10-Q 1 hep6-30x201610q.htm 10-Q Document


                    
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.


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

- 2 -


FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains certain “forward-looking statements” within the meaning of the federal securities laws. All statements, other than statements of historical fact included in this Form 10-Q, including, but not limited to, 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 -

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 -

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 -

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 -

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 -

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

 
—

 
—

 
79,438

Other assets
 
642

 
13,061

 
—

 
—

 
13,703

Total assets
 
$
601,381

 
$
1,438,069

 
$
388,363

 
$
(884,048
)
 
$
1,543,765

 
 
 
 
 
 
 
 
 
 
 
LIABILITIES AND EQUITY
 
 
 
 
 
 
 
 
 
 
Current liabilities:
 
 
 
 
 
 
 
 
 
 
Accounts payable
 
$
—

 
$
19,448

 
$
3,333

 
$
(198
)
 
$
22,583

Accrued interest
 
6,500

 
252

 
—

 
—

 
6,752

Deferred revenue
 
—

 
6,010

 
6,006

 
—

 
12,016

Accrued property taxes
 
—

 
2,627

 
1,137

 
—

 
3,764

Other current liabilities
 
7

 
3,802

 
—

 
—

 
3,809

Total current liabilities
 
6,507

 
32,139

 
10,476

 
(198
)
 
48,924

 
 
 
 
 
 
 
 
 
 
 
Long-term debt
 
296,752

 
712,000

 
—

 
—

 
1,008,752

Other long-term liabilities
 
210

 
20,363

 
171

 
—

 
20,744

Deferred revenue
 
—

 
39,063

 
—

 
—

 
39,063

Class B unit
 
—

 
33,941

 
—

 
—

 
33,941

Equity - partners
 
297,912

 
600,563

 
377,716

 
(978,279
)
 
297,912

Equity - noncontrolling interest
 
—

 
—

 
—

 
94,429

 
94,429

Total liabilities and equity
 
$
601,381

 
$
1,438,069

 
$
388,363

 
$
(884,048
)
 
$
1,543,765


(1) Retrospectively adjusted as described in Note 1.


- 23 -

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




Condensed Consolidating Statement of Comprehensive Income
Three Months Ended June 30, 2016
 
Parent
 
Guarantor Restricted
Subsidiaries
 
Non-Guarantor Non-restricted Subsidiaries
 
Eliminations
 
Consolidated
 
 
(In thousands)
Revenues:
 
 
 
 
 
 
 
 
 
 
Affiliates
 
$
—

 
$
74,787

 
$
4,392

 
$
—

 
$
79,179

Third parties
 
—

 
11,691

 
4,027

 
—

 
15,718

 
 
—

 
86,478

 
8,419

 
—

 
94,897

Operating costs and expenses:
 
 
 
 
 
 
 
 
 
 
Operations (exclusive of depreciation and amortization)
 
—

 
24,444

 
2,811

 
—

 
27,255

Depreciation and amortization
 


 
11,922

 
3,787

 
—

 
15,709

General and administrative
 
971

 
1,892

 
—

 
—

 
2,863

 
 
971

 
38,258

 
6,598

 
—

 
45,827

Operating income (loss)
 
(971
)
 
48,220

 
1,821

 
—

 
49,070

Equity in earnings of subsidiaries
 
45,164

 
1,370

 
—

 
(46,534
)
 
—

Equity in earnings of equity method investments
 
—

 
3,623

 
—

 
—

 
3,623

Interest expense
 
(5,073
)
 
(6,203
)
 
—

 
—

 
(11,276
)
Interest income
 
—

 
107

 
5

 
—

 
112

Loss on sale of assets
 
—

 
(5
)
 
—

 
—

 
(5
)
Other income (expense)
 
—

 
5

 
—

 
—

 
5

 
 
40,091

 
(1,103
)
 
5

 
(46,534
)
 
(7,541
)
Income (loss) before income taxes
 
39,120

 
47,117

 
1,826

 
(46,534
)
 
41,529

State income tax expense
 
—

 
(54
)
 
—

 
—

 
(54
)
Net income (loss)
 
39,120

 
47,063

 
1,826

 
(46,534
)
 
41,475

Allocation of net (income) attributable to noncontrolling interests
 
—

 
—

 
—

 
(2,355
)
 
(2,355
)
Net income (loss) attributable to Holly Energy Partners
 
39,120

 
47,063

 
1,826

 
(48,889
)
 
39,120

Other comprehensive income (loss)
 
(142
)
 
(142
)
 
—

 
142

 
(142
)
Comprehensive income (loss) attributable to Holly Energy Partners
 
$
38,978

 
$
46,921

 
$
1,826

 
$
(48,747
)
 
$
38,978



- 24 -

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




Condensed Consolidating Statement of Comprehensive Income
Three Months Ended June 30, 2015 (1)
 
Parent
 
Guarantor
Restricted Subsidiaries
 
Non-Guarantor Non-Restricted Subsidiaries
 
Eliminations
 
Consolidated
 
 
(In thousands)
Revenues:
 
 
 
 
 
 
 
 
 
 
Affiliates
 
$
—

 
$
64,727

 
$
3,545

 
$
25

 
$
68,297

Third parties
 
—

 
11,895

 
3,287

 
—

 
15,182

 
 
—

 
76,622

 
6,832

 
25

 
83,479

Operating costs and expenses:
 
 
 
 
 
 
 
 
 
 
Operations (exclusive of depreciation and amortization)
 
—

 
22,222

 
3,153

 
25

 
25,400

Depreciation and amortization
 
—

 
11,432

 
3,747

 
—

 
15,179

General and administrative
 
637

 
2,059

 
—

 
—

 
2,696

 
 
637

 
35,713

 
6,900

 
25

 
43,275

Operating income (loss)
 
(637
)
 
40,909

 
(68
)
 
—

 
40,204

Equity in earnings of subsidiaries
 
36,111

 
(88
)
 
—

 
(36,023
)
 
—

Equity in earnings of equity method investments
 
—

 
631

 
—

 
—

 
631

Interest expense
 
(5,073
)
 
(3,983
)
 
—

 
—

 
(9,056
)
Interest income
 
—

 
3

 
—

 
—

 
3

Gain on sale of assets
 
—

 
50

 
—

 
—

 
50

Other income (expense)
 
—

 
70

 
(49
)
 
—

 
21

 
 
31,038

 
(3,317
)
 
(49
)
 
(36,023
)
 
(8,351
)
Income (loss) before income taxes
 
30,401

 
37,592

 
(117
)
 
(36,023
)
 
31,853

State income tax expense
 
—

 
64

 
—

 
—

 
64

Net income (loss)
 
30,401

 
37,656

 
(117
)
 
(36,023
)
 
31,917

Allocation of net (income) attributable to noncontrolling interests
 
—

 
—

 
—

 
(1,743
)
 
(1,743
)
Net income (loss) attributable to Holly Energy Partners
 
30,401

 
37,656

 
(117
)
 
(37,766
)
 
30,174

Other comprehensive income (loss)
 
222

 
222

 
—

 
(222
)
 
222

Comprehensive income (loss) attributable to Holly Energy Partners
 
$
30,623

 
$
37,878

 
$
(117
)
 
$
(37,988
)
 
$
30,396


(1) Retrospectively adjusted as described in Note 1.


- 25 -

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




Condensed Consolidating Statement of Comprehensive Income
Six Months Ended June 30, 2016
 
Parent
 
Guarantor Restricted
Subsidiaries
 
Non-Guarantor Non-restricted Subsidiaries
 
Eliminations
 
Consolidated
 
 
(In thousands)
Revenues:
 
 
 
 
 
 
 
 
 
 
Affiliates
 
$
—

 
$
147,039

 
$
14,986

 
$
—

 
$
162,025

Third parties
 
—

 
22,423

 
12,459

 
—

 
34,882

 
 
—

 
169,462

 
27,445

 
—

 
196,907

Operating costs and expenses:
 
 
 
 
 
 
 
 
 
 
Operations (exclusive of depreciation and amortization)
 
—

 
48,335

 
5,842

 
—

 
54,177

Depreciation and amortization
 
—

 
24,715

 
7,545

 
—

 
32,260

General and administrative
 
2,136

 
3,818

 
—

 
—

 
5,954

 
 
2,136

 
76,868

 
13,387

 
—

 
92,391

Operating income (loss)
 
(2,136
)
 
92,594

 
14,058

 
—

 
104,516

Equity in earnings (loss) of subsidiaries
 
94,154

 
10,553

 
—

 
(104,707
)
 
—

Equity in earnings of equity method investments
 
—

 
6,388

 
—

 
—

 
6,388

Interest expense
 
(10,140
)
 
(11,671
)
 
—

 
—

 
(21,811
)
Interest income
 
—

 
212

 
12

 
—

 
224

Loss on sale of assets
 
—

 
(5
)
 
—

 
—

 
(5
)
Other income (expense)
 
—

 
(4
)
 
1

 
—

 
(3
)
 
 
84,014

 
5,473

 
13

 
(104,707
)
 
(15,207
)
Income (loss) before income taxes
 
81,878

 
98,067

 
14,071

 
(104,707
)
 
89,309

State income tax expense
 
—

 
(149
)
 
—

 
—

 
(149
)
Net income (loss)
 
81,878

 
97,918

 
14,071

 
(104,707
)
 
89,160

Allocation of net income attributable to noncontrolling interests
 
—

 
—

 
—

 
(7,282
)
 
(7,282
)
Net income (loss) attributable to Holly Energy Partners
 
81,878

 
97,918

 
14,071

 
(111,989
)
 
81,878

Other comprehensive income (loss)
 
(595
)
 
(595
)
 
—

 
595

 
(595
)
Comprehensive income (loss)
 
$
81,283

 
$
97,323

 
$
14,071

 
$
(111,394
)
 
$
81,283



- 26 -

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



Condensed Consolidating Statement of Comprehensive Income
Six Months Ended June 30, 2015 (1)
 
Parent
 
Guarantor
Restricted Subsidiaries
 
Non-Guarantor Non-Restricted Subsidiaries
 
Eliminations
 
Consolidated
 
 
(In thousands)
Revenues:
 
 
 
 
 
 
 
 
 
 
Affiliates
 
$
—

 
$
127,783

 
$
12,769

 
$
—

 
$
140,552

Third parties
 
—

 
23,282

 
9,401

 
—

 
32,683

 
 
—

 
151,065

 
22,170

 
—

 
173,235

Operating costs and expenses:
 
 
 
 
 
 
 
 
 
 
Operations (exclusive of depreciation and amortization)
 
—

 
47,852

 
5,613

 
—

 
53,465

Depreciation and amortization
 
—

 
22,498

 
7,479

 
—

 
29,977

General and administrative
 
1,700

 
4,286

 
—

 
—

 
5,986

 
 
1,700

 
74,636

 
13,092

 
—

 
89,428

Operating income (loss)
 
(1,700
)
 
76,429

 
9,078

 
—

 
83,807

Equity in earnings (loss) of subsidiaries
 
74,044

 
6,772

 
—

 
(80,816
)
 
—

Equity in earnings of equity method investments
 
—

 
1,365

 
—

 
—

 
1,365

Interest expense
 
(10,140
)
 
(7,684
)
 
—

 
—

 
(17,824
)
Interest income
 
—

 
3

 
—

 
—

 
3

Gain on sale of assets
 
—

 
209

 
—

 
—

 
209

Other income
 
—

 
70

 
(49
)
 
—

 
21

 
 
63,904

 
735

 
(49
)
 
(80,816
)
 
(16,226
)
Income (loss) before income taxes
 
62,204

 
77,164

 
9,029

 
(80,816
)
 
67,581

State income tax expense
 
—

 
(37
)
 
—

 
—

 
(37
)
Net income (loss)
 
62,204

 
77,127

 
9,029

 
(80,816
)
 
67,544

Allocation of net income attributable to noncontrolling interests
 
—

 
—

 
—

 
(5,770
)
 
(5,770
)
Net income (loss) attributable to Holly Energy Partners
 
62,204

 
77,127

 
9,029

 
(86,586
)
 
61,774

Other comprehensive income (loss)
 
(527
)
 
(527
)
 
—

 
527

 
(527
)
Comprehensive income (loss)
 
$
61,677

 
$
76,600

 
$
9,029

 
$
(86,059
)
 
$
61,247


(1) Retrospectively adjusted as described in Note 1.















- 27 -

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



Condensed Consolidating Statement of Cash Flows
Six Months Ended June 30, 2016
 
Parent
 
Guarantor
Restricted Subsidiaries
 
Non-Guarantor Non-Restricted Subsidiaries
 
Eliminations
 
Consolidated
 
 
(In thousands)
Cash flows from operating activities
 
$
(10,608
)
 
$
113,145

 
$
19,155

 
$
(7,500
)
 
$
114,192

 
 
 
 
 
 
 
 
 
 
 
Cash flows from investing activities
 
 
 
 
 
 
 
 
 
 
Additions to properties and equipment
 
—

 
(18,440
)
 
(14,227
)
 
—

 
(32,667
)
Purchase of investment in Frontier Pipeline
 
—

 
(42,500
)
 
—

 
—

 
(42,500
)
Proceeds from sale of assets
 
—

 
18

 
—

 
—

 
18

Distributions in excess of equity in earnings of equity investments
 
—

 
1,496

 
—

 
—

 
1,496

 
 
—

 
(59,426
)
 
(14,227
)
 
—

 
(73,653
)
 
 
 
 
 
 
 
 
 
 
 
Cash flows from financing activities
 
 
 
 
 
 
 
 
 
 
Net borrowings under credit agreement
 
—

 
74,000

 
—

 
—

 
74,000

Net intercompany financing activities
 
86,789

 
(86,789
)
 
—

 
—

 
—

Proceeds from issuance of common units
 
14,586

 
(896
)
 
—

 
—

 
13,690

Contribution from general partner
 
120

 
—

 
—

 
—

 
120

Contribution from general partner for Osage
 
31,285

 
(31,285
)
 
—

 
—

 
—

Distributions to HEP unitholders
 
(91,109
)
 
—

 
—

 
—

 
(91,109
)
Distribution to HFC for Osage
 
—

 
(1,245
)
 
—

 
—

 
(1,245
)
Distributions to HFC for Tulsa tank acquisition
 
(30,378
)
 
(9,122
)
 
—

 
—

 
(39,500
)
Contributions from HFC for Tulsa tank expenditures
 
99

 
—

 
—

 
—

 
99

Distributions to noncontrolling interests
 
—

 
—

 
(10,000
)
 
7,500

 
(2,500
)
Purchase of units for incentive grants
 
(784
)
 
—

 
—

 
—

 
(784
)
Deferred financing cost
 
—

 
(3,084
)
 
—

 
—

 
(3,084
)
Other
 
—

 
(357
)
 
—

 
—

 
(357
)
 
 
10,608

 
(58,778
)
 
(10,000
)
 
7,500

 
(50,670
)
 
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
 
 
 
 
 
 
 
 
 
Increase (decrease) for the period
 
—

 
(5,059
)
 
(5,072
)
 
—

 
(10,131
)
Beginning of period
 
2

 
5,452

 
9,559

 
—

 
15,013

End of period
 
$
2

 
$
393

 
$
4,487

 
$
—

 
$
4,882



- 28 -

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




Condensed Consolidating Statement of Cash Flows
Six Months Ended June 30, 2015 (1)
 
Parent
 
Guarantor
Restricted Subsidiaries
 
Non-Guarantor Non-Restricted Subsidiaries
 
Eliminations
 
Consolidated
 
 
(In thousands)
Cash flows from operating activities
 
$
(9,639
)
 
$
111,307

 
$
15,358

 
$
(6,772
)
 
$
110,254

 
 
 
 
 
 
 
 
 
 
 
Cash flows from investing activities
 
 
 
 
 
 
 
 
 
 
Additions to properties and equipment
 
—

 
(41,559
)
 
(784
)
 
—

 
(42,343
)
Purchase of El Dorado crude tanks
 
—

 
(27,500
)
 
—

 
—

 
(27,500
)
Proceeds from sale of assets
 
—

 
965

 
—

 
—

 
965

Distributions from noncontrolling interest
 
—

 
1,853

 
—

 
(1,853
)
 
—

Distributions in excess of equity in earnings of equity investments
 
—

 
198

 
—

 
—

 
198

 
 
—

 
(66,043
)
 
(784
)
 
(1,853
)
 
(68,680
)
 
 
 
 
 
 
 
 
 
 
 
Cash flows from financing activities
 
 
 
 
 
 
 
 
 
 
Net repayments under credit agreement
 
—

 
33,000

 
—

 
—

 
33,000

Net intercompany financing activities
 
92,498

 
(92,498
)
 
—

 
—

 
—

Contributions from HFC for El Dorado Operating acquisition
 
—

 
18,888

 
—

 
—

 
18,888

Distributions to HEP unitholders
 
(82,614
)
 
—

 
—

 
—

 
(82,614
)
Contribution from HFC for Tulsa tank expenditures
 
—

 
722

 
—

 
—

 
722

Distributions to noncontrolling interests
 
—

 
—

 
(11,500
)
 
8,625

 
(2,875
)
Purchase of units for incentive grants
 
(247
)
 
—

 
—

 
—

 
(247
)
Other
 
—

 
(854
)
 
—

 
—

 
(854
)
 
 
9,637

 
(40,742
)
 
(11,500
)
 
8,625

 
(33,980
)
 
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
 
 
 
 
 
 
 
 
 
Increase (decrease) for the period
 
(2
)
 
4,522

 
3,074

 
—

 
7,594

Beginning of period
 
2

 
2,828

 
—

 
—

 
2,830

End of period
 
$
—

 
$
7,350

 
$
3,074

 
$
—

 
$
10,424


(1) Retrospectively adjusted as described in Note 1.


- 29 -

HOLLY ENERGY PARTNERS, L.P.

Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

This Item 2, including but not limited to the sections under “Results of Operations” and “Liquidity and Capital Resources,” contains forward-looking statements. See “Forward-Looking Statements” at the beginning of Part I of this Quarterly Report on Form 10-Q. In this document, the words “we,” “our,” “ours” and “us” refer to Holly Energy Partners, L. P. (“HEP”) and its consolidated subsidiaries or to HEP or an individual subsidiary and not to any other person.


OVERVIEW

HEP is a Delaware limited partnership. We own and operate petroleum product and crude oil pipelines, terminal, tankage and loading rack facilities and refinery processing units that support the refining and marketing operations of HollyFrontier Corporation (“HFC”) in the Mid-Continent, Southwest and Rocky Mountain regions of the United States and Alon USA, Inc’s (“Alon”) refinery in Big Spring, Texas. HEP, through its subsidiaries and joint ventures, owns and/or operates petroleum product and crude gathering pipelines, tankage and terminals in Texas, New Mexico, Arizona, Washington, Idaho, Oklahoma, Utah, Nevada, Wyoming and Kansas as well as refinery processing units in Kansas. HFC owns a 39% interest in us, including the 2% general partnership interest.

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 charging a tolling fee per barrel or thousand standard cubic feet of feedstock throughput in our refinery processing units. We do not take ownership of products that we transport, terminal or store, and therefore, we are not directly exposed to changes in commodity prices.

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. 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.

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. We used the net proceeds to repay indebtedness under our revolving credit agreement.

We believe the long-term growth of global refined product demand and US crude production should support high utilization rates for the refineries we serve, which in turn will support volumes in our product pipelines, crude gathering system and terminals.

UNEV Pipeline Interest Acquisition
Under the terms of the transaction to acquire HFC’s 75% interest in UNEV in 2012, we issued to HFC a Class B unit comprising a noncontrolling equity interest in a wholly-owned subsidiary subject to redemption to the extent that HFC is entitled to a 50% interest in our share of annual UNEV earnings before interest, income taxes, depreciation, and amortization above $30 million beginning July 1, 2015, and ending in June 2032, subject to certain limitations. However, to the extent earnings thresholds are not achieved, no redemption payments are required. No redemption payments were required for the period ending June 30, 2016.

Contemporaneously with this transaction, HEP Logistics Holdings, L.P. (“HEP Logistics”) (our general partner) agreed to forego its right to incentive distributions of up to $1.25 million per quarter over twelve consecutive quarterly periods following the closing of the transaction and up to an additional four quarters if HFC’s Woods Cross Refinery expansion did not attain certain thresholds. HEP Logistics’ waiver of its right to incentive distributions of $1.25 million per quarter will end in the third quarter of 2016. In connection with the transaction, we entered into 15-year throughput agreements with shippers, which currently require minimum annual revenue commitments to us of $30 million.
Acquisitions
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 will continue to be operated by an affiliate of Plains All American Pipeline, L.P., 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.


- 30 -

On March 31, 2016, we acquired crude oil tanks located at HFC’s Tulsa refinery from an affiliate of Plains All American Pipeline, L.P. for $39.5 million. In connection with this transaction, we expect to enter into a 10-year throughput agreement containing minimum quarterly throughput commitments from HFC that provide minimum annualized revenues of $6.4 million.

On February 22, 2016, HFC obtained a 50% membership interest in Osage Pipe Line Company, LLC (“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 that require 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 has a connection to the Jayhawk pipeline that services the CHS Inc. refinery in McPherson, Kansas. The Osage Pipeline is the primary pipeline that supplies 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 have also 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 variable interest entity 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 carrying basis in the El Paso terminal of $12.1 million with the difference treated as a contribution from HFC.

On November 1, 2015, we acquired from HollyFrontier El Dorado Refining LLC, 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. We are a consolidated variable interest entity of HFC. Therefore, this transaction was recorded as a transfer between entities under common control and reflected HFC’s carrying basis in El Dorado Operating’s assets and liabilities.

Agreements with HFC and Alon
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 has agreed to transport, store and process throughput volumes of refined product, crude oil and feedstocks on our pipelines, terminal, 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 the agreements, a shortfall payment may be applied as a credit in the following four quarters after minimum obligations are met.

We also have a pipelines and terminals agreement with Alon expiring in 2020 under which Alon has agreed to transport on our pipelines and throughput through our terminals volumes of refined products that result in a minimum level of annual revenue that is also subject to annual tariff rate adjustments. We also have a capacity lease agreement under which we lease Alon space on our Orla to El Paso pipeline for the shipment of refined product. The terms under this agreement expire beginning in 2018 through 2022. As of June 30, 2016, these agreements with Alon require minimum annualized payments to us of $32.3 million.

A significant reduction in revenues under these agreements could have a material adverse effect on our results of operations.

Under certain provisions of an omnibus agreement we have with HFC (“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 Holly Logistic Services, L.L.C. (“HLS”), or the cost of their employee benefits, which are separately charged to us by HFC. We also reimburse HFC and its affiliates for direct expenses they incur on our behalf.

Under HLS’s Secondment Agreement with HFC, 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 of these employees for our benefit.

We have a long-term strategic relationship with HFC. Our current growth plan is to continue to pursue purchases of logistic and other assets at HFC’s existing refining locations in New Mexico, Utah, Oklahoma, Kansas and Wyoming. We also expect to work

- 31 -

with HFC on logistic asset acquisitions that support HFC’s refinery acquisition strategies. Furthermore, we plan to continue to pursue third-party logistic asset acquisitions that are accretive to our unitholders and increase the diversity of our revenues.


- 32 -


RESULTS OF OPERATIONS (Unaudited)

Income, Distributable Cash Flow and Volumes
The following tables present income, distributable cash flow and volume information for the three and the six months ended June 30, 2016 and 2015.
 
 
Three Months Ended June 30,
 
Change from
 
 
2016
 
2015
 
2015
 
 
(In thousands, except per unit data)
Revenues:
 
 
 
 
 
 
Pipelines:
 
 
 
 
 
 
Affiliates—refined product pipelines
 
$
19,392

 
$
18,245

 
$
1,147

Affiliates—intermediate pipelines
 
6,780

 
7,172

 
(392
)
Affiliates—crude pipelines
 
18,581

 
15,096

 
3,485

 
 
44,753

 
40,513

 
4,240

Third parties—refined product pipelines
 
11,434

 
11,213

 
221

 
 
56,187

 
51,726

 
4,461

Terminals, tanks and loading racks:
 
 
 
 
 
 
Affiliates
 
30,250

 
27,784

 
2,466

Third parties
 
4,285

 
3,969

 
316

 
 
34,535

 
31,753

 
2,782

 
 
 
 
 
 
 
Affiliates—refinery processing units
 
4,175

 
—

 
4,175

 
 
 
 
 
 
 
Total revenues
 
94,897

 
83,479

 
11,418

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

 
25,400

 
1,855

Depreciation and amortization
 
15,709

 
15,179

 
530

General and administrative
 
2,863

 
2,696

 
167

 
 
45,827

 
43,275

 
2,552

Operating income
 
49,070

 
40,204

 
8,866

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

 
631

 
2,992

Interest expense, including amortization
 
(11,276
)
 
(9,056
)
 
(2,220
)
Interest income
 
112

 
3

 
109

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

 
(55
)
Other
 
5

 
21

 
(16
)
 
 
(7,541
)
 
(8,351
)
 
810

Income before income taxes
 
41,529

 
31,853

 
9,676

State income tax benefit (expense)
 
(54
)
 
64

 
(118
)
Net income
 
41,475

 
31,917

 
9,558

Allocation of net income attributable to noncontrolling interests
 
(2,355
)
 
(1,743
)
 
(612
)
Net income attributable to Holly Energy Partners
 
39,120

 
30,174

 
8,946

General partner interest in net income, including incentive distributions (1)
 
(12,677
)
 
(9,969
)
 
(2,708
)
Limited partners’ interest in net income
 
$
26,443

 
$
20,205

 
$
6,238

Limited partners’ earnings per unit—basic and diluted (1)
 
$
0.45

 
$
0.34

 
$
0.11

Weighted average limited partners’ units outstanding
 
58,865

 
58,657

 
208

EBITDA (2)
 
$
66,047

 
$
54,342

 
$
11,705

Distributable cash flow (3)
 
$
55,709

 
$
47,299

 
$
8,410

 
 
 
 
 
 
 
Volumes (bpd)
 
 
 
 
 
 
Pipelines:
 
 
 
 
 
 
Affiliates—refined product pipelines
 
125,535

 
121,982

 
3,553

Affiliates—intermediate pipelines
 
135,165

 
143,140

 
(7,975
)
Affiliates—crude pipelines
 
278,414

 
295,793

 
(17,379
)
 
 
539,114

 
560,915

 
(21,801
)
Third parties—refined product pipelines
 
74,386

 
73,659

 
727

 
 
613,500

 
634,574

 
(21,074
)
Terminals and loading racks:
 
 
 
 
 

Affiliates
 
418,233

 
420,564

 
(2,331
)
Third parties
 
71,415

 
79,133

 
(7,718
)
 
 
489,648

 
499,697

 
(10,049
)
 
 
 
 
 
 
 
Affiliates—refinery processing units
 
50,376

 
—

 
50,376

 
 
 
 
 
 
 
Total for pipelines and terminal and refiney processing unit assets (bpd)
 
1,153,524

 
1,134,271

 
19,253


- 33 -

 
 
Six Months Ended June 30,
 
Change from
 
 
2016
 
2015
 
2015
 
 
(In thousands, except per unit data)
Revenues:
 
 
 
 
 
 
Pipelines:
 
 
 
 
 
 
Affiliates—refined product pipelines
 
$
44,574

 
$
40,786

 
$
3,788

Affiliates—intermediate pipelines
 
14,193

 
14,034

 
159

Affiliates—crude pipelines
 
36,072

 
32,090

 
3,982

 
 
94,839

 
86,910

 
7,929

Third parties—refined product pipelines
 
26,200

 
24,936

 
1,264

 
 
121,039

 
111,846

 
9,193

Terminals, tanks and loading racks:
 
 
 
 
 
 
Affiliates
 
58,503

 
53,642

 
4,861

Third parties
 
8,683

 
7,747

 
936

 
 
67,186

 
61,389

 
5,797

 
 
 
 
 
 
 
Affiliates—refinery processing units
 
8,682

 
—

 
8,682

 
 
 
 
 
 
 
Total revenues
 
196,907

 
173,235

 
23,672

Operating costs and expenses:
 
 
 
 
 
 
Operations (exclusive of depreciation and amortization)
 
54,177

 
53,465

 
712

Depreciation and amortization
 
32,260

 
29,977

 
2,283

General and administrative
 
5,954

 
5,986

 
(32
)
 
 
92,391

 
89,428

 
2,963

Operating income
 
104,516

 
83,807

 
20,709

Other income (expense):
 
 
 
 
 
 
Equity in earnings of equity method investments
 
6,388

 
1,365

 
5,023

Interest expense, including amortization
 
(21,811
)
 
(17,824
)
 
(3,987
)
Interest income
 
224

 
3

 
221

Gain (loss) on sale of assets
 
(5
)
 
209

 
(214
)
Other
 
(3
)
 
21

 
(24
)
 
 
(15,207
)
 
(16,226
)
 
1,019

Income before income taxes
 
89,309

 
67,581

 
21,728

State income tax expense
 
(149
)
 
(37
)
 
(112
)
Net income
 
89,160

 
67,544

 
21,616

Allocation of net income attributable to noncontrolling interests
 
(7,282
)
 
(5,770
)
 
(1,512
)
Net income attributable to Holly Energy Partners
 
81,878

 
61,774

 
20,104

General partner interest in net income, including incentive distributions (1)
 
(24,562
)
 
(19,576
)
 
(4,986
)
Limited partners’ interest in net income
 
$
57,316

 
$
42,198

 
$
15,118

Limited partners’ earnings per unit—basic and diluted (1)
 
$
0.96

 
$
0.71

 
$
0.25

Weighted average limited partners’ units outstanding
 
58,761

 
58,657

 
104

EBITDA (2)
 
$
135,874

 
$
109,609

 
$
26,265

Distributable cash flow (3)
 
$
111,075

 
$
93,189

 
$
17,886

 
 
 
 
 
 
 
Volumes (bpd)
 
 
 
 
 
 
Pipelines:
 
 
 
 
 
 
Affiliates—refined product pipelines
 
128,983

 
118,724

 
10,259

Affiliates—intermediate pipelines
 
136,288

 
140,620

 
(4,332
)
Affiliates—crude pipelines
 
282,923

 
289,285

 
(6,362
)
 
 
548,194

 
548,629

 
(435
)
Third parties—refined product pipelines
 
76,360

 
72,546

 
3,814

 
 
624,554

 
621,175

 
3,379

Terminals and loading racks:
 
 
 
 
 

Affiliates
 
387,628

 
367,538

 
20,090

Third parties
 
76,370

 
76,574

 
(204
)
 
 
463,998

 
444,112

 
19,886

 
 
 
 
 
 
 
Affiliates—refinery processing units
 
46,409

 
—

 
46,409

 
 
 
 
 
 
 
Total for pipelines and terminal and refinery processing unit assets (bpd)
 
1,134,961

 
1,065,287

 
69,674


- 34 -

 
 
June 30,
2016
 
December 31,
2015
 
 
(In thousands)
Balance Sheet Data
 
 
 
 
Cash and cash equivalents
 
$
4,882

 
$
15,013

Working capital
 
$
13,540

 
$
12,218

Total assets
 
$
1,617,329

 
$
1,543,765

Long-term debt
 
$
1,083,136

 
$
1,008,752

Partners’ equity (5)
 
$
295,264

 
$
297,912



(1)
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.

(2)
Earnings before interest, taxes, depreciation and amortization (“EBITDA”) is calculated as net income attributable to Holly Energy Partners plus (i) interest expense and loss on early extinguishment of debt, net of interest income, (ii) state income tax and (iii) depreciation and amortization. EBITDA is not a calculation based upon generally accepted accounting principles (“GAAP”). However, the amounts included in the EBITDA calculation are derived from amounts included in our consolidated financial statements operations. EBITDA should not be considered as an alternative to net income attributable to Holly Energy Partners or operating income, as an indication of our operating performance or as an alternative to operating cash flow as a measure of liquidity. EBITDA is not necessarily comparable to similarly titled measures of other companies. EBITDA is presented here because it is a widely used financial indicator used by investors and analysts to measure performance. EBITDA is also used by our management for internal analysis and as a basis for compliance with financial covenants. Set forth below is our calculation of EBITDA.
 
 
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

Add (subtract):
 
 
 
 
 
 
 
 
Interest expense
 
10,493

 
8,562

 
20,435

 
16,894

Interest income
 
(112
)
 
(3
)
 
(224
)
 
(3
)
Amortization of discount and deferred debt issuance costs
 
783

 
494

 
1,376

 
930

State income tax expense (benefit)
 
54

 
(64
)
 
149

 
37

Depreciation and amortization
 
15,709

 
15,179

 
32,260

 
29,977

EBITDA
 
$
66,047

 
$
54,342

 
$
135,874

 
$
109,609


(3)
Distributable cash flow is not a calculation based upon GAAP. However, the amounts included in the calculation are derived from amounts presented in our consolidated financial statements, with the general exceptions of maintenance capital expenditures. Distributable cash flow should not be considered in isolation or as an alternative to net income or operating income as an indication of our operating performance or as an alternative to operating cash flow as a measure of liquidity. Distributable cash flow is not necessarily comparable to similarly titled measures of other companies. Distributable cash flow is presented here because it is a widely accepted financial indicator used by investors to compare partnership performance. It is also used by management for internal analysis and for our performance units. We believe that this measure provides investors an enhanced perspective of the operating performance of our assets and the cash our business is generating. Set forth below is our calculation of distributable cash flow.

- 35 -

 
 
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

Add (subtract):
 
 
 
 
 
 
 
 
Depreciation and amortization
 
15,709

 
15,179

 
32,260

 
29,977

Amortization of discount and deferred debt issuance costs
 
783

 
494

 
1,376

 
930

Increase (decrease) in deferred revenue related to minimum revenue commitments
 
1,731

 
1,355

 
(1,927
)
 
(2,195
)
Maintenance capital expenditures (4)
 
(2,661
)
 
(1,870
)
 
(4,322
)
 
(3,519
)
Increase (decrease) in environmental liability
 
(113
)
 
(386
)
 
(442
)
 
3,471

Increase (decrease) in reimbursable deferred revenue
 
(628
)
 
1,537

 
(1,155
)
 
992

Other non-cash adjustments
 
1,768

 
816

 
3,407

 
1,759

Distributable cash flow
 
$
55,709

 
$
47,299

 
$
111,075

 
$
93,189


(4)
Maintenance capital expenditures are capital expenditures made to replace partially or fully depreciated assets in order to maintain the existing operating capacity of our assets and to extend their useful lives. Maintenance capital expenditures include expenditures required to maintain equipment reliability, tankage and pipeline integrity, safety and to address environmental regulations.

(5)
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 partners’ equity since our regular quarterly distributions have exceeded our quarterly net income attributable to HEP. Additionally, if the assets contributed and acquired from HFC while we were a consolidated variable interest entity of HFC had been acquired from third parties, our acquisition cost in excess of HFC’s basis in the transferred assets would have been recorded in our financial statements as increases to our properties and equipment and intangible assets at the time of acquisition instead of decreases to partners’ equity.

Results of Operations—Three Months Ended June 30, 2016 Compared with Three Months Ended June 30, 2015

Summary
Net income attributable to Holly Energy Partners for the second quarter was $39.1 million ($0.45 per basic and diluted limited partner unit) compared to $30.2 million ($0.34 per basic and diluted limited partner unit) for the second quarter of 2015. The increase in earnings is primarily due to our share of earnings from our acquisitions of 50% interests in Frontier Aspen LLC, Osage Pipe Line Company, LLC, and Cheyenne Pipeline LLC, our Tulsa crude tanks acquired in the first quarter of 2016, our refinery processing units acquired in the fourth quarter of 2015, and increased revenues from our 75% interest in the UNEV products pipeline, as well as annual tariff increases.
Our major shippers are obligated to make deficiency payments to us if they do not meet their minimum volume shipping obligations. Revenues for the three months ended June 30, 2016, include the recognition of $0.3 million of prior shortfalls billed to shippers in 2015 compared to revenues for the three months ended June 30, 2015, which included the recognition of $0.5 million of prior shortfalls billed to shippers in 2014. Additional shortfall billings of $2.4 million associated with certain guaranteed shipping contracts were deferred during the three months ended June 30, 2016. Such deferred revenue will be recognized in earnings either as (a) payment for shipments in excess of guaranteed levels, if and to the extent the pipeline system will have the necessary capacity for shipments in excess of guaranteed levels, or (b) when shipping rights expire unused over the contractual make-up period.

Revenues
Revenues for the quarter were $94.9 million, an $11.4 million increase compared to the second quarter of 2015 primarily due to revenues from the El Dorado refinery processing units acquired in the fourth quarter of 2015, increased UNEV pipeline revenues, the inclusion of Tulsa crude tanks revenues as well as the effect of annual tariff increases. Overall pipeline volumes were down 3% compared to the three months ended June 30, 2015 largely due to decreased volumes from pipelines servicing HFC's Navajo refinery offset by increased volumes on the UNEV pipeline.

Revenues from our refined product pipelines were $30.8 million, an increase of $1.4 million compared to the second quarter of 2015, mainly due to increased revenue from UNEV of $1.3 million in addition to increased volumes and annual tariff increases.

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Shipments averaged 199.9 mbpd compared to 195.6 mbpd for the second quarter of 2015 mainly due to increased throughput volumes on the UNEV pipeline.
Revenues from our intermediate pipelines were $6.8 million, an increase of $0.4 million, on shipments averaging 135.2 mbpd compared to 143.1 mbpd for the second quarter of 2015 mainly due to lower volumes from pipelines servicing HFC’s Navajo Refinery.
Revenues from our crude pipelines were $18.6 million, an increase of $3.5 million, on shipments averaging 278.4 mbpd compared to 295.8 mbpd for the second quarter of 2015. Revenues increased mainly due to tariff increases and an increase in deferred revenue recognized.

Revenues from terminal, tankage and loading rack fees were $34.5 million, an increase of $2.8 million compared to the second quarter of 2015. Refined products terminalled in the facilities averaged 489.6 mbpd compared to 499.7 mbpd for the second quarter of 2015. The volume decrease is mainly due to the transfer of the El Paso terminal to HollyFrontier in the first quarter of 2016 offset by the inclusion of volumes from our Tulsa crude tanks acquired in the first quarter of 2016. Revenues increased due to increased revenue from the Tulsa crude tanks as well as annual tariff increases.

Operations Expense
Operations (exclusive of depreciation and amortization) expense for the three months ended June 30, 2016, increased by $1.9 million compared to the three months ended June 30, 2015. The increase is mainly due to operating expenses from the newly acquired El Dorado processing units partially offset by lower environmental costs.

Depreciation and Amortization
Depreciation and amortization for the three months ended June 30, 2016, increased by $0.5 million compared to the three months ended June 30, 2015. The increase is principally due to higher depreciation from our newly acquired El Dorado operating units.

General and Administrative
General and administrative costs for the three months ended June 30, 2016, increased by $0.2 million compared to the three months ended June 30, 2015 mainly due to increased professional fees and incentive compensation.

Equity in Earnings of Equity Method Investments
 
Three months ended June 30,
Equity Method Investment
2016
2015
 
(in thousands)
SLC Pipeline LLC
$
1,089

$
631

Frontier Aspen, LLC
938

—

Osage Pipe Line Company, LLC
1,233

—

Cheyenne Pipeline LLC
363

—

Total
$
3,623

$
631


Interest Expense
Interest expense for the three months ended June 30, 2016, totaled $11.3 million, an increase of $2.2 million compared to the three months ended June 30, 2015. The increase is primarily due to a higher balance outstanding on the Credit Agreement. Our aggregate effective interest rates were 4.2% and 4.0% for the three months ended June 30, 2016 and 2015, respectively.

State Income Tax
We recorded a state income tax expense of $54,000 and a benefit of $64,000 for the three months ended June 30, 2016 and 2015, respectively. All tax expense is solely attributable to the Texas margin tax.

Results of Operations—Six Months Ended June 30, 2016 Compared with Six Months Ended June 30, 2015

Summary
Net income attributable to Holly Energy Partners for the six months ended June 30, 2016, was $81.9 million compared to $61.8 million for the six months ended June 30, 2015. The increase in earnings is primarily due to our share of earnings from our acquisitions of 50% interests in Frontier Aspen LLC, Osage Pipe Line Company, LLC, and Cheyenne Pipeline LLC, our Tulsa crude tanks acquired in the first quarter of 2016, our refinery processing units acquired in the fourth quarter of 2015, increased revenues from our 75% interest in the UNEV products pipeline, as well as annual tariff increases.

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Revenues for the six months ended June 30, 2016, include the recognition of $7.0 million of prior shortfalls billed to shippers in 2015 as they did not meet their minimum volume commitments within the contractual makeup period. Deficiency payments of $3.9 million associated with certain guaranteed shipping contracts were deferred during the six months ended June 30, 2016. Such deferred revenue will be recognized in earnings either as (a) payment for shipments in excess of guaranteed levels, if and to the extent the pipeline system will have the necessary capacity for shipments in excess of guaranteed levels, or (b) when shipping rights expire unused over the contractual make-up period.

Revenues
Revenues for the six months ended June 30, 2016, were $196.9 million, a $23.7 million increase compared to the six months ended June 30, 2015. This is due principally to increased revenue from the El Dorado refinery processing units, increased UNEV revenues, and the inclusion of Tulsa crude tanks revenues, as well the effect of annual tariff increases and increased pipeline shipments. The volume increase resulted in overall pipeline volumes being up 0.5% compared to the six months ended June 30, 2015.

Revenues from our refined product pipelines were $70.8 million, an increase of $5.1 million compared to the six months ended June 30, 2015, mainly due to increased revenue from UNEV of $4.2 million in addition to increased volumes and annual tariff increases. Shipments averaged 205.3 mbpd compared to 191.3 mbpd for the six months ended June 30, 2015, largely due to increased volumes from pipelines servicing HFC’s Navajo refinery and the UNEV pipeline.
Revenues from our intermediate pipelines were $14.2 million, an increase of $0.2 million, on shipments averaging 136.3 mbpd compared to 140.6 mbpd for the six months ended June 30, 2015. The increase in revenue was mainly due to the effects of annual tariff increases.
Revenues from our crude pipelines were $36.1 million, an increase of $4.0 million, on shipments averaging 282.9 mbpd compared to 289.3 mbpd for the six months ended June 30, 2015. Revenues increased mainly due to annual tariff increases and increase in deferred revenue recognized.

Revenues from terminal, tankage and loading rack fees were $67.2 million, an increase of $5.8 million compared to the six months ended June 30, 2015. Revenues increased primarily due to increased revenue from the El Dorado and Tulsa crude tanks, higher volumes through the UNEV terminals, as well as annual tariff increases. Refined products terminalled in the facilities averaged 464.0 mbpd compared to 444.1 mbpd for the six months ended June 30, 2015, largely due to the El Dorado and Tulsa crude tank volumes offset by lower volumes through the El Paso terminal.

Operations Expense
Operations expense (exclusive of depreciation and amortization) for the six months ended June 30, 2016, increased by $0.7 million compared to the six months ended June 30, 2015. The increase is mainly due to operating expenses from our El Dorado operating units acquired in the fourth quarter of 2015.

Depreciation and Amortization
Depreciation and amortization for the six months ended June 30, 2016, increased by $2.3 million compared to the six months ended June 30, 2015. The increase is due principally to higher depreciation from our newly acquired El Dorado refinery processing units.

General and Administrative
General and administrative costs for the six months ended June 30, 2016, remained level compared to the six months ended June 30, 2015.

Equity in Earnings of Equity Method Investments
 
Six months ended June 30,
Equity Method Investments
2016
2015
 
(in thousands)
SLC Pipeline LLC
$
2,114

$
1,365

Frontier Aspen, LLC
2,463

—

Osage Pipe Line Company, LLC
1,448

—

Cheyenne Pipeline LLC
363

—

Total
$
6,388

$
1,365


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Interest Expense
Interest expense for the six months ended June 30, 2016, totaled $21.8 million, an increase of $4.0 million compared to the six months ended June 30, 2015. The increase is primarily due to a higher balance outstanding on the Credit Agreement. Our aggregate effective interest rates were 4.2% and 4.0% for the six months ended June 30, 2016 and 2015, respectively.

State Income Tax
We recorded state income tax expense of $149,000 and $37,000 for the six months ended June 30, 2016 and 2015, respectively. All tax expense is solely attributable to the Texas margin tax.


LIQUIDITY AND CAPITAL RESOURCES

Overview
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, which 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.

During the six months ended June 30, 2016, we received advances totaling $239.0 million and repaid $165.0 million, resulting in a net increase of $74.0 million under the Credit Agreement and an outstanding balance of $786.0 million at June 30, 2016. We have no letters of credit outstanding under the Credit Agreement at June 30, 2016, and the available capacity under the Credit Agreement is $414.0 million at June 30, 2016.
If any particular lender under the Credit Agreement could not honor its commitment, we believe the unused capacity that would be available from the remaining lenders would be sufficient to meet our borrowing needs. Additionally, we review publicly available information on the lenders in order to monitor their financial stability and assess their ongoing ability to honor their commitments under the Credit Agreement. We do not expect to experience any difficulty in the lenders’ ability to honor their respective commitments, and if it were to become necessary, we believe there would be alternative lenders or options available.

On July 19, 2016, we closed a private placement of $400 million aggregate principal amount of 6.0% senior unsecured notes due in 2024. 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. As of June 30, 2016, HEP has issued 444,799 units under this program, providing approximately $14.9 million in gross proceeds. We accrued sales commissions of $0.3 million associated with the issuance of these units. We intend to use the 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.
Under our registration statement filed with the SEC using a “shelf” registration process, we currently have the authority to raise up to $2.0 billion, less amounts issued under the $200 million continuous offering program, by offering securities, through one or more prospectus supplements that would describe, among other things, the specific amounts, prices and terms of any securities offered and how the proceeds would be used. Any proceeds from the sale of securities would be used for general business purposes, which may include, among other things, funding acquisitions of assets or businesses, working capital, capital expenditures, investments in subsidiaries, the retirement of existing debt and/or the repurchase of common units or other securities.

We believe our current cash balances, future internally generated funds and funds available under the Credit Agreement will provide sufficient resources to meet our working capital liquidity needs for the foreseeable future.

In February and May 2016, we paid regular quarterly cash distributions of $0.565 and $0.5750 on all units in an aggregate amount of $91.1 million including $22.4 million of incentive distribution payments to our general partner.

Contemporaneously with our UNEV interest acquisition on July 12, 2012, HEP Logistics, our general partner, agreed to forego its right to incentive distributions of $1.25 million per quarter over twelve consecutive quarterly periods following the close of the transaction and up to an additional four quarters if HFC’s Woods Cross Refinery expansion did not attain certain thresholds. HEP Logistics’ waiver of its right to incentive distributions of $1.25 million per quarter will end in the third quarter of 2016.


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Cash and cash equivalents decreased by $10.1 million during the six months ended June 30, 2016. The cash flows provided by operating activities of $114.2 million were less than the cash flows used for financing activities of $50.7 million and investing activities of $73.7 million. Working capital increased by $1.3 million to $13.5 million at June 30, 2016, from $12.2 million at December 31, 2015.

Cash Flows—Operating Activities
Cash flows from operating activities increased by $3.9 million from $110.3 million for the six months ended June 30, 2015, to $114.2 million for the six months ended June 30, 2016. This increase is due principally to higher cash receipts for services performed and higher distributions received from equity investments partially offset by higher payments for interest and operating expenses in the six months ended June 30, 2016, as compared to the prior year.

Cash Flows—Investing Activities
Cash flows used for investing activities were $73.7 million for the six months ended June 30, 2016, compared to $68.7 million for the six months ended June 30, 2015, an increase of $5.0 million. During the six months ended June 30, 2016 and 2015, we invested $32.7 million and $42.3 million in additions to properties and equipment, respectively. We purchased a 50% interest in Cheyenne Pipeline LLC for $42.5 million in June 2016, and the El Dorado crude tank assets for $27.5 million in March 2015.

Cash Flows—Financing Activities
Cash flows used for financing activities were $50.7 million for the six months ended June 30, 2016, compared to $34.0 million for the six months ended June 30, 2015, an increase of $16.7 million. During the six months ended June 30, 2016, we received $239.0 million and repaid $165.0 million in advances under the Credit Agreement. We also received net proceeds of $13.7 million from issuance of common units under our continuous offering program. Additionally, we paid $91.1 million in regular quarterly cash distributions to our general and limited partners, $2.5 million to our noncontrolling interest and $0.8 million for the purchase of common units for recipients of our incentive grants. We also paid $39.5 million for the crude oil tanks located at HFC’s Tulsa refinery acquired in March 2016, and we paid $3.1 million in deferred financing charges to amend our credit agreement. During the six months ended June 30, 2015, we received $254.1 million and repaid $221.1 million in advances under the Credit Agreement. We paid $82.6 million in regular quarterly cash distributions to our general and limited partners, distributed $2.9 million to our noncontrolling interest, and paid $0.2 million for the purchase of common units for recipients of our incentive grants. In addition, we received $18.9 million for the El Dorado Operating acquisition and $0.7 million for Tulsa tank expenditures from HFC.

Capital Requirements
Our pipeline and terminalling operations are capital intensive, requiring investments to maintain, expand, upgrade or enhance existing operations and to meet environmental and operational regulations. Our capital requirements have consisted of, and are expected to continue to consist of, maintenance capital expenditures and expansion capital expenditures. “Maintenance capital expenditures” represent capital expenditures to replace partially or fully depreciated assets to maintain the operating capacity of existing assets. Maintenance capital expenditures include expenditures required to maintain equipment reliability, tankage and pipeline integrity, safety and to address environmental regulations. “Expansion capital expenditures” represent capital expenditures to expand the operating capacity of existing or new assets, whether through construction or acquisition. Expansion capital expenditures include expenditures to acquire assets, to grow our business and to expand existing facilities, such as projects that increase throughput capacity on our pipelines and in our terminals. Repair and maintenance expenses associated with existing assets that are minor in nature and do not extend the useful life of existing assets are charged to operating expenses as incurred.

Each year the board of directors of HLS, our ultimate general partner, approves our annual capital budget, which specifies capital projects that our management is authorized to undertake. Additionally, at times when conditions warrant or as new opportunities arise, additional projects may be approved. The funds allocated for a particular capital project may be expended over a period in excess of a year, depending on the time required to complete the project. Therefore, our planned capital expenditures for a given year consist of expenditures approved for capital projects included in the current year’s capital budget as well as, in certain cases, expenditures approved for capital projects in capital budgets for prior years. The 2016 capital budget is comprised of $13 million for maintenance capital expenditures and $57 million for expansion capital expenditures. We expect the majority of the expansion capital budget to be invested in refined product pipeline expansions, crude system enhancements, new storage tanks, and enhanced blending capabilities at our racks. In addition to our capital budget, we may spend funds periodically to perform capital upgrades or additions to our assets where a customer reimburses us for such costs. The upgrades or additions would generally benefit the customer over the remaining life of the related service agreements.

We are currently evaluating a potential dropdown from HFC of certain assets related to the initial phase of the expansion at HFC’s Woods Cross refinery, which we expect to close in the second half of 2016.
We expect that our currently planned sustaining and maintenance capital expenditures, as well as expenditures for acquisitions and capital development projects, will be funded with cash generated by operations, the sale of additional limited partner common

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units, the issuance of debt securities and advances under our Credit Agreement, or a combination thereof. With volatility and uncertainty at times in the credit and equity markets, there may be limits on our ability to issue new debt or equity financing. Additionally, due to pricing movements in the debt and equity markets, we may not be able to issue new debt and equity securities at acceptable pricing. Without additional capital beyond amounts available under the Credit Agreement, our ability to obtain funds for some of these capital projects may be limited.

Under the terms of the transaction to acquire HFC’s 75% interest in UNEV, we issued to HFC a Class B unit comprising a noncontrolling equity interest in a wholly-owned subsidiary subject to redemption to the extent that HFC is entitled to a 50% interest in our share of annual UNEV earnings before interest, income taxes, depreciation, and amortization above $30 million beginning July 1, 2015, and ending in June 2032, subject to certain limitations.

Credit Agreement
In March 2016, we amended our senior secured revolving credit facility (the “Credit Agreement”) 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 as well as 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, 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 with 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.

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.


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


See “Risk Management” for a discussion of our interest rate swaps.

Contractual Obligations
There were no significant changes to our long-term contractual obligations during this period.

Impact of Inflation
Inflation in the United States has been relatively moderate in recent years and did not have a material impact on our results of operations for the six months ended June 30, 2016 and 2015. Historically, the PPI has increased an average of 2.3% annually over the past five calendar years.

The substantial majority of our revenues are generated under long-term contracts that provide for increases in our rates and minimum revenue guarantees annually for increases in the PPI. Certain of these contracts have provisions that limit the level of annual PPI percentage rate increases. Although the recent PPI increase may not be indicative of additional increases to be realized in the future, a significant and prolonged period of high inflation could adversely affect our cash flows and results of operations if costs increase at a rate greater than the fees we charge our shippers.

Environmental Matters
Our operation of pipelines, terminals, and associated facilities in connection with the transportation and storage of refined products and crude oil is subject to stringent and complex federal, state, and local laws and regulations governing the discharge of materials into the environment, or otherwise relating to the protection of the environment. As with the industry generally, compliance with existing and anticipated laws and regulations increases our overall cost of business, including our capital costs to construct, maintain, and upgrade equipment and facilities. While these laws and regulations affect our maintenance capital expenditures and net income, we believe that they do not affect our competitive position given that the operations of our competitors are similarly affected. We believe our operations are in substantial compliance with applicable environmental laws and regulations. However, these laws and regulations, and the interpretation or enforcement thereof, are subject to frequent change by regulatory authorities, and we are unable to predict the ongoing cost to us of complying with these laws and regulations or the future impact of these laws and regulations on our operations. Violation of environmental laws, regulations, and permits can result in the imposition of significant administrative, civil and criminal penalties, injunctions, and construction bans or delays. A major discharge of hydrocarbons or hazardous substances into the environment could, to the extent the event is not insured, subject us to substantial expense, including both the cost to comply with applicable laws and regulations and claims made by employees, neighboring landowners and other third parties for personal injury and property damage.

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.
We have an environmental agreement with Alon with respect to pre-closing environmental costs and liabilities relating to the pipelines and terminals acquired from Alon in 2005, under which Alon will indemnify us subject to certain monetary and time limitations.

There are environmental remediation projects in progress that relate to certain assets acquired from HFC. Certain of these projects were underway prior to our purchase and represent liabilities retained by HFC. At June 30, 2016, we have a net accrual of $7.2 million that relates to environmental clean-up projects for which we have assumed liability or for which the indemnity provided

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for by HFC has expired or will expire. The remaining projects, including assessment and monitoring activities, are covered under the HFC environmental indemnification discussed above and represent liabilities of HFC.


CRITICAL ACCOUNTING POLICIES

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities as of the date of the financial statements. Actual results may differ from these estimates under different assumptions or conditions. Our significant accounting policies are described in “Item 7. Management’s Discussion and Analysis of Financial Condition and Operations—Critical Accounting Policies” in our Annual Report on Form 10-K for the year ended December 31, 2015. Certain critical accounting policies that materially affect the amounts recorded in our consolidated financial statements include revenue recognition, assessing the possible impairment of certain long-lived assets and goodwill, and assessing contingent liabilities for probable losses. There have been no changes to these policies in 2016. We consider these policies to be the most critical to understanding the judgments that are involved and the uncertainties that could impact our results of operations, financial condition and cash flows.

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.

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 have adopted this standard as of January 1, 2016, as required. In connection with the dropdown of assets from HFC’s Tulsa refinery on March 31, 2016, we reduced net income by $0.2 million for the three months ending March 31, 2015. This reduction had no impact on the historical earnings per unit.


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 $150.0 million of Credit Agreement advances. The swaps effectively convert $150.0 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 review publicly available information on our counterparties in order to monitor their financial stability and assess their ongoing ability to honor their commitments under the interest rate swap contracts. These counterparties are large financial institutions.

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Furthermore, we have not experienced, nor do we expect to experience, any difficulty in the counterparties honoring their respective commitments.

The market risk inherent in our debt positions is the potential change arising from increases or decreases in interest rates as discussed below.

At June 30, 2016, we had an outstanding principal balance on our 6.5% Senior Notes of $300 million. A change in interest rates generally would affect the fair value of the Senior Notes, but not our earnings or cash flows. At June 30, 2016, the fair value of our 6.5% Senior Notes was $301.5 million. We estimate a hypothetical 10% change in the yield-to-maturity applicable to the 6.5% Senior Notes at June 30, 2016, would result in a change of approximately $6.4 million in the fair value of the underlying notes.

For the variable rate Credit Agreement, changes in interest rates would affect cash flows, but not the fair value. At June 30, 2016, borrowings outstanding under the Credit Agreement were $786.0 million. By means of our cash flow hedges, we have effectively converted the variable rate on $150.0 million of outstanding borrowings to a fixed rate. For the remaining unhedged Credit Agreement borrowings of $636.0 million, a hypothetical 10% change in interest rates applicable to the Credit Agreement would not materially affect our cash flows.

Our operations are subject to normal hazards of operations, including fire, explosion and weather-related perils. We maintain various insurance coverages, including business interruption insurance, subject to certain deductibles. We are not fully insured against certain risks because such risks are not fully insurable, coverage is unavailable, or premium costs, in our judgment, do not justify such expenditures.

We have a risk management oversight committee that is made up of members from our senior management.  This committee monitors our risk environment and provides direction for activities to mitigate, to an acceptable level, identified risks that may adversely affect the achievement of our goals.


Item 3.
Quantitative and Qualitative Disclosures About Market Risk

Market risk is the risk of loss arising from adverse changes in market rates and prices. See “Risk Management” under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for a discussion of market risk exposures that we have with respect to our long-term debt, which disclosure should be read in conjunction with the quantitative and qualitative disclosures about market risk contained in our Annual Report on Form 10-K for the fiscal year ended December 31, 2015. We utilize derivative instruments to hedge our interest rate exposure, as discussed under “Risk Management.”

Since we do not own products shipped on our pipelines or terminalled at our terminal facilities, we do not have direct market risks associated with commodity prices.


Item 4.
Controls and Procedures

(a) Evaluation of disclosure controls and procedures
Our principal executive officer and principal financial officer have evaluated, as required by Rule 13a-15(b) under the Securities Exchange Act of 1934 (the “Exchange Act”), our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this quarterly report on Form 10-Q. Our disclosure controls and procedures are designed to provide reasonable assurance that the information we are required to disclose in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure and is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Based upon the evaluation, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures were effective as of June 30, 2016, at a reasonable level of assurance.

(b) Changes in internal control over financial reporting
There have been no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that occurred during our last fiscal quarter that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 1.
Legal Proceedings

We are a party to various legal and regulatory proceedings, which we believe will not have a material adverse impact on our financial condition, results of operations or cash flows.
 

Item 1A.
Risk Factors

There have been no material changes in our risk factors as previously disclosed in Part 1, “Item 1A. Risk Factors” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2015. In addition to the other information set forth in this quarterly report, you should consider carefully the factors discussed in our 2015 Form 10-K, which could materially affect our business, financial condition or future results. The risks described in our 2015 Form 10-K are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may also materially and adversely affect our business, financial condition or future results.


Item 6.
Exhibits

The Exhibit Index on page 47 of this Quarterly Report on Form 10-Q lists the exhibits that are filed or furnished, as applicable, as part of the Quarterly Report on Form 10-Q.


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HOLLY ENERGY PARTNERS, L.P.
SIGNATURES

Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
HOLLY ENERGY PARTNERS, L.P.
 
(Registrant)
 
 
 
 
 
By: HEP LOGISTICS HOLDINGS, L.P.
its General Partner
 
 
 
 
 
By: HOLLY LOGISTIC SERVICES, L.L.C.
its General Partner
 
 
 
Date: August 3, 2016
 
/s/    Richard L. Voliva III
 
 
Richard L. Voliva III
 
 
Senior Vice President and
Chief Financial Officer
(Principal Financial Officer)
 
 
 
Date: August 3, 2016
 
/s/    Kenneth P. Norwood
 
 
Kenneth P. Norwood
 
 
Vice President and Controller
(Principal Accounting Officer)
 


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Exhibit Index
Exhibit
Number
 
Description
 
 
 
3.1
 
First Amended and Restated Agreement of Limited Partnership of Holly Energy Partners, L.P. (incorporated by reference to Exhibit 3.1 of Registrant’s Quarterly Report on Form 10-Q for its quarterly period ended June 30, 2004, File No. 1-32225).
3.2
 
Amendment No. 1 to the First Amended and Restated Agreement of Limited Partnership of Holly Energy Partners, L.P., dated February 28, 2005 (incorporated by reference to Exhibit 3.1 of Registrant’s Form 8-K Current Report dated February 28, 2005, File No. 1-32225).
3.3
 
Amendment No. 2 to the First Amended and Restated Agreement of Limited Partnership of Holly Energy Partners, L.P., as amended, dated July 6, 2005 (incorporated by reference to Exhibit 3.1 of Registrant’s Form 8-K Current Report dated July 6, 2005, File No. 1-32225).
3.4
 
Amendment No. 3 to First Amended and Restated Agreement of Limited Partnership of Holly Energy Partners, L.P., dated April 11, 2008 (incorporated by reference to Exhibit 4.1 of Registrant’s Current Report on Form 8-K dated April 15, 2008, File No. 1-32225).
3.5
 
Amendment No. 4 to First Amended and Restated Agreement of Limited Partnership of Holly Energy Partners, L.P., dated January 16, 2013 (incorporated by reference to Exhibit 3.1 of Registrant’s Current Report on Form 8-K dated January 16, 2013, File No. 1-32225).
3.6
 
Amendment No. 5 to First Amended and Restated Agreement of Limited Partnership of Holly Energy Partners, L.P., dated June 13, 2016 (incorporated by reference to Exhibit 3.1 of Registrant’s Current Report on Form 8-K dated June 15, 2016, File No. 1-32225).
3.7
 
Limited Partial Waiver of Incentive Distribution Rights under the First Amended and Restated Agreement of Limited Partnership of Holly Energy Partners, L.P., dated as of July 12, 2012 (incorporated by reference to Exhibit 3.1 of Registrant’s Current Report on Form 8-K dated July 12, 2012, File No. 1-32225).
3.8
 
First Amended and Restated Agreement of Limited Partnership of Holly Energy Partners - Operating Company, L.P. (incorporated by reference to Exhibit 3.2 of Registrant’s Quarterly Report on Form 10-Q for its quarterly period ended June 30, 2004, File No. 1-32225).
3.9
 
First Amended and Restated Agreement of Limited Partnership of HEP Logistics Holdings, L.P. (incorporated by reference to Exhibit 3.4 of Registrant’s Quarterly Report on Form 10-Q for its quarterly period ended June 30, 2004, File No. 1-32225).
3.10
 
First Amended and Restated Limited Liability Company Agreement of Holly Logistic Services, L.L.C. (incorporated by reference to Exhibit 3.5 of Registrant’s Quarterly Report on Form 10-Q for its quarterly period ended June 30, 2004, File No. 1-32225).
3.11
 
Amendment No. 1 to the First Amended and Restated Limited Liability Company Agreement of Holly Logistic Services, L.L.C., dated April 27, 2011 (incorporated by reference to Exhibit 3.1 of Registrant’s Form 8-K Current Report dated May 3, 2011, File No. 1-32225).
3.12
 
First Amended and Restated Limited Liability Company Agreement of HEP Logistics GP, L.L.C. (incorporated by reference to Exhibit 3.6 of Registrant’s Quarterly Report on Form 10-Q for its quarterly period ended June 30, 2004, File No. 1-32225).
4.1+
 
Sixth Supplemental Indenture dated June 21, 2016, among HEP Cheyenne LLC, Holly Energy Partners, L.P., and Holly Energy Finance Corp., the other Guarantors and U.S. Bank National Association.
4.2
 
Indenture dated July 19, 2016, among Holly Energy Partners, L.P., Holly Energy Finance Corp., and each of the Guarantors party thereto and U.S. Bank National Association (incorporated by reference to Exhibit 4.1 of Registrant’s Current Report on Form 8-K dated July 19, 2016, File No. 1-32225).
10.1+**
 
Equity Distribution Agreement, dated May 10, 2016, by and between Holly Energy Partners, L.P., HEP Logistics Holdings, L.P., Holly Logistic Services, L.L.C. and Citigroup Global Markets Inc., Goldman, Sachs & Co., and Merrill Lynch, Pierce, Fenner & Smith Incorporated.
31.1+
 
Certification of Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of 2002.
31.2+
 
Certification of Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act of 2002.
32.1++
 
Certification of Chief Executive Officer under Section 906 of the Sarbanes-Oxley Act of 2002.
32.2++
 
Certification of Chief Financial Officer under Section 906 of the Sarbanes-Oxley Act of 2002.

101*
 
The following financial information from Holly Energy Partners, L.P.’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2016, formatted in XBRL (Extensible Business Reporting Language): (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Comprehensive Income, (iv) Consolidated Statements of Cash Flows, (v) Consolidated Statement of Partners’ Equity, and (vi) Notes to Consolidated Financial Statements.



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 +
Filed herewith.
 ++
Furnished herewith.
 *
Filed electronically herewith.
**
Exhibit reflects correction of minor error in previously filed exhibit.


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