HEP 9-30-2012 10Q


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 ______________________________________________________________________________________
FORM 10-Q
 ______________________________________________________________________________________

(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2012
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 October 26, 2012 was 28,391,024.


Table of Contentsril 19,

HOLLY ENERGY PARTNERS, L.P.
INDEX
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
 
 
Item 3.
 
 
 
 
 
Item 4.
 
 
 
 
 
 
 
Item 1.
 
 
 
 
 
Item 1A.
 
 
 
 
 
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
 
 
 
 
 
Item 6.
 
 
 
 
 
 
 
 
 
 
 
 

- 2 -
Table of Contentsril 19,


FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains certain “forward-looking statements” within the meaning of the federal securities laws. All statements, other than statements of historical fact included in this Form 10-Q, including, but not limited to, those under “Results of Operations” and “Liquidity and Capital Resources” in Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part I are forward-looking statements. Forward looking statements use words such as “anticipate,” “project,” “expect,” “plan,” “goal,” “forecast,” “intend,” “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. Such 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 successfully purchase and integrate additional operations in the future;
•
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, 2011 in “Risk Factors” and in this Form 10-Q in “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” All forward-looking statements included in this Form 10-Q and all subsequent written or oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. The forward-looking statements speak only as of the date made and, other than as required by law, we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.


- 3 -
Table of Contentsril 19,

PART I. FINANCIAL INFORMATION


Item 1.
Financial Statements
HOLLY ENERGY PARTNERS, L.P.
CONSOLIDATED BALANCE SHEETS  
(Unaudited)
 
 
September 30, 2012
 
December 31, 2011 (1)
 
 
(In thousands, except unit data)
ASSETS
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
1,993

 
$
6,369

Accounts receivable:
 
 
 
 
Trade
 
6,527

 
6,130

Affiliates
 
36,305

 
31,922

 
 
42,832

 
38,052

Prepaid and other current assets
 
4,313

 
3,729

Total current assets
 
49,138

 
48,150

 
 
 
 
 
Properties and equipment, net
 
943,604

 
954,864

Transportation agreements, net
 
96,333

 
101,543

Goodwill
 
256,498

 
256,498

Investment in SLC Pipeline
 
25,179

 
25,302

Other assets
 
9,021

 
7,204

Total assets
 
$
1,379,773

 
$
1,393,561

 
 
 
 
 
LIABILITIES AND PARTNERS’ EQUITY
 
 
 
 
Current liabilities:
 
 
 
 
Accounts payable:
 
 
 
 
Trade
 
$
5,662

 
$
18,375

Affiliates
 
5,641

 
6,474

 
 
11,303

 
24,849

 
 
 
 
 
Accrued interest
 
2,506

 
8,280

Deferred revenue
 
9,280

 
4,032

Accrued property taxes
 
5,040

 
2,196

Other current liabilities
 
2,489

 
1,777

Total current liabilities
 
30,618

 
41,134

 
 
 
 
 
Long-term debt
 
874,434

 
605,888

Other long-term liabilities
 
7,574

 
4,000

 
 
 
 
 
Class B unit
 
12,414

 
—

 
 
 
 
 
Equity:
 
 
 
 
Partners’ equity:
 
 
 
 
Common unitholders (28,391,024 and 27,361,124 units issued and outstanding
    at September 30, 2012 and December 31, 2011, respectively)
 
505,293

 
482,509

General partner interest (2% interest)
 
(144,555
)
 
167,492

Accumulated other comprehensive loss
 
(5,886
)
 
(6,464
)
Total partners’ equity
 
354,852

 
643,537

Noncontrolling interest
 
99,881

 
99,002

Total equity
 
454,733

 
742,539

Total liabilities and equity
 
$
1,379,773

 
$
1,393,561


(1) Recast as described in Note 2.

See accompanying notes.

- 4 -
Table of Contentsril 19,

HOLLY ENERGY PARTNERS, L.P.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
 
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2012
 
2011 (1)
 
2012
 
2011 (1)
 
 
(In thousands, except per unit data)
Revenues:
 
 
 
 
 
 
 
 
Affiliates
 
$
60,576

 
$
40,714

 
$
172,341

 
$
111,874

Third parties
 
11,920

 
8,322

 
34,648

 
33,035

 
 
72,496

 
49,036

 
206,989

 
144,909

Operating costs and expenses:
 
 
 
 
 
 
 
 
Operations
 
21,324

 
16,398

 
61,355

 
43,804

Depreciation and amortization
 
13,044

 
8,916

 
39,899

 
24,627

General and administrative
 
1,399

 
2,012

 
5,925

 
4,948

 
 
35,767

 
27,326

 
107,179

 
73,379

Operating income
 
36,729

 
21,710

 
99,810

 
71,530

 
 
 
 
 
 
 
 
 
Other income (expense):
 
 
 
 
 
 
 
 
Equity in earnings of SLC Pipeline
 
877

 
641

 
2,502

 
1,848

Interest expense
 
(12,540
)
 
(8,828
)
 
(34,269
)
 
(26,101
)
Loss on early extinguishment of debt
 
—

 
—

 
(2,979
)
 
—

Other (income) expense
 
—

 
20

 
—

 
8

 
 
(11,663
)
 
(8,167
)
 
(34,746
)
 
(24,245
)
Income before income taxes
 
25,066

 
13,543

 
65,064

 
47,285

State income tax (expense) benefit
 
(137
)
 
77

 
(287
)
 
(169
)
Net income
 
24,929

 
13,620

 
64,777

 
47,116

Allocation of net loss attributable to Predecessors
 
146

 
3,000

 
4,199

 
3,515

Allocation of net loss (income) attributable to noncontrolling interests
 
(582
)
 
124

 
658

 
295

Net income attributable to Holly Energy Partners
 
24,493

 
16,744

 
69,634

 
50,926

General partner interest in net income, including incentive distributions
 
(5,299
)
 
(4,009
)
 
(16,724
)
 
(11,418
)
Limited partners’ interest in net income
 
$
19,194

 
$
12,735

 
$
52,910

 
$
39,508

Limited partners’ per unit interest in earnings—basic and diluted
 
$
0.68

 
$
0.58

 
$
1.91

 
$
1.79

Weighted average limited partners’ units outstanding
 
28,268

 
22,079

 
27,666

 
22,079


(1) Recast as described in Note 2.

See accompanying notes.


- 5 -

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

 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2012
 
2011 (1)
 
2012
 
2011 (1)
 
 
(In thousands)
 
 
 
 
 
 
 
 
 
Net income
 
$
24,929

 
$
13,620

 
$
64,777

 
$
47,116

Allocation of net loss attributable to Predecessors
 
146

 
3,000

 
4,199

 
3,515

Net income before noncontrolling interests
 
25,075

 
16,620

 
68,976

 
50,631

 
 
 
 
 
 
 
 
 
Other comprehensive income (loss):
 
 
 
 
 
 
 
 
Change in fair value of cash flow hedge
 
(1,381
)
 
1,094

 
(3,243
)
 
2,648

Amortization of unrealized loss attributable to discontinued cash flow hedge
 
1,274

 
—

 
3,821

 
—

Other comprehensive income (loss)
 
(107
)
 
1,094

 
578

 
2,648

Comprehensive income before noncontrolling interest
 
24,968

 
17,714

 
69,554

 
53,279

Allocation of comprehensive (income) loss to noncontrolling interests
 
(582
)
 
124

 
658

 
295

Comprehensive income
 
$
24,386

 
$
17,838

 
$
70,212

 
$
53,574


(1) Recast as described in Note 2.
    
See accompanying notes.


- 6 -
Table of Contentsril 19,


HOLLY ENERGY PARTNERS, L.P.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
 
 
Nine Months Ended September 30,
 
 
2012
 
2011 (1)
 
 
(In thousands)
Cash flows from operating activities
 
 
 
 
Net income
 
$
64,777

 
$
47,116

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Depreciation and amortization
 
39,899

 
24,627

Equity in earnings of SLC Pipeline, net of distributions
 
123

 
89

Amortization of restricted and performance units
 
2,233

 
1,634

(Increase) decrease in current assets:
 
 
 
 
Accounts receivable—trade
 
(3,397
)
 
(561
)
Accounts receivable—affiliates
 
(1,240
)
 
(750
)
Prepaid and other current assets
 
(584
)
 
(870
)
Increase (decrease) in current liabilities:
 
 
 
 
Accounts payable—trade
 
(7,097
)
 
3,326

Accounts payable—affiliates
 
(833
)
 
(496
)
Accrued interest
 
(5,774
)
 
(5,977
)
Deferred revenue
 
5,248

 
(3,917
)
Accrued property taxes
 
2,845

 
810

Other current liabilities
 
711

 
(124
)
Other, net
 
6,416

 
2,482

Net cash provided by operating activities
 
103,327

 
67,389

 
 
 
 
 
Cash flows from investing activities
 
 
 
 
Additions to properties and equipment
 
(32,087
)
 
(149,885
)
Net cash used for investing activities
 
(32,087
)
 
(149,885
)
 
 
 
 
 
Cash flows from financing activities
 
 
 
 
Borrowings under credit agreement
 
523,000

 
93,000

Repayments of credit agreement borrowings
 
(292,000
)
 
(50,000
)
Proceeds from issuance of senior notes
 
294,750

 
—

Cash distribution to HFC for UNEV Acquisition
 
(260,922
)
 
—

Repayment of promissory notes
 
(257,900
)
 
—

Contributions from UNEV joint venture partners
 
16,748

 
123,500

Distributions to HEP unitholders
 
(91,063
)
 
(67,963
)
Purchase of units for incentive grants
 
(4,919
)
 
(1,641
)
Deferred financing costs
 
(3,222
)
 
(3,150
)
Other
 
(88
)
 
—

Net cash provided (used) by financing activities
 
(75,616
)
 
93,746

 
 
 
 
 
Cash and cash equivalents
 
 
 
 
Increase (decrease) for the period
 
(4,376
)
 
11,250

Beginning of period
 
6,369

 
8,052

End of period
 
$
1,993

 
$
19,302

(1) Recast as described in Note 2.

See accompanying notes.

- 7 -
Table of Contentsril 19,

HOLLY ENERGY PARTNERS, L.P.
CONSOLIDATED STATEMENTS OF PARTNERS' EQUITY
(Unaudited)
 
 
 
Common
Units
 
General
Partner
Interest
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Noncontrolling Interest
 
Total Equity
 
 
(In thousands)
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2011 (1)
 
$
482,509

 
$
167,492

 
$
(6,464
)
 
$
99,002

 
$
742,539

Net income
 
52,909

 
18,188

 
—

 
(2,121
)
 
68,976

Net loss - Predecessor
 
—

 
(4,199
)
 
—

 
—

 
(4,199
)
Other comprehensive income
 
—

 
—

 
578

 
—

 
578

Capital contribution
 
—

 
10,286

 
—

 
3,000

 
13,286

Distributions to HEP unitholders
 
(73,596
)
 
(17,467
)
 
—

 
—

 
(91,063
)
Purchase of 75% interest in UNEV Pipeline from HollyFrontier:
 
 
 
 
 
 
 
 
 
 
Cash distributions
 
—

 
(260,922
)
 
—

 
—

 
(260,922
)
Issuance of common units
 
45,839

 
(45,839
)
 
—

 
—

 
—

Issuance of Class B unit
 
—

 
(12,200
)
 
—

 
—

 
(12,200
)
Purchase of units for restricted grants
 
(4,392
)
 
—

 
—

 
—

 
(4,392
)
Amortization of restricted and performance units
 
2,233

 
—

 
—

 
—

 
2,233

   Class B unit accretion
 
(209
)
 
(4
)
 
—

 
—

 
(213
)
   Other
 
—

 
110

 
—

 
—

 
110

Balance September 30, 2012
 
$
505,293

 
$
(144,555
)
 
$
(5,886
)
 
$
99,881

 
$
454,733


(1) Recast as described in Note 2.

See accompanying notes.


- 8 -
Table of Contentsril 19,

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
UNEV Pipeline percentage acquired
75
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


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 44% owned (including the 2% general partner interest) by HollyFrontier Corporation (“HFC”) and its subsidiaries. In these consolidated financial statements, the words “we,” “our,” “ours” and “us” refer to HEP unless the context otherwise indicates.

We own and operate petroleum product and crude oil pipelines and terminal, tankage and loading rack facilities 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 25% joint venture interest in a 95-mile intrastate crude oil pipeline system (the “SLC Pipeline”) that serves refineries in the Salt Lake City area.

On July 12, 2012, we acquired a 75% interest in UNEV Pipeline, LLC (“UNEV”), which owns a recently constructed 400-mile, 12-inch refined products pipeline running from Woods Cross, Utah to Las Vegas, Nevada (the “UNEV Pipeline”), product terminals near Cedar City, Utah and Las Vegas, Nevada and related assets. We have retrospectively adjusted our historical financial position, results of operations, cash flows and statements of partners' equity for all periods to include UNEV for the periods we were under common control of HFC. Results of operations of UNEV prior to the acquisition on July 12, 2012 are herein referred to as the results of operations attributable to the previous owner ("Predecessor"). Additionally, Predecessor equity prior to the acquisition is included in general partner equity on the balance sheet due to the common control ownership. See Note 2 below for additional information on this acquisition.

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 and providing other services at our storage tanks and terminals. 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.

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 Form 10-K for the year ended December 31, 2011. 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, 2012.

On November 9, 2011, we acquired from HFC certain tankage, loading rack and crude oil receiving assets located at HFC’s El Dorado and Cheyenne refineries. See Note 2 below for additional information on this acquisition. We accounted for this transaction as a business combination between entities under common control and were required to retrospectively adjust the operating results as if we had acquired such assets on July 1, 2011 (the date HFC acquired the assets). Although these assets did not generate revenues prior to November 9, 2011, our operating results included $3.8 million of operating costs and depreciation incurred by HFC prior to the acquisition date. We have revised limited partners' interest in net income and limited partners' per unit interest in earnings - basic and diluted from continuing operations from amounts originally reported in our historical financial statements

- 9 -

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


included in the Form 10-K for the year ended December 31, 2011. This loss was allocated in the originally reported amounts principally to the limited partners. As the pre-acquisition loss was not attributable to HEP, but rather to the Predecessor, the pre-acquisition loss should have been reported as a loss attributable to the Predecessor. Limited partners' interest in net income was originally reported at $61.2 million or $2.68 per basic and diluted unit. This revision in the classification of the Predecessor's loss increased limited partners' interest in net income to $64.9 million or $2.84 per basic and diluted unit from continuing operations. This change had no impact on the reported net income or distributable cash flow.

Additionally, originally reported limited partners' interest in net income and per unit interest in net income for the third and fourth quarters of 2011 of $10.2 million and $0.46 and $24.3 million and $0.97, respectively, as reported in Note 14 of the 2011 consolidated financial statements have been adjusted to $12.7 million and $0.58 and $25.4 million and $1.01, respectively. This change had no impact on the reported net income or distributable cash flow.


Note 2:
Acquisitions

UNEV Pipeline Interest Acquisition
On July 12, 2012, we acquired HFC's 75% interest in UNEV. We paid consideration consisting of $260.0 million in cash and 1,029,900 of our common units. We paid an additional $0.9 million to HFC for a post-closing working capital adjustment as provided for by the acquisition agreement. As a result of the common units issued to HFC, HFC's ownership interest in us increased from 42% to 44% (including the 2% general partner interest). Also under the terms of the transaction, 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 an interest in our share of annual UNEV earnings before interest, income taxes, depreciation, and amortization above $30 million beginning July 1, 2016 and ending in June 2032, subject to certain limitations. Such contingent redemption payments are limited to a maximum payment amount calculated as described below. However, to the extent earnings thresholds are not achieved, no redemption payments are required. Contemporaneously with this transaction, HFC (our general partner) agreed to forego its right to incentive distributions of up to $1.25 million per quarter over the next twelve consecutive quarterly periods and up to an additional four quarters in certain circumstances. The Class B unit has an initial value of $12.2 million which will increase with each foregone incentive distribution as described above and by a 7% factor compounded annually on the outstanding unredeemed balance through its expiration date. At our option, we may redeem, in whole or in part, the Class B unit at the current unredeemed value based on the calculation described.

We are a consolidated variable interest entity of HFC. Therefore, this transaction was recorded as a transfer between entities under common control and reflects HFC's carrying basis in UNEV's assets and liabilities. We have retrospectively adjusted our financial position and operating results as if UNEV were a consolidated subsidiary for all periods while we were under common control of HFC. For the three and the nine months ended September 30, 2012, our consolidated statement of income includes revenues from UNEV of $3.0 million and $10.8 million, respectively, and net losses of $3.5 million and $8.5 million, respectively. Predecessor revenues are $0.3 million and $8.1 million, respectively, and Predecessor net losses are $0.1 million and $4.2 million, respectively. For the three and the nine months ended September 30, 2011, there were no Predecessor revenues as UNEV was not yet operational. Predecessor net losses were $0.4 million and $0.9 million, respectively, for the three and the nine months ended September 30, 2011. At September 30, 2012, UNEV had transportation agreements with shippers that provide minimum annualized revenues of $25.0 million, of which $16.9 million relates to a transportation agreement with HFC.
The following table provides HFC's carrying basis related to UNEV on July 12, 2012, immediately prior to the acquisition, and at December 31, 2011.

- 10 -

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


 
 
July 12, 2012
 
December 31, 2011 (1)
 
 
(In thousands)
Current assets
 
$
7,083

 
$
8,265

Properties and equipment, net
 
418,764

 
418,439

Total assets
 
$
425,847

 
$
426,704

 
 
 
 
 
Current liabilities
 
$
7,040

 
$
13,542

General partner interest related to Predecessor
 
318,310

 
314,160

Noncontrolling interest
 
100,497

 
99,002

Total liabilities and equity
 
$
425,847

 
$
426,704

(1) Our previously reported balance sheet as of December 31, 2011 has been recast to include such balances.

Legacy Frontier Pipeline and Tankage Asset Transaction
On November 9, 2011, we acquired from HFC certain tankage, loading rack and crude receiving assets located at HFC’s El Dorado and Cheyenne refineries. We paid non-cash consideration consisting of promissory notes with an aggregate principal amount of $150.0 million and 3,807,615 of our common units. In 2011, we retrospectively adjusted our historical financial position, results of operations, cash flows and statements of partners' equity to include these assets as we were under common control of HFC from July 1, 2011, the date these assets were acquired by HFC as part of the merger with Frontier Oil Corporation. Results of operations of these assets prior to the acquisition date of November 9, 2011 are also included in the results attributable to the Predecessor.
  
As an entity under common control with HFC, we recorded this transfer at HFC's carrying basis. We recorded properties and equipment of $88.1 million, goodwill of $207.4 million and a non-cash capital contribution of $295.5 million, representing HFC's cost basis in the acquired assets. On November 9, 2011, we recorded a $150.0 million liability representing the promissory notes issued to HFC at the time of the closing of this transaction.

Assuming both acquisitions had occurred on January 1, 2011 and our throughput agreements with HFC were in effect at that time, pro forma revenues, net income and earnings per unit for the three and the nine months ended September 30, 2011 and 2012 are presented below:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
 
 
 
(In thousands, except per share amounts)
Revenues
$
72,496

 
$
60,858

 
$
206,989

 
$
156,731

Net income
22,369

 
23,384

 
59,124

 
52,761

Earnings per unit
$
0.60

 
$
0.87

 
$
1.51

 
$
1.87



Note 3:
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.

- 11 -

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


•
(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 at September 30, 2012 and December 31, 2011 were as follows:
 
 
 
 
September 30, 2012
 
December 31, 2011
Financial Instrument
 
Fair Value Input Level
 
Carrying
Value
 
Fair Value
 
Carrying
Value
 
Fair Value
 
 
 
 
(In thousands)
Liabilities:
 
 
 
 
 
 
 
 
 
 
Senior notes:
 
 
 
 
 
 
 
 
 
 
6.25% senior notes
 
Level 2
 
$
—

 
$
—

 
$
184,895

 
$
186,850

6.5% senior notes
 
Level 2
 
295,112

 
311,250

 
—

 
—

8.25% senior notes
 
Level 2
 
148,322

 
162,375

 
148,093

 
157,500

 
 
 
 
443,434

 
473,625

 
332,988

 
344,350

 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
 
Level 2
 
3,764

 
3,764

 
520

 
520

 
 
 
 
$
447,198

 
$
477,389

 
$
333,508

 
$
344,870


Level 2 Financial Instruments
Our senior notes and interest rate swaps are measured and recorded 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. With respect to our interest rate swaps, the fair value 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 7 for additional information on these instruments.


Note 4:
Properties and Equipment 

The carrying amounts of our properties and equipment are as follows:
 
 
September 30,
2012
 
December 31,
2011
 
 
(In thousands)
Pipelines and terminals
 
$
1,023,811

 
$
879,670

Land and right of way
 
62,627

 
43,904

Construction in progress
 
28,399

 
172,072

Other
 
18,815

 
17,554

 
 
1,133,652

 
1,113,200

Less accumulated depreciation
 
190,048

 
158,336

 
 
$
943,604

 
$
954,864


We capitalized $0.2 million and $0.8 million in interest related to construction projects during the nine months ended September 30, 2012 and 2011, respectively.



- 12 -

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


Note 5:
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:
 
 
September 30,
2012
 
December 31,
2011
 
 
(In thousands)
Alon transportation agreement
 
$
59,933

 
$
59,933

HFC transportation agreement
 
74,231

 
74,231

 
 
134,164

 
134,164

Less accumulated amortization
 
37,831

 
32,621

 
 
$
96,333

 
$
101,543


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


Note 6:
Employees, Retirement and Incentive Plans

Employees who provide direct services to us are employed by Holly Logistic Services, L.L.C., an HFC subsidiary. 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 $1.6 million and $0.8 million for the three months ended September 30, 2012 and 2011, respectively, and $4.7 million and $2.2 million for the nine months ended September 30, 2012 and 2011, respectively.

We have an incentive plan (“Long-Term Incentive Plan”) for employees, consultants and non-employee directors who perform services for us. The Long-Term Incentive Plan consists of four components: restricted units, performance units, unit options and unit appreciation rights.

As of September 30, 2012, we have two types of incentive-based awards which are described below. The compensation cost charged against income was $0.5 million and $0.6 million, respectively, for the three months ended September 30, 2012 and 2011, respectively, and $2.1 million and $1.6 million for the nine months ended September 30, 2012 and 2011, 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. Effective February 2012, the units authorized to be granted under our Long-Term Incentive Plan were increased from 350,000 to 1,250,000 units, of which 916,512 have not yet been granted, assuming no forfeitures of the unvested units and full achievement of goals for the performance units already granted.

Restricted Units
Under our Long-Term Incentive Plan, we grant restricted units to selected employees and non-employee directors who perform services for us, with most awards vesting over a period of one to three years. Although full ownership of the units does not transfer to the recipients until the units vest, the recipients have distribution and voting rights on these units from the date of grant. The fair value of each restricted unit award is measured at the market price as of the date of grant and is amortized over the vesting period.


- 13 -

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


A summary of restricted unit activity and changes during the nine months ended September 30, 2012 is presented below: 

Restricted Units
 
Units
 
Weighted-
Average
Grant-Date
Fair Value
 
Weighted-
Average
Remaining
Contractual
Term
 
Aggregate
Intrinsic
Value
($000)
Outstanding at January 1, 2012 (nonvested)
 
29,536

 
$
50.45

 
 
 
 
Granted
 
45,264

 
62.02

 
 
 
 
Vesting and transfer of full ownership to recipients
 
(28,110
)
 
52.54

 
 
 
 
Forfeited
 
(1,047
)
 
57.32

 
 
 
 
Outstanding at September 30, 2012 (nonvested)
 
45,643

 
$
60.48

 
1.1 years
 
$
2,584


The fair value of restricted units that were vested and transferred to recipients during the nine months ended September 30, 2012 and 2011 were $1.5 million and $1.7 million, respectively. As of September 30, 2012, there was $1.5 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.

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 based upon the growth in our distributable cash flow per common unit over the performance period, and vest over a period of three years. As of September 30, 2012, estimated unit payouts for outstanding nonvested performance unit awards were 110%.

We granted 5,718 performance units to certain officers in March 2012. These units will vest over a three-year performance period ending December 31, 2014 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 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. The fair value of these performance units is based on the grant date closing unit price of $61.21 and will apply to the number of units ultimately awarded.

A summary of performance unit activity and changes during the nine months ended September 30, 2012 is presented below:
Performance Units
 
Units
Outstanding at January 1, 2012 (nonvested)
 
42,991

Granted
 
5,718

Vesting and transfer of common units to recipients
 
(21,460
)
Outstanding at September 30, 2012 (nonvested)
 
27,249


For the nine months ended September 30, 2012, we issued 23,391 of our common units having a grant-date fair value of $0.5 million related to vested performance units having a 109% payout. Based on the weighted average fair value at September 30, 2012 of $52.11, 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 1.0 years.

During the nine months ended September 30, 2012, we paid $4.9 million for the purchase of our common units in the open market for the issuance and settlement of all unit awards under our Long-Term Incentive Plan.


Note 7:
Debt

Credit Agreement
In June 2012, we amended our credit agreement increasing the size of the credit facility from $375 million to $550 million. Our $550 million senior secured revolving credit facility expires in June 2017 (the “Credit Agreement”) and is available to fund capital expenditures, investments, acquisitions, distribution payments and working capital and for general partnership purposes. It is

- 14 -

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


available also to fund letters of credit up to a $50 million sub-limit and to fund distributions to unitholders up to a $60 million sub-limit.

During the nine months ended September 30, 2012, we received advances totaling $523.0 million and repaid $292.0 million, resulting in net borrowings of $231.0 million under the Credit Agreement and an outstanding balance of $431.0 million at September 30, 2012.

Our obligations under the Credit Agreement are collateralized by substantially all of our assets. Indebtedness under the Credit Agreement is recourse to HEP Logistics Holdings, L.P. (“HEP Logistics”), our general partner, and 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 which we are currently in compliance with, 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 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
In March 2012, we issued $300 million in aggregate principal amount outstanding of 6.5% senior notes maturing March 1, 2020 (the “6.5% Senior Notes”). Net proceeds of $294.8 million were used to redeem $157.8 million aggregate principal amount of our 6.25% senior notes maturing March 1, 2015 (the “6.25% Senior Notes”) tendered pursuant to a cash tender offer and consent solicitation, to repay $72.9 million in promissory notes due to HFC as discussed below, to pay related fees, expenses and accrued interest in connection with these transactions and to repay borrowings under the Credit Agreement.

In April 2012, we redeemed $27.2 million aggregate principal amount of 6.25% Senior Notes that remained outstanding following the cash tender offer and consent solicitation.

Also, we have $150 million in aggregate principal amount outstanding of 8.25% senior notes (the “8.25% Senior Notes”) maturing March 15, 2018.

The 6.5% and 8.25% Senior Notes (collectively, the “Senior Notes”) are unsecured and impose certain restrictive covenants, which we are currently in compliance with, 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. 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 under the Senior Notes.

Indebtedness under the Senior Notes is recourse to HEP Logistics, our general partner, and guaranteed by our wholly-owned subsidiaries. However, any recourse to HEP Logistics would be limited to the extent of its assets, which other than its investment in us, are not significant.

Promissory Notes
In November 2011, we issued senior unsecured promissory notes to HFC (the “Promissory Notes”) having an aggregate principal amount of $150 million to finance a portion of our November 9, 2011 acquisition of assets located at HFC's El Dorado and Cheyenne refineries (see Note 2). In December 2011, we repaid $77.1 million of outstanding principal using proceeds received in our December 2011 common unit offering and existing cash. We repaid the remaining $72.9 million balance in March 2012.


- 15 -

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


Long-term Debt
The carrying amounts of our long-term debt are as follows:
 
 
September 30,
2012
 
December 31,
2011
 
 
(In thousands)
Credit Agreement
 
$
431,000

 
$
200,000

6.5% Senior Notes
 
 
 
 
Principal
 
300,000

 
—

Unamortized discount
 
(4,888
)
 
—

 
 
295,112

 
—

6.25% Senior Notes
 
 
 
 
Principal
 
—

 
185,000

Unamortized net discount
 
—

 
(105
)
 
 
—

 
184,895

8.25% Senior Notes
 
 
 
 
Principal
 
150,000

 
150,000

Unamortized discount
 
(1,678
)
 
(1,907
)
 
 
148,322

 
148,093

 
 
 
 
 
Promissory Notes
 
—

 
72,900

 
 
 
 
 
Total long-term debt
 
$
874,434

 
$
605,888


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

As of September 30, 2012, we have three interest rate swaps that hedge our exposure to the cash flow risk caused by the effects of LIBOR changes on $305.0 million of Credit Agreement advances. Our first interest rate swap effectively converts $155.0 million of our LIBOR based debt to fixed rate debt having an interest rate of 0.99% plus an applicable margin of 2.50% as of September 30, 2012, which equaled an effective interest rate of 3.49%. This swap contract matures in February 2016. In August 2012, we entered into two similar interest rate swaps with identical terms which 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 2.50% as of September 30, 2012, which equaled an effective interest rate of 3.24%. 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 that these interest rate swaps are effective in offsetting the variability in interest payments on $305.0 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 its fair value with the offsetting fair value adjustment to accumulated other comprehensive 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 swap against the expected future interest payments on $305.0 million of our variable rate debt. Any ineffectiveness is recorded directly to interest expense. As of September 30, 2012, we had no ineffectiveness on our cash flow hedges.

At September 30, 2012, we have an accumulated other comprehensive loss of $5.9 million that relates to our current and previous cash flow hedging instruments. Of this amount, $2.1 million represents an unrecognized loss attributable to a cash flow hedge terminated in December 2011 and relates to the application of hedge accounting prior to termination. This amount is being amortized as a charge to interest expense through February 2013, the remaining term of the terminated swap contract. Of the remaining $3.8 million, approximately $1.0 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.


- 16 -

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)
September 30, 2012
 
 
 
 
 
 
 
 
Interest rate swap designated as cash flow hedging instrument:
 
 
 
 
 
 
Variable-to-fixed interest rate swap contract ($305.0 million of LIBOR based debt interest)
 
Other long-term
    liabilities
 
$
3,764

 
Accumulated other
    comprehensive loss
 
$
3,764

 
 
 
 
 
 
 
 
 
December 31, 2011
 
 
 
 
 
 
 
 
Interest rate swap designated as cash flow hedging instrument:
 
 
 
 
 
 
Variable-to-fixed interest rate swap contract ($155.0 million of LIBOR based debt interest)
 
Other long-term
    liabilities
 
$
520

 
Accumulated other
    comprehensive loss
 
$
520



Interest Expense and Other Debt Information
Interest expense consists of the following components:
 
 
Nine Months Ended September 30,
 
 
2012
 
2011
 
 
(In thousands)
Interest on outstanding debt:
 
 
 
 
Credit Agreement, net of interest on interest rate swaps
 
$
5,667

 
$
7,744

6.5% Senior Notes
 
10,842

 
—

6.25% Senior Notes
 
2,422

 
8,675

8.25% Senior Notes
 
9,286

 
9,286

Promissory Notes
 
543

 
—

Amortization of discount and deferred debt issuance costs
 
5,224

 
903

Commitment fees
 
507

 
332

Total interest incurred
 
34,491

 
26,940

Less capitalized interest
 
222

 
839

Net interest expense
 
$
34,269

 
$
26,101

Cash paid for interest
 
$
35,007

 
$
32,006


We recognized a charge of $3.0 million upon the early extinguishment of debt for the nine months ended September 30, 2012. This charge represents the premium paid to our 6.25% Senior Note holders upon their tender of an aggregate principal amount of $185.0 million and related net discount.


Note 8:
Significant Customers

All revenues are domestic revenues, of which 96% are currently generated from our two largest customers: HFC and Alon. The vast majority of our revenues are derived from activities conducted in the southwest United States.

The following table presents the percentage of total revenues generated by each of these customers:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2012
 
2011
 
2012
 
2011
HFC
 
84
%
 
83
%
 
83
%
 
77
%
Alon
 
12
%
 
13
%
 
12
%
 
14
%


- 17 -

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



Note 9:
Related Party Transactions

We serve HFC's refineries under long-term pipeline and terminal, tankage and throughput agreements expiring from 2019 to 2026. Under these agreements, HFC agreed to transport, store and throughput volumes of refined product and crude oil on our pipelines and terminal, tankage and loading rack facilities that result in minimum annual payments to us. These minimum annual payments or revenues are subject to annual tariff rate adjustments on July 1, based on the Producer Price Index (“PPI”) or Federal Energy Regulatory Commission (“FERC”) index. As of September 30, 2012, these agreements with HFC will result in minimum annualized payments to us of $217.2 million.

If HFC fails to meet its minimum volume commitments under the agreements in any quarter, it will be required to pay us in cash the amount of any shortfall 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 for the provision by HFC or its affiliates of various general and administrative services to us, currently $2.3 million. This fee does not include the salaries of pipeline and terminal personnel 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 $60.6 million and $40.7 million for the three months ended September 30, 2012 and 2011, respectively, and $172.3 million and $111.9 million for the nine months ended September 30, 2012 and 2011, respectively.
•
HFC charged us general and administrative services under the Omnibus Agreement of $0.5 million and $0.6 million, respectively, for the three months ended September 30, 2012 and 2011, and $1.7 million for the nine months ended September 30, 2012 and 2011.
•
We reimbursed HFC for costs of employees supporting our operations of $7.8 million and $5.0 million for the three months ended September 30, 2012 and 2011, respectively, and $22.6 million and $14.7 million for the nine months ended September 30, 2012 and 2011, respectively.
•
HFC reimbursed us $2.9 million and $1.0 million for the three months ended September 30, 2012 and 2011, respectively, and $7.5 million and $9.7 million for the nine months ended September 30, 2012 and 2011, respectively for certain costs paid on their behalf.
•
We distributed $16.3 million and $10.3 million for the three months ended September 30, 2012 and 2011, respectively, to HFC as regular distributions on its common units and general partner interest, including general partner incentive distributions. For the nine months ended September 30, 2012 and 2011, we distributed $47.3 million and $30.0 million, respectively.
•
Accounts receivable from HFC were $36.3 million and $31.9 million at September 30, 2012 and December 31, 2011, respectively.
•
Accounts payable to HFC were $5.6 million and $6.5 million at September 30, 2012 and December 31, 2011, respectively.
•
Revenues for the three and nine months ended September 30, 2012 include $0.7 million and $3.2 million of shortfall payments billed in 2011, as HFC did not exceed its minimum volume commitment in any of the subsequent four quarters. Deferred revenue in the consolidated balance sheets at September 30, 2012 and December 31, 2011, includes $7.5 million and $4.0 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 $7.5 million deferred at September 30, 2012.
•
We acquired from HFC 75% interest in the UNEV Pipeline in July 2012 and certain tankage and terminal assets in November 2011. See Note 2 for a description of these transactions.


Note 10:
Partners’ Equity

As of September 30, 2012, HFC held 12,127,515 of our common units and the 2% general partner interest, which together constituted a 44% ownership interest in us. On July 12, 2012, we issued HFC 1,029,900 of our common units as partial consideration for our

- 18 -

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


acquisition of its 75% interest in UNEV, which increased HFC's ownership interest in us from 42% to 44%, inclusive of the general partner interest.

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 September 30,
 
Nine Months Ended September 30,
 
 
2012
 
2011
 
2012
 
2011
 
 
(In thousands)
General partner interest in net income
 
$
392

 
$
260

 
$
1,080

 
$
807

General partner incentive distribution
 
4,907

 
3,749

 
15,644

 
10,611

Total general partner interest in net income
 
$
5,299

 
$
4,009

 
$
16,724

 
$
11,418


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 October 26, 2012 we announced our cash distribution for the third quarter of 2012 of $0.925 per unit. The distribution is payable on all common and general partner units and will be paid November 14, 2012 to all unitholders of record on November 5, 2012.

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 September 30,
 
Nine Months Ended September 30,
 
 
2012
 
2011
 
2012
 
2011
 
 
(In thousands, except per unit data)
General partner interest
 
$
659

 
$
471

 
$
1,886

 
$
1,386

General partner incentive distribution
 
4,907

 
3,749

 
15,644

 
10,611

Total general partner distribution
 
5,566

 
4,220

 
17,530

 
11,997

Limited partner distribution
 
26,148

 
19,318

 
75,534

 
57,294

Total regular quarterly cash distribution
 
$
31,714

 
$
23,538

 
$
93,064

 
$
69,291

Cash distribution per unit applicable to limited partners
 
$
0.925

 
$
0.875

 
$
2.730

 
$
2.475


As a master limited partnership, we distribute our available cash, which historically has exceeded our net income attributable to Holly Energy Partners 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 Holly Energy Partners. Additionally, if the assets contributed and acquired 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 of $312.8 million, exclusive of depreciation and amortization would have been recorded in our financial statements, as increases to our properties and equipment and intangible assets instead of decreases to our partners’ equity.



- 19 -

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


Note 11:
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 wholly-owned subsidiaries (“Guarantor Subsidiaries”). These guarantees are full and unconditional.

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

Prior period amounts have been recast to include UNEV operations acquired July 12, 2012, as if it had been acquired January 1, 2011 and certain tankage, loading rack and crude receiving assets located at HFC’s El Dorado and Cheyenne refineries acquired on November 9, 2011 as if they had been acquired on July 1, 2011, the date upon which HFC obtained control of such assets. This treatment is required as the transactions were between entities under common control.

Condensed Consolidating Balance Sheet
September 30, 2012
 
Parent
 
Guarantor
Subsidiaries
 
Non-Guarantor Subsidiaries
 
Eliminations
 
Consolidated
 
 
(In thousands)
ASSETS
 
 
 
 
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
2

 
$
1,991

 
$
—

 
$
—

 
$
1,993

Accounts receivable
 
—

 
34,094

 
8,738

 
—

 
42,832

Intercompany accounts receivable (payable)
 
63,900

 
(63,900
)
 
—

 
—

 
—

Prepaid and other current assets
 
344

 
2,948

 
1,021

 
—

 
4,313

Total current assets
 
64,246

 
(24,867
)
 
9,759

 
—

 
49,138

Properties and equipment, net
 
—

 
543,832

 
399,772

 
—

 
943,604

Investment in subsidiaries
 
735,086

 
299,644

 
—

 
(1,034,730
)
 
—

Transportation agreements, net
 
—

 
96,333

 
—

 
—

 
96,333

Goodwill
 
—

 
256,498

 
—

 
—

 
256,498

Investment in SLC Pipeline
 
—

 
25,179

 
—

 
—

 
25,179

Other assets
 
1,738

 
7,283

 
—

 
—

 
9,021

Total assets
 
$
801,070

 
$
1,203,902

 
$
409,531

 
$
(1,034,730
)
 
$
1,379,773

 
 
 
 
 
 
 
 
 
 
 
LIABILITIES AND PARTNERS’ EQUITY
 
 
 
 
 
 
 
 
 
 
Current liabilities:
 
 
 
 
 
 
 
 
 
 
Accounts payable
 
$
—

 
$
9,847

 
$
1,456

 
$
—

 
$
11,303

Accrued interest
 
2,229

 
277

 
—

 
—

 
2,506

Deferred revenue
 
—

 
2,820

 
6,460

 
—

 
9,280

Accrued property taxes
 
—

 
3,017

 
2,023

 
—

 
5,040

Other current liabilities
 
555

 
1,867

 
67

 
—

 
2,489

Total current liabilities
 
2,784

 
17,828

 
10,006

 
—

 
30,618


 
 
 
 
 
 
 
 
 
 
Long-term debt
 
443,434

 
431,000

 
—

 
—

 
874,434

Other long-term liabilities
 
—

 
7,574

 
—

 
—

 
7,574

Class B unit
 
—

 
12,414

 
—

 
—

 
12,414

Equity - partners
 
354,852

 
735,086

 
399,525

 
(1,134,611
)
 
354,852

Equity - noncontrolling interest
 
—

 
—

 
—

 
99,881

 
99,881

Total liabilities and partners’ equity
 
$
801,070

 
$
1,203,902

 
$
409,531

 
$
(1,034,730
)
 
$
1,379,773




- 20 -

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




Condensed Consolidating Balance Sheet
December 31, 2011
 
Parent
 
Guarantor
Subsidiaries
 
Non-Guarantor Subsidiaries
 
Eliminations
 
Consolidated
 
 
(In thousands)
ASSETS
 
 
 
 
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
2

 
$
3,267

 
$
3,100

 
$
—

 
$
6,369

Accounts receivable
 
—

 
33,972

 
4,080

 
—

 
38,052

Intercompany accounts receivable (payable)
 
17,745

 
(17,745
)
 
—

 
—

 
—

Prepaid and other current assets
 
266

 
2,378

 
1,085

 
—

 
3,729

Total current assets
 
18,013

 
21,872

 
8,265

 
—

 
48,150

Properties and equipment, net
 
—

 
553,577

 
401,287

 
—

 
954,864

Investment in subsidiaries
 
965,377

 
297,008

 
—

 
(1,262,385
)
 
—

Transportation agreements, net
 
—

 
101,543

 
—

 
—

 
101,543

Goodwill
 
—

 
256,498

 
—

 
—

 
256,498

Investment in SLC Pipeline
 
—

 
25,302

 
—

 
—

 
25,302

Other assets
 
1,322

 
5,882

 
—

 
—

 
7,204

Total assets
 
$
984,712

 
$
1,261,682

 
$
409,552

 
$
(1,262,385
)
 
$
1,393,561

 
 
 
 
 
 
 
 
 
 
 
LIABILITIES AND PARTNERS’ EQUITY
 
 
 
 
 
 
 
 
 
 
Current liabilities:
 
 
 
 
 
 
 
 
 
 
Accounts payable
 
$
—

 
$
11,307

 
$
13,542

 
$
—

 
$
24,849

Accrued interest
 
7,498

 
782

 
—

 
—

 
8,280

Deferred revenue
 
—

 
4,032

 
—

 
—

 
4,032

Accrued property taxes
 
—

 
2,196

 
—

 
—

 
2,196

Other current liabilities
 
689

 
1,088

 
—

 
—

 
1,777

Total current liabilities
 
8,187

 
19,405

 
13,542

 
—

 
41,134

Long-term debt
 
332,988

 
272,900

 
—

 
—

 
605,888

Other long-term liabilities
 
—

 
4,000

 
—

 
—

 
4,000

Equity - partners
 
643,537

 
965,377

 
396,010

 
(1,361,387
)
 
643,537

Equity - noncontrolling interest
 
$
—

 
$
—

 
$
—

 
$
99,002

 
$
99,002

Total liabilities and partners’ equity
 
$
984,712

 
$
1,261,682

 
$
409,552

 
$
(1,262,385
)
 
$
1,393,561



- 21 -

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




Condensed Consolidating Statement of Comprehensive Income
Three Months Ended September 30, 2012
 
Parent
 
Guarantor
Subsidiaries
 
Non-Guarantor Subsidiaries
 
Eliminations
 
Consolidated
 
 
(In thousands)
Revenues:
 
 
 
 
 
 
 
 
 
 
Affiliates
 
$
—

 
$
59,025

 
$
1,826

 
$
(275
)
 
$
60,576

Third parties
 
—

 
10,794

 
1,126

 
—

 
11,920

 
 
—

 
69,819

 
2,952

 
(275
)
 
72,496

Operating costs and expenses:
 
 
 
 
 
 
 
 
 
 
Operations
 
—

 
18,697

 
2,902

 
(275
)
 
21,324

Depreciation and amortization
 
—

 
9,464

 
3,580

 
—

 
13,044

General and administrative
 
743

 
656

 
—

 
—

 
1,399

 
 
743

 
28,817

 
6,482

 
(275
)
 
35,767

Operating income (loss)
 
(743
)
 
41,002

 
(3,530
)
 
—

 
36,729

Equity in earnings (loss) of subsidiaries
 
34,805

 
(2,645
)
 
—

 
(32,160
)
 
—

Equity in earnings of SLC Pipeline
 
—

 
877

 
—

 
—

 
877

Interest (expense) income
 
(8,252
)
 
(4,292