 
 
 
 
LIABILITIES AND EQUITY
 
 
 
 
Current liabilities:
 
 
 
 
Accounts payable:
 
 
 
 
Trade
 
$
11,459

 
$
10,518

Affiliates
 
6,481

 
16,424

 
 
17,940

 
26,942

 
 
 
 
 
Accrued interest
 
4,518

 
18,069

Deferred revenue
 
11,807

 
11,102

Accrued property taxes
 
5,407

 
5,397

Other current liabilities
 
2,779

 
3,225

Total current liabilities
 
42,451

 
64,735

 
 
 
 
 
Long-term debt
 
1,240,565

 
1,243,912

Other long-term liabilities
 
16,521

 
16,445

Deferred revenue
 
46,881

 
47,035

 
 
 
 
 
Class B unit
 
41,000

 
40,319

 
 
 
 
 
Equity:
 
 
 
 
Partners’ equity:
 
 
 
 
Common unitholders (63,922,861 and 62,780,503 units issued and outstanding
    at March 31, 2017 and December 31, 2016, respectively)
 
521,050

 
510,975

General partner interest (2% interest)
 
(131,678
)
 
(132,832
)
Accumulated other comprehensive income
 
154

 
91

Total partners’ equity
 
389,526

 
378,234

Noncontrolling interest
 
93,191

 
93,557

Total equity
 
482,717

 
471,791

Total liabilities and equity
 
$
1,870,135

 
$
1,884,237


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
March 31,
 
 
2017
 
2016 (1)
Revenues:
 
 
 
 
Affiliates
 
$
89,025

 
$
82,846

Third parties
 
16,609

 
19,164

 
 
105,634

 
102,010

Operating costs and expenses:
 
 
 
 
Operations (exclusive of depreciation and amortization)
 
32,489

 
27,855

Depreciation and amortization
 
18,777

 
16,551

General and administrative
 
2,634

 
3,091

 
 
53,900

 
47,497

Operating income
 
51,734

 
54,513

 
 
 
 
 
Other income (expense):
 
 
 
 
Equity in earnings of equity method investments
 
1,840

 
2,765

Interest expense
 
(13,539
)
 
(10,535
)
Interest income
 
102

 
112

Loss on early extinguishment of debt
 
(12,225
)
 
—

Gain (loss) on sale of assets and other
 
73

 
(8
)
 
 
(23,749
)
 
(7,666
)
Income before income taxes
 
27,985

 
46,847

State income tax expense
 
(106
)
 
(95
)
Net income
 
27,879

 
46,752

Allocation of net loss attributable to Predecessor
 
—

 
1,150

Allocation of net income attributable to noncontrolling interests
 
(2,316
)
 
(4,927
)
Net income attributable to the partners
 
25,563

 
42,975

General partner interest in net income attributable to the partners
 
(17,138
)
 
(12,103
)
Limited partners’ interest in net income
 
$
8,425

 
$
30,872

Limited partners’ per unit interest in earnings—basic and diluted
 
$
0.13

 
$
0.52

Weighted average limited partners’ units outstanding
 
63,113

 
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
March 31,
 
 
2017
 
2016 (1)
Net income
 
$
27,879

 
$
46,752

 
 
 
 
 
Other comprehensive income:
 
 
 
 
Change in fair value of cash flow hedging instruments
 
76

 
(683
)
Reclassification adjustment to net income on partial settlement of cash flow hedge
 
(13
)
 
230

Other comprehensive income (loss)
 
63

 
(453
)
Comprehensive income before noncontrolling interest
 
27,942

 
46,299

Allocation of net loss attributable to Predecessor
 
—

 
1,150

Allocation of comprehensive income to noncontrolling interests
 
(2,316
)
 
(4,927
)
Comprehensive income attributable to Holly Energy Partners
 
$
25,626

 
$
42,522


(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)
 
 
 
Three Months Ended
March 31,
 
 
2017
 
2016 (1)
Cash flows from operating activities
 
 
 
 
Net income
 
$
27,879

 
$
46,752

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Depreciation and amortization
 
18,777

 
16,551

Gain on sale of assets
 
(58
)
 
—

Amortization of deferred charges
 
770

 
593

Amortization of restricted and performance units
 
398

 
651

Earnings distributions greater (less) than income from equity investments
 
273

 
(365
)
Loss on early extinguishment of debt
 
12,225

 
—

(Increase) decrease in operating assets:
 
 
 
 
Accounts receivable—trade
 
375

 
657

Accounts receivable—affiliates
 
7,733

 
(637
)
Prepaid and other current assets
 
(282
)
 
(128
)
Increase (decrease) in operating liabilities:
 
 
 
 
Accounts payable—trade
 
(1,122
)
 
(1,082
)
Accounts payable—affiliates
 
(9,943
)
 
(5,460
)
Accrued interest
 
(13,551
)
 
(4,780
)
Deferred revenue
 
551

 
(4,588
)
Accrued property taxes
 
9

 
343

Other current liabilities
 
(328
)
 
(843
)
Other, net
 
(106
)
 
(295
)
Net cash provided by operating activities
 
43,600

 
47,369

 
 
 
 
 
Cash flows from investing activities
 
 
 
 
Additions to properties and equipment
 
(8,265
)
 
(17,873
)
Purchase of Woods Cross refinery processing units
 
—

 
(24,311
)
Proceeds from sale of assets
 
424

 
12

Distributions in excess of equity in earnings of equity investments
 
3,016

 
99

Net cash used for investing activities
 
(4,825
)
 
(42,073
)
 
 
 
 
 
Cash flows from financing activities
 
 
 
 
Borrowings under credit agreement
 
380,000

 
522,000

Repayments of credit agreement borrowings
 
(86,000
)
 
(469,000
)
Redemption of 6.5 % Senior Notes
 
(309,750
)
 
—

Proceeds from issuance of common units
 
37,563

 
—

Distributions to HEP unitholders
 
(54,805
)
 
(44,960
)
Distributions to noncontrolling interest
 
(2,000
)
 
(1,250
)
Distribution to HFC for Tulsa tank acquisition
 
—

 
(39,500
)
Distribution to HFC for El Dorado tanks
 
(103
)
 
—

Contributions from HFC for acquisitions
 
—

 
25,343

Purchase of units for incentive grants
 
—

 
(784
)
Deferred financing costs
 
—

 
(2,964
)
Other
 
(330
)
 
(160
)
Net cash used by financing activities
 
(35,425
)
 
(11,275
)
 
 
 
 
 
Cash and cash equivalents
 
 
 
 
Increase (decrease) for the period
 
3,350

 
(5,979
)
Beginning of period
 
3,657

 
15,013

End of period
 
$
7,007

 
$
9,034

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

- 7 -
Table of Contents ril 19,

HOLLY ENERGY PARTNERS, L.P.
CONSOLIDATED STATEMENT OF EQUITY
(Unaudited)
(In thousands)
 
 
 
Common
Units
 
General
Partner
Interest
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Noncontrolling Interest
 
Total Equity
 
 
 
Balance December 31, 2016
 
$
510,975

 
$
(132,832
)
 
$
91

 
$
93,557

 
$
471,791

Issuance of common units
 
39,371

 
—

 
—

 
—

 
39,371

Contribution from HFC
 
—

 
805

 
—

 
—

 
805

Distribution to HFC for acquisition

 
—

 
(103
)
 
—

 
—

 
(103
)
Distributions to HEP unitholders
 
(38,134
)
 
(16,672
)
 
—

 
—

 
(54,806
)
Distributions to noncontrolling interest
 
—

 
—

 
—

 
(2,000
)
 
(2,000
)
Amortization of restricted and performance units
 
398

 
—

 
—

 
—

 
398

Class B unit accretion
 
(667
)
 
(14
)
 
—

 
—

 
(681
)
Net income
 
9,107

 
17,138

 
—

 
1,634

 
27,879

Other comprehensive income
 
—

 
—

 
63

 
—

 
63

Balance March 31, 2017
 
$
521,050

 
$
(131,678
)
 
$
154

 
$
93,191

 
$
482,717


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 36% owned (including the 2% general partner interest) by HollyFrontier Corporation (“HFC”) and its subsidiaries as of March 31, 2017 . 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 own and operate petroleum product and crude oil pipelines, terminal, tankage and loading rack facilities and refinery processing units that support HFC’s refining and marketing operations in the Mid-Continent, Southwest and Northwest 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 operate in two reportable segments, a Pipelines and Terminals segment and a Refinery Processing Unit segment. Disclosures around these segments are discussed in Note 13.

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, 2016 . 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, 2017 .

Principles of Consolidation and Common Control Transactions
The consolidated financial statements include our accounts, our Predecessor's (defined below) 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. U.S. generally accepted accounting principles ("GAAP") require transfers of a business between entities under common control to be accounted for as though the transfer occurred as of the beginning of the period of transfer, and prior period financial statements and financial information are retrospectively adjusted to include the historical results and assets of the acquisitions from HFC for all periods presented prior to the effective dates of each acquisition. We refer to the historical results of the acquisitions prior to their respective acquisition dates as those of our "Predecessor." Many of these transactions are cash purchases and do not involve the issuance of equity; however, GAAP requires the retrospective adjustment of financial statements. Therefore, in such transactions, the prior year balance sheet includes as equity the amount of cost incurred by HFC to that date. See Acquisitions below for further discussion as well as effects of the retrospective adjustments.

Acquisitions

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.


- 9 -

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 became the named operator of the Osage Pipeline and transitioned into that role on September 1, 2016. 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 recorded as a contribution from HFC. However, since these transactions were concurrent, there was no impact on periods prior to February 22, 2016.

Tulsa Tanks
On March 31, 2016, we acquired crude oil tanks (the “Tulsa Tanks”) located at HFC’s Tulsa refinery from an affiliate of Plains All American Pipeline, L.P. (“Plains”) for cash consideration of $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 had remained on HFC’s balance sheet and were being depreciated for accounting purposes.

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 the net assets acquired. In the previously reported consolidated statement of income and consolidated cash flows for the three months ended March 31, 2016, we adjusted our financial position and operating results as if these units were owned for all periods while we were under common control of HFC.

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 $42.6 million in cash to Cheyenne Pipeline LLC. Cheyenne Pipeline LLC will continue to be operated by an affiliate of 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 (“bpd”) capacity.

Woods Cross Operating
Effective October 1, 2016, we acquired all the membership interests of Woods Cross Operating LLC (“Woods Cross Operating”), a wholly owned subsidiary of HFC, which owns the newly constructed atmospheric distillation tower, fluid catalytic cracking unit, and polymerization unit located at HFC’s Woods Cross Refinery, for cash consideration of $278 million . The consideration was funded with $103 million in proceeds from the private placement of 3,420,000 common units with the balance funded with borrowings under our credit facility. 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 $56.7 million .

The Utah Division of Air Quality issued an air quality permit to HollyFrontier Woods Cross Refining LLC (“HFC Woods Cross Refining”) authorizing the expansion units at the Woods Cross Refinery. The appeal proceeding challenging the Utah Department of Environmental Quality’s decision to uphold the air quality permit is still pending. The purchase agreement provides us with the option to compel HFC Woods Cross Refining to repurchase the interests for the full purchase price paid if the assets are required to be idled for 90 or more days as a result of a final decision in the appeal proceedings. If we do not exercise the foregoing right and, by reason of the appeal proceedings, the assets must be modified, then HFC will be responsible for the costs of such modifications.

As we are a consolidated VIE of HFC, this transaction was recorded as a transfer between entities under common control and reflect HFC’s carrying basis in the net assets acquired. We have retrospectively adjusted our financial position and operating results as if these units were owned for all periods while we were under common control of HFC.

The following table presents lines in our previously reported income statement for the three months ended March 31, 2016, that were impacted by Predecessor transactions, and retrospectively adjusts only the acquisition of Woods Cross Operating as the Tulsa Tanks acquisition included Predecessor transactions in the previously reported income statement for the three months ended March 31, 2016. However, the presentation of the Tulsa Tanks’ Predecessor transactions have been modified as shown in the table below.

- 10 -

 
 
Three Months Ended March 31, 2016
 
 
Holly Energy Partners, L.P. (Previously reported)
 
Tulsa Tanks
 
Woods Cross Operating
 
Holly Energy Partners, L.P. (Currently reported)
 
 
(In Thousands)
Operating costs and expenses:
 
 
 
 
 
 
 
 
       Operations (exclusive of depreciation and
       amortization)
 
$
26,922

 
$
—

 
$
933

 
$
27,855

Allocation of net loss attributable to predecessor
 
—

 
217

 
933

 
1,150


The following table presents lines in our previously reported cash flows for the three months ended March 31, 2016, that were impacted by Predecessor transactions, and retrospectively adjusts only the acquisition of Woods Cross Operating as the Tulsa Tanks acquisition included Predecessor transactions in the previously reported cash flows for the three months ended March 31, 2016.
 
 
Three Months Ended March 31, 2016
 
 
Holly Energy Partners, L.P. (Previously reported)
 
Woods Cross Operating
 
Holly Energy Partners, L.P.
(Currently reported)
Cash flows from operating activities
 
(In Thousands)
Net income
 
$
47,685

 
$
(933
)
 
$
46,752

Net cash provided by operating activities
 
$
48,302

 
$
(933
)
 
$
47,369

 
 
 
 
 
 
 
Cash flows from investing activities
 
 
 
 
 
 
Additions to properties and equipment
 
$
(17,873
)
 
$
—

 
$
(17,873
)
Acquisition of tanks and operating units
 
—

 
(24,311
)
 
(24,311
)
Net cash used for investing activities
 
$
(17,762
)
 
$
(24,311
)
 
$
(42,073
)
 
 
 
 
 
 
 
Cash flows from financing activities
 
 
 
 
 
 
Contributions from HFC for acquisitions
 
$
99

 
$
25,244

 
$
25,343

Net cash provided (used) by financing activities
 
$
(36,519
)
 
$
25,244

 
$
(11,275
)

Accounting Pronouncements Adopted During the Periods Presented

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, and the purchase of HFC’s Woods Cross refinery units on October 1, 2016, we reduced net income by $0.2 million and $0.9 million , respectively, for the three months ended March 31, 2016 . This reduction had no impact on the historical earnings per limited partner unit.

Share-Based Compensation
In March 2016, an accounting standard update was issued which simplifies the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures and statutory tax withholding requirements, as well as classification in the statement of cash flows. We adopted this standard effective January 1, 2017, with no impact to our financial condition, results of operations and cash flows. As permitted by the standard, we continue to account for forfeitures on an estimated basis.


- 11 -

Accounting Pronouncements Not Yet Adopted

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, and we intend to account for the new guidance using the modified retrospective implementation method, whereby a cumulative effect adjustment is recorded to retained earnings as of the date of initial application. Our preparation for adoption of this standard is in progress, and we are currently evaluating terms, conditions and our performance obligations of our existing contracts with customers. We are evaluating the effect of this standard on our revenue recognition policies and whether it will have a material impact on our financial condition or results of operations.

Business Combinations
In December 2014, an accounting standard update was issued to provide new guidance on the definition of a business in relation to accounting for identifiable intangible assets in business combinations. This standard has an effective date of January 1, 2018, and we are evaluating its impact.

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.


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 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.


- 12 -

The carrying amounts and estimated fair values of our senior notes and interest rate swaps were as follows:
 
 
 
 
March 31, 2017
 
December 31, 2016
Financial Instrument
 
Fair Value Input Level
 
Carrying
Value
 
Fair Value
 
Carrying
Value
 
Fair Value
 
 
 
 
(In thousands)
Assets:
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
 
Level 2
 
$
154

 
$
154

 
$
91

 
$
91

 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
 
6.5% Senior notes
 
Level 2
 
$
—

 
$
—

 
$
297,519

 
$
308,250

6% Senior notes
 
Level 2
 
393,565

 
422,288

 
393,393

 
415,500

 
 
 
 
$
393,565

 
$
422,288

 
$
690,912

 
$
723,750


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.


Note 3:
Properties and Equipment  

The carrying amounts of our properties and equipment are as follows:
 
 
March 31,
2017
 
December 31,
2016
 
 
(In thousands)
Pipelines, terminals and tankage
 
$
1,247,967

 
$
1,246,746

Refinery assets
 
347,075

 
346,058

Land and right of way
 
65,331

 
65,331

Construction in progress
 
35,148

 
28,753

Other
 
27,662

 
27,133

 
 
1,723,183

 
1,714,021

Less accumulated depreciation
 
402,202

 
385,626

 
 
$
1,320,981

 
$
1,328,395


We capitalized $0.2 million and $0.1 million in interest attributable to construction projects during the three months ended March 31, 2017 and 2016 , respectively.

Depreciation expense was $16.9 million and $14.7 million for the three months ended March 31, 2017 and 2016 , respectively, and includes depreciation of assets acquired under capital leases.


Note 4:
Transportation Agreements

Our transportation agreements are intangible assets that represent a portion of the total purchase price of certain assets acquired from Alon in 2005 and from HFC in 2008 prior to HEP becoming a consolidated VIE of HFC. 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).


- 13 -

The carrying amounts of our transportation agreements are as follows:
 
 
March 31,
2017
 
December 31,
2016
 
 
(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
 
69,096

 
67,358

 
 
$
65,118

 
$
66,856


Amortization expense was $1.7 million for each of the three months ended March 31, 2017 and 2016 .

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.


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 $1.7 million and $1.6 million for the three months ended March 31, 2017 and 2016 , 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, 2017 , we have two types of incentive-based awards outstanding, which are described below. The compensation cost charged against income was $0.3 million and $0.7 million for the three months ended March 31, 2017 and 2016 , 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, 2017 , 2,500,000 units were authorized to be granted under our Long-Term Incentive Plan, of which 1,409,261 have not yet been granted, assuming no forfeitures of the unvested units and full achievement of goals for the unvested performance units.

Restricted 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.

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.


- 14 -

A summary of restricted unit activity and changes during the three months ended March 31, 2017 , is presented below:
Restricted Units
 
Units
 
Weighted Average Grant-Date Fair Value
Outstanding at January 1, 2017 (nonvested)
 
123,988

 
$
32.96

Granted
 
20,348

 
36.01

Forfeited
 
(17,653
)
 
29.75

Outstanding at March 31, 2017 (nonvested)
 
126,683

 
$
33.90


As of March 31, 2017 , there was $2.0 million of total unrecognized compensation expense related to nonvested restricted unit grants, which is expected to be recognized over a weighted-average period of 1.2 years.

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 March 31, 2017 , 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, 2017 . Performance units granted in 2016 vest over a three-year performance period ending December 31, 2019, 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 three months ended March 31, 2017 , is presented below:
Performance Units
 
Units
Outstanding at January 1, 2017 (nonvested)
 
49,520

Vesting and transfer of common units to recipients
 
(2,262
)
Forfeited
 
(21,228
)
Outstanding at March 31, 2017 (nonvested)
 
26,030


The grant-date fair value of performance units vested and transferred to recipients during the three months ended March 31, 2017 , was $0.1 million . Based on the weighted average fair value of performance units outstanding at March 31, 2017 , of $0.9 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 2.0 years.


Note 6:
Debt

Credit Agreement
We have a $1.2 billion senior secured revolving credit facility (the “Credit Agreement”) expiring in November 2018 . 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 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

- 15 -

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. We were in compliance with the covenants as of March 31, 2017 .

Senior Notes
On January 4, 2017, we redeemed the $300 million aggregate principal amount of 6.5% senior notes (the “6.5% Senior Notes”) at a redemption cost of $309.8 million at which time we recognized a $12.2 million early extinguishment loss consisting of a $9.8 million debt redemption premium and unamortized discount and financing costs of $2.4 million . We funded the redemption with borrowings under our Credit Agreement.

On July 19, 2016, we closed a private placement of $400 million in aggregate principal amount of 6% senior unsecured notes due in 2024 (the “6% Senior Notes”). We used the net proceeds to repay indebtedness under our Credit Agreement.

The 6% 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% Senior Notes as of March 31, 2017 . At any time when the 6% 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 6% Senior Notes.

Indebtedness under the 6% Senior Notes is guaranteed by our wholly-owned subsidiaries.

Long-term Debt
The carrying amounts of our long-term debt are as follows:
 
 
March 31,
2017
 
December 31,
2016
 
 
(In thousands)
Credit Agreement
 
 
 
 
Amount outstanding
 
$
847,000

 
$
553,000

 
 
 
 
 
6% Senior Notes
 
 
 
 
Principal
 
400,000

 
400,000

Unamortized debt issuance costs
 
(6,435
)
 
(6,607
)
 
 
393,565

 
393,393

6.5% Senior Notes
 
 
 
 
Principal
 
—

 
300,000

Unamortized discount and debt issuance costs
 
—

 
(2,481
)
 
 
—

 
297,519

 
 
 
 
 
Total long-term debt
 
$
1,240,565

 
$
1,243,912


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

As of March 31, 2017 , 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 March 31, 2017 , 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

- 16 -

future interest payments on $150 million of our variable rate debt. Any ineffectiveness is recorded directly to interest expense. As of March 31, 2017 , we had no ineffectiveness on our cash flow hedges.

At March 31, 2017 , we have accumulated other comprehensive income of $0.2 million that relates to our current cash flow hedging instruments. Approximately $0.2 million will be transferred from accumulated other comprehensive income into interest expense as interest is paid on the underlying swap agreement over the next twelve-month period, assuming interest rates remain unchanged.

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)
March 31, 2017
 
 
 
 
 
 
 
 
Interest rate swaps designated as cash flow hedging instrument:
 
 
 
 
 
 
Variable-to-fixed interest rate swap contracts ($150 million of LIBOR-based debt interest)
 
Other current   assets
 
$
154

 
Accumulated other
    comprehensive income
 
$
154

 
 
 
 
$
154

 
 
 
$
154

 
 
 
 
 
 
 
 
 
December 31, 2016
 
 
 
 
 
 
 
 
Interest rate swaps designated as cash flow hedging instrument:
 
 
 
 
 
 
Variable-to-fixed interest rate swap contract ($150 million of LIBOR-based debt interest)
 
Other current  assets
 
$
91

 
Accumulated other
    comprehensive income
 
$
91

 
 
 
 
$
91

 
 
 
$
91


Interest Expense and Other Debt Information
Interest expense consists of the following components:
 
 
Three Months Ended March 31,
 
 
2017
 
2016
 
 
(In thousands)
Interest on outstanding debt:
 
 
 
 
Credit Agreement, net of interest on interest rate swaps
 
$
6,449

 
$
5,006

6.5% Senior Notes
 
162

 
4,875

6% Senior Notes
 
6,000

 
—

Amortization of discount and deferred debt issuance costs
 
770

 
593

Commitment fees and other
 
354

 
201

Total interest incurred
 
13,735

 
10,675

Less capitalized interest
 
196

 
140

Net interest expense
 
$
13,539

 
$
10,535

Cash paid for interest
 
$
26,517

 
$
14,841


Capital Lease Obligations
Our capital lease obligations relate to vehicle leases with initial terms of 33 to 48 months. The total cost of assets under capital leases was $5.3 million and $4.9 million as of March 31, 2017 and December 31, 2016 , respectively, with accumulated depreciation of $2.9 million and $2.4 million as of March 31, 2017 and December 31, 2016 , 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:

- 17 -

 
 
Three Months Ended March 31,
 
 
2017
 
2016
HFC
 
84
%
 
81
%
Alon
 
8
%
 
8
%


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 March 31, 2017 , these agreements with HFC require minimum annualized payments to us of $321 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 $89.0 million and $82.8 million for the three months ended March 31, 2017 and 2016 , respectively.
•
HFC charged us general and administrative services under the Omnibus Agreement of $0.6 million for each of the three months ended March 31, 2017 and 2016 .
•
We reimbursed HFC for costs of employees supporting our operations of $11.4 million and $9.8 million for the three months ended March 31, 2017 and 2016 , respectively.
•
HFC reimbursed us $1.3 million and $1.8 million for the three months ended March 31, 2017 and 2016 , respectively, for expense and capital projects.
•
We distributed $30.3 million and $24.5 million for the three months ended March 31, 2017 and 2016 , respectively, to HFC as regular distributions on its common units and general partner interest, including general partner incentive distributions.
•
Accounts receivable from HFC were $35.6 million and $42.6 million at March 31, 2017 , and December 31, 2016 , respectively.
•
Accounts payable to HFC were $6.5 million and $16.4 million at March 31, 2017 , and December 31, 2016 , respectively.
•
Revenues for the three months ended March 31, 2017 and 2016 , include $2.1 million and $5.2 million , respectively, of shortfall payments billed to HFC in 2016 and 2015, respectively. Deferred revenue in the consolidated balance sheets at March 31, 2017 and December 31, 2016 , includes $5.8 million and $5.6 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 $5.8 million deferred at March 31, 2017 .



- 18 -

Note 9:
Partners’ Equity

As of March 31, 2017 , HFC held 22,380,030 of our common units and the 2% general partner interest, which together constituted a 36% ownership interest in us. Additionally, HFC owned all incentive distribution rights.

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 . For the three months ended March 31, 2017 , HEP issued 1,142,358 units under this program, providing $40.3 million in gross proceeds. We incurred sales commissions of $0.8 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 $0.8 million . As of March 31, 2017, HEP has issued 1,845,813 units under this program, providing $63.8 million in gross proceeds.

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 incentive distributions and other priority allocations are 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 March 31,
 
 
2017
 
2016
 
 
(In thousands)
General partner interest in net income
 
$
511

 
$
630

General partner incentive distribution
 
16,627

 
11,473

Net loss attributable to Predecessor
 
—

 
(1,150
)
Total general partner interest in net income
 
$
17,138

 
$
10,953


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 April 27, 2017 , we announced our cash distribution for the first quarter of 2017 of $0.620 per unit. The distribution is payable on all common and general partner units and will be paid May 15, 2017 , to all unitholders of record on May 8, 2017 .

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 March 31,
 
 
2017
 
2016
 
 
(In thousands, except per unit data)
General partner interest in distribution
 
$
1,148

 
$
948

General partner incentive distribution
 
16,627

 
11,473

Total general partner distribution
 
17,775

 
12,421

Limited partner distribution
 
39,632

 
33,728

Total regular quarterly cash distribution
 
$
57,407

 
$
46,149

Cash distribution per unit applicable to limited partners
 
$
0.6200

 
$
0.5750


- 19 -


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 March 31, 2017 , included common units, general partner units and incentive distribution rights (IDRs). 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. The dilutive securities are immaterial for all periods presented.

When our financial statements are retrospectively adjusted after a dropdown transaction, the earnings of the acquired business, prior to the closing of the transaction, are allocated entirely to our general partner and presented as net income (loss) attributable to Predecessors. 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 March 31,
 
 
2017
 
2016
 
 
(In thousands)
Net income attributable to the partners
 
$
25,563

 
$
42,975

Less: General partner’s distribution declared (including IDRs)
 
(17,775
)
 
(12,421
)
Limited partner’s distribution declared on common units
 
(39,632
)
 
(33,728
)
Distributions in excess of net income attributable to the partners
 
$
(31,844
)
 
$
(3,174
)


- 20 -

 
 
General Partner (including IDRs)
 
Limited Partners’ Common Units
 
Total
 
 
(In thousands, except per unit data)
Three Months Ended March 31, 2017
 
 
 
 
 
 
Net income attributable to the partners:
 
 
 
 
 
 
Distributions declared
 
$
17,775

 
$
39,632

 
$
57,407

Distributions in excess of net income attributable to the partners
 
(637
)
 
(31,207
)
 
(31,844
)
Net income attributable to the partners
 
$
17,138

 
$
8,425

 
$
25,563

Weighted average limited partners' units outstanding
 
 
 
63,113

 
 
Limited partners' per unit interest in earnings - basic and diluted
 
 
 
$
0.13

 
 
 
 
 
 
 
 
 
Three Months Ended March 31, 2016
 
 
 
 
 
 
Net income attributable to the partners:
 
 
 
 
 
 
Distributions declared
 
$
12,421

 
$
33,728

 
$
46,149

Distributions in excess of net income attributable to the partners
 
(63
)
 
(3,111
)
 
(3,174
)
Net income attributable to the partners
 
$
12,358

 
$
30,617

 
$
42,975

Weighted average limited partners' units outstanding
 
 
 
58,657

 
 
Limited partners' per unit interest in earnings - basic and diluted
 
 
 
$
0.52

 
 


Note 11:
Environmental

We incurred no expenses for the three months ended March 31, 2017 and 2016, for environmental remediation obligations. The accrued environmental liability, net of expected recoveries from indemnifying parties, reflected in our consolidated balance sheets was $6.9 million and $7.1 million at March 31, 2017 , and December 31, 2016 , respectively, of which $5.1 million and $5.4 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 March 31, 2017 , and December 31, 2016 , our consolidated balance sheets included additional accrued environmental liabilities of $0.8 million and $0.9 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 operations or cash flows.


Note 13:
Segments

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

The pipelines and terminals segment has been aggregated 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

- 21 -

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 operating 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 operating segment.
 
 
Three Months Ended March 31,
 
 
2017
 
2016
 
 
 
Revenues:
 
 
 
 
Pipelines and terminals - affiliate
 
$
69,645

 
$
78,339

Pipelines and terminals - third-party
 
16,609

 
19,164

Refinery processing units - affiliate
 
19,380

 
4,507

Total segment revenues
 
$
105,634

 
$
102,010

 
 
 
 
 
Segment operating income:
 
 
 
 
Pipelines and terminals
 
$
46,485

 
$
57,248

Refinery processing units
 
7,883

 
356

Total segment operating income
 
54,368

 
57,604

Unallocated general and administrative expenses
 
(2,634
)
 
(3,091
)
Interest and financing costs, net
 
(25,662
)
 
(10,423
)
Equity in earnings of unconsolidated affiliates
 
1,840

 
2,765

Gain (loss) on sale of assets and other
 
73

 
(8
)
Income before income taxes
 
$
27,985

 
$
46,847

 
 
 
 
 
Capital Expenditures:
 
 
 
 
  Pipelines and terminals
 
$
8,129

 
$
17,873

  Refinery processing units
 
136

 
24,311

Total capital expenditures
 
$
8,265

 
$
42,184


 
 
March 31, 2017
 
December 31, 2016
 
 
(in thousands)
Identifiable assets:
 
 
 
 
  Pipelines and terminals
 
$
1,356,168

 
$
1,369,756

  Refinery processing units
 
341,363

 
342,506

Other
 
172,604

 
171,975

Total identifiable assets
 
$
1,870,135

 
$
1,884,237




- 22 -

Note 14:
Supplemental Guarantor/Non-Guarantor Financial Information

Obligations of HEP (“Parent”) under the 6% 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.

In conjunction with the preparation of our Condensed Consolidating Balance Sheet and Statements of Comprehensive Income included below, we identified and corrected the presentation of noncontrolling interests presented in the eliminations column in prior periods to reflect such balances and activity within the respective guarantor and non-guarantor subsidiaries columns.


Condensed Consolidating Balance Sheet
March 31, 2017
 
Parent
 
Guarantor
Restricted Subsidiaries
 
Non-Guarantor Non-Restricted Subsidiaries
 
Eliminations
 
Consolidated
 
 
(In thousands)
ASSETS
 
 
 
 
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
2

 
$
1,278

 
$
5,727

 
$
—

 
$
7,007

Accounts receivable
 
—

 
42,055

 
4,063

 
(373
)
 
45,745

Prepaid and other current assets
 
131

 
2,688

 
351

 
—

 
3,170

Total current assets
 
133

 
46,021

 
10,141

 
(373
)
 
55,922

 
 
 
 
 
 
 
 
 
 
 
Properties and equipment, net
 
—

 
952,758

 
368,223

 
—

 
1,320,981

Investment in subsidiaries

 
786,512

 
279,572

 
—

 
(1,066,084
)
 
—

Transportation agreements, net
 
—

 
65,118

 
—

 
—

 
65,118

Goodwill
 
—

 
256,498

 
—

 
—

 
256,498

Equity method investments
 
—

 
162,319

 
—

 
—

 
162,319

Other assets
 
725

 
8,572

 
—

 
—

 
9,297

Total assets
 
$
787,370

 
$
1,770,858

 
$
378,364

 
$
(1,066,457
)
 
$
1,870,135

 
 
 
 
 
 
 
 
 
 
 
LIABILITIES AND EQUITY
 
 
 
 
 
 
 
 
 
 
Current liabilities:
 
 
 
 
 
 
 
 
 
 
Accounts payable
 
$
—

 
$
14,849

 
$
3,464

 
$
(373
)
 
$
17,940

Accrued interest
 
4,000

 
518

 
—

 
—

 
4,518

Deferred revenue
 
—

 
11,732

 
75

 
—

 
11,807

Accrued property taxes
 
—

 
3,538

 
1,869

 
—

 
5,407

Other current liabilities
 
53

 
2,721

 
5

 
—

 
2,779

Total current liabilities
 
4,053

 
33,358

 
5,413

 
(373
)
 
42,451


 
 
 
 
 
 
 
 
 
 
Long-term debt
 
393,505

 
847,060

 
—

 
—

 
1,240,565

Other long-term liabilities
 
286

 
16,047

 
188

 
—

 
16,521

Deferred revenue
 
—

 
46,881

 
—

 
—

 
46,881

Class B unit
 
—

 
41,000

 
—

 
—

 
41,000

Equity - partners
 
389,526

 
786,512

 
279,572

 
(1,066,084
)
 
389,526

Equity - noncontrolling interest
 
—

 
—

 
93,191

 
—

 
93,191

Total liabilities and equity
 
$
787,370

 
$
1,770,858

 
$
378,364

 
$
(1,066,457
)
 
$
1,870,135



- 23 -


Condensed Consolidating Balance Sheet
December 31, 2016
 
Parent
 
Guarantor
Restricted Subsidiaries
 
Non-Guarantor Non-Restricted Subsidiaries
 
Eliminations
 
Consolidated
 
 
(In thousands)
ASSETS
 
 
 
 
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
2

 
$
301

 
$
3,354

 
$
—

 
$
3,657

Accounts receivable
 
—

 
45,056

 
5,554

 
(202
)
 
50,408

Prepaid and other current assets
 
11

 
2,633

 
244

 
—

 
2,888

Total current assets
 
13

 
47,990

 
9,152

 
(202
)
 
56,953

 
 
 
 
 
 
 
 
 
 
 
Properties and equipment, net
 
—

 
957,045

 
371,350

 
—

 
1,328,395

Investment in subsidiaries
 
1,086,008

 
280,671

 
—

 
(1,366,679
)
 
—

Transportation agreements, net
 
—

 
66,856

 
—

 
—

 
66,856

Goodwill
 
—

 
256,498

 
—

 
—

 
256,498

Equity method investments
 
—

 
165,609

 
—

 
—

 
165,609

Other assets
 
725

 
9,201

 
—

 
—

 
9,926

Total assets
 
$
1,086,746

 
$
1,783,870

 
$
380,502

 
$
(1,366,881
)
 
$
1,884,237

 
 
 
 
 
 
 
 
 
 
 
LIABILITIES AND EQUITY
 
 
 
 
 
 
 
 
 
 
Current liabilities:
 
 
 
 
 
 
 
 
 
 
Accounts payable
 
$
—

 
$
24,245

 
$
2,899

 
$
(202
)
 
$
26,942

Accrued interest
 
17,300

 
769

 
—

 
—

 
18,069

Deferred revenue
 
—

 
8,797

 
2,305

 
—

 
11,102

Accrued property taxes
 
—

 
4,514

 
883

 
—

 
5,397

Other current liabilities
 
14

 
3,208

 
3

 
—

 
3,225

Total current liabilities
 
17,314

 
41,533

 
6,090

 
(202
)
 
64,735

 
 
 
 
 
 
 
 
 
 
 
Long-term debt
 
690,912