UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES ACT OF 1934

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		(I.R.S. Employer
incorporation or organization)		Identification No.)

100 Crescent Court, Suite 1600
Dallas, Texas 75201-6915

(214) 871-3555

None

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 þ No o

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 o No o

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 o		Accelerated filer þ		Non-accelerated filer o		Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act).
Yes o No þ

The number of the registrant’s outstanding common units at April 22, 2011 was 22,078,509.

 

 

HOLLY ENERGY PARTNERS, L.P.
INDEX

PART I. FINANCIAL INFORMATION			3
FORWARD-LOOKING STATEMENTS			3
Item 1. Financial Statements (Unaudited, except December 31, 2010 Balance Sheet)			4
Consolidated Balance Sheets			4
Consolidated Statements of Income			5
Consolidated Statements of Cash Flows			6
Consolidated Statement of Partners’ Equity			7
Notes to Consolidated Financial Statements			8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			21
Item 3. Quantitative and Qualitative Disclosures About Market Risks			34
Item 4. Controls and Procedures			34
PART II. OTHER INFORMATION			35
Item 1. Legal Proceedings			35
Item 6. Exhibits			35
SIGNATURES			36
Index to Exhibits			37
Exhibit 12.1
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2

PART I. FINANCIAL INFORMATION

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 in our terminals;

•

the economic viability of Holly 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 risk factors and other cautionary statements set forth in our Annual Report on Form 10-K for the year ended December 31, 2010 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.

Item 1.		Financial Statements

Holly Energy Partners, L.P.

		March 31, 2011				December 31,
		(Unaudited)				2010
		(In thousands, except unit data)
ASSETS
Current assets:
Cash and cash equivalents		$	1,502			$	403
Accounts receivable:
Trade			3,102				3,544
Affiliates			20,373				18,964
			23,475				22,508
Prepaid and other current assets			546				775
Total current assets			25,523				23,686
Properties and equipment, net			440,523				434,950
Transportation agreements, net			106,753				108,489
Goodwill			49,109				49,109
Investment in SLC Pipeline			25,802				25,437
Other assets			4,440				1,602
Total assets		$	652,150			$	643,273
LIABILITIES AND PARTNERS’ EQUITY
Current liabilities:
Accounts payable:
Trade		$	5,991			$	6,347
Affiliates			4,334				3,891
			10,325				10,238
Accrued interest			1,541				7,517
Deferred revenue			9,333				10,437
Accrued property taxes			1,738				1,990
Other current liabilities			1,079				1,262
Total current liabilities			24,016				31,444
Long-term debt			514,733				491,648
Other long-term liabilities			9,511				10,809
Partners’ equity:
Common unitholders (22,078,509 units issued and outstanding at March 31, 2011 and December 31, 2010)			265,087				271,649
General partner interest (2% interest)			(152,454	)			(152,251	)
Accumulated other comprehensive loss			(8,743	)			(10,026	)
Total partners’ equity			103,890				109,372
Total liabilities and partners’ equity		$	652,150			$	643,273

See accompanying notes.

Holly Energy Partners, L.P.

		Three Months Ended
		March 31,
		2011				2010
		(In thousands, except per unit data)
Revenues:
Affiliates		$	34,107			$	33,597
Third parties			10,910				7,099
			45,017				40,696
Operating costs and expenses:
Operations			12,796				13,060
Depreciation and amortization			7,640				7,210
General and administrative			1,363				2,563
			21,799				22,833
Operating income			23,218				17,863
Other income (expense):
Equity in earnings of SLC Pipeline			740				481
Interest income			—				3
Interest expense			(8,549	)			(7,544	)
Other expense			(12	)			(7	)
			(7,821	)			(7,067	)
Income before income taxes			15,397				10,796
State income tax			(228	)			(94	)
Net income			15,169				10,702
Less general partner interest in net income, including incentive distributions			3,562				2,646
Limited partners’ interest in net income		$	11,607			$	8,056
Limited partners’ per unit interest in earnings — basic and diluted:		$	0.53			$	0.36
Weighted average limited partners’ units outstanding			22,079				22,079

See accompanying notes.

Holly Energy Partners, L.P.

		Three Months Ended
		March 31,
		2011				2010
		(In thousands)
Cash flows from operating activities
Net income		$	15,169			$	10,702
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			7,640				7,210
Equity in earnings of SLC Pipeline, net of distributions			(365	)			(481	)
Change in fair value — interest rate swaps			—				1,464
Amortization of restricted and performance units			670				966
(Increase) decrease in current assets:
Accounts receivable — trade			442				392
Accounts receivable — affiliates			(1,409	)			(2,081	)
Prepaid and other current assets			229				225
Current assets of discontinued operations			—				2,195
Increase (decrease) in current liabilities:
Accounts payable — trade			(356	)			(499	)
Accounts payable — affiliates			443				504
Accrued interest			(5,976	)			(1,157	)
Deferred revenue			(1,104	)			1,108
Accrued property taxes			(252	)			(214	)
Other current liabilities			(183	)			(109	)
Other, net			274				(1,502	)
Net cash provided by operating activities			15,222				18,723
Cash flows from investing activities
Additions to properties and equipment			(11,475	)			(1,911	)
Acquisition of assets from Holly Corporation			—				(37,234	)
Net cash used for investing activities			(11,475	)			(39,145	)
Cash flows from financing activities
Borrowings under credit agreement			30,000				33,000
Repayments of credit agreement borrowings			(7,000	)			(68,000	)
Proceeds from issuance of senior notes			—				147,540
Distributions to HEP unitholders			(22,205	)			(20,506	)
Purchase price in excess of transferred basis in assets acquired from Holly Corporation			—				(55,766	)
Purchase of units for restricted grants			(399	)			(1,745	)
Deferred financing costs			(3,044	)			—
Net cash provided by (used for) financing activities			(2,648	)			34,523
Cash and cash equivalents
Increase for the period			1,099				14,101
Beginning of period			403				2,508
End of period		$	1,502			$	16,609

See accompanying notes.

Holly Energy Partners, L.P.

										Accumulated
						General				Other
		Common				Partner				Comprehensive
		Units				Interest				Loss				Total
Balance December 31, 2010		$	271,649			$	(152,251	)		$	(10,026	)		$	109,372
Distributions to HEP unitholders			(18,648	)			(3,557	)			—				(22,205	)
Purchase of units for restricted grants			(399	)			—				—				(399	)
Amortization of restricted and performance units			670				—				—				670
Comprehensive income:
Net income			11,815				3,354				—				15,169
Other comprehensive income			—				—				1,283				1,283
Comprehensive income			11,815				3,354				1,283				16,452
Balance March 31, 2011		$	265,087			$	(152,454	)		$	(8,743	)		$	103,890

See accompanying notes.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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, currently 34% owned (including the 2% general partner interest) by Holly Corporation (“Holly”) 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 business segment — the operation of petroleum product and crude oil pipelines and terminals, tankage and loading rack facilities.

We own and operate petroleum product and crude oil pipelines and terminal, tankage and loading rack facilities that support Holly’s refining and marketing operations in west Texas, New Mexico, Utah, Oklahoma, Idaho and Arizona. We also own and operate refined product pipelines and terminals, located primarily in Texas, that service 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.

We generate revenues by charging tariffs for transporting petroleum products and crude oil through our pipelines, by charging fees for terminalling refined products and other hydrocarbons and storing 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, 2010. 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, 2011.

On the Consolidated Balance Sheet for the year ended December 31, 2010, we have reclassified $10.3 in partner’s equity from the general partner interest to our common unitholders and have revised the corresponding equity balances at December 31, 2010 in the Consolidated Statement of Partners’ Equity. This amount represents general partner incentive distributions paid in 2010 that were incorrectly classified as common unit distributions.

Note 2: Acquisitions

2010 Acquisitions

Tulsa East / Lovington Storage Asset Transaction

On March 31, 2010, we acquired from Holly certain storage assets for $88.6 million consisting of hydrocarbon storage tanks having approximately 2 million barrels of storage capacity, a rail loading rack and a truck unloading rack located at Holly’s Tulsa refinery east facility.

Also, as part of this same transaction, we acquired Holly’s asphalt loading rack facility located at its Navajo refinery facility in Lovington, New Mexico for $4.4 million.

We are a consolidated variable interest entity of Holly. In accounting for these acquisitions from Holly, we recorded total property and equipment at Holly’s cost basis of $37.2 million and the purchase price in excess of Holly’s basis in the assets of $55.8 million as a decrease to our partners’ equity.

Note 3: Financial Instruments

Our financial instruments consist of cash and cash equivalents, accounts receivable, accounts payable, debt and an interest rate swap. 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.

Our debt consists of borrowings outstanding under our $275 million revolving credit agreement (the “Credit Agreement”), our 6.25% senior notes due 2015 (the “6.25% Senior Notes”) and our 8.25% senior notes due 2018 (the “8.25% Senior Notes”). The $182 million carrying amount of borrowings outstanding under the Credit Agreement approximates fair value as interest rates are reset frequently using current rates. The estimated fair values of our 6.25% Senior Notes and 8.25% Senior Notes were $185 million and $160.5 million, respectively, at March 31, 2011. These fair value estimates are based on market quotes provided from a third-party bank. See Note 7 for additional information on these instruments.

Fair Value Measurements

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.

We have an interest rate swap that is measured at fair value on a recurring basis using Level 2 inputs that as of March 31, 2011 represented a liability having a fair value of $8.7 million. With respect to this instrument, fair value is based on the net present value of expected future cash flows related to both variable and fixed rate legs of our interest rate swap agreement. Our 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 our interest rate swap.

Note 4: Properties and Equipment

		March 31,				December 31,
		2011				2010
		(In thousands)
Pipelines and terminals		$	509,064			$	507,260
Land and right of way			25,271				25,264
Other			15,018				14,591
Construction in progress			25,799				16,601
			575,152				563,716
Less accumulated depreciation			134,629				128,766
		$	440,523			$	434,950

We capitalized $0.2 million and $0.1 million in interest related to major construction projects during the three months ended March 31, 2011 and 2010, respectively.

Note 5: Transportation Agreements

Our transportation agreements consist of the following:

•

The Alon pipelines and terminals agreement (the “Alon PTA”) represents a portion of the total purchase price of the Alon assets acquired in 2005 that was allocated based on an estimated fair value derived under an income approach. This asset is being amortized over 30 years ending 2035, the 15-year initial term of the Alon PTA plus the expected 15-year extension period.

•

The Holly crude pipelines and tankage agreement (the “Holly CPTA”) represents a portion of the total purchase price of certain crude pipelines and tankage assets acquired from Holly in 2008 (at which time we were not a consolidated variable interest entity of Holly) that was allocated using a fair value based on the agreement’s expected contribution to our future earnings under an income approach. This asset is being amortized over 15 years ending 2023, the 15-year term of the Holly CPTA.

The carrying amounts of our transportation agreements are as follows:

		March 31,				December 31,
		2011				2010
		(In thousands)
Alon transportation agreement		$	59,933			$	59,933
Holly crude pipelines and tankage agreement			74,231				74,231
			134,164				134,164
Less accumulated amortization			27,411				25,675
		$	106,753			$	108,489

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

In addition, we have an agreement to provide transportation and storage services to Holly via our Tulsa logistics and storage assets acquired from Sinclair. Since this agreement is with Holly and not between Sinclair and us, there is no purchase price allocation attributable to this agreement.

Note 6: Employees, Retirement and Incentive Plans

Employees who provide direct services to us are employed by Holly Logistic Services, L.L.C., a Holly 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 Holly. These employees participate in the retirement and benefit plans of Holly. Our share of retirement and benefit plan costs was $0.7 million for the three months ended March 31, 2011 and 2010.

We have adopted 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 March 31, 2011, we have two types of equity-based compensation, which are described below. The compensation cost charged against income for these plans was $0.7 million and $1 million for the three months ended March 31, 2011 and 2010, respectively. We currently purchase units in the open market instead of issuing new units for settlement of restricted unit grants. At March 31, 2011, 350,000 units were authorized to be granted under the equity-based compensation plans, of which 63,027 had not yet been granted.

Restricted Units

Under our Long-Term Incentive Plan, we grant restricted units to selected employees and directors who perform services for us, with vesting generally over a period of one to five 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.

A summary of restricted unit activity and changes during the three months ended March 31, 2011 is presented below:

										Weighted-
						Weighted-				Average				Aggregate
						Average				Remaining				Intrinsic
						Grant-Date				Contractual				Value
Restricted Units		Grants				Fair Value				Term				($000)
Outstanding at January 1, 2011 (nonvested)			47,295			$	37.47
Granted			20,924				59.65
Vesting and transfer of full ownership to recipients			(24,055	)			41.48
Forfeited			(7,802	)			43.71
Outstanding at March 31, 2011 (nonvested)			36,362			$	46.24			1.2 years				$	2,109

The fair value of restricted units that were vested and transferred to recipients during the three months ended March 31, 2011 and 2010 were $1 million and $1.3 million, respectively. As of March 31, 2011, there was $1.1 million of total unrecognized compensation costs related to nonvested restricted unit grants. That cost is expected to be recognized over a weighted-average period of 1.2 years.

During the three months ended March 31, 2011, we paid $0.4 million for the purchase of our common units in the open market for the recipients of our restricted unit grants.

Performance Units

Under our Long-Term Incentive Plan, we grant performance units to selected executives who perform services for us. Performance units granted in 2011 and 2010 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. Performance units granted in 2009 are payable based upon the growth in distributions on our common units during the requisite period, and vest over a period of three years. As of March 31, 2011, estimated share payouts for outstanding nonvested performance unit awards ranged from 110% to 120%.

We granted 12,113 performance units to certain officers in March 2011. These units will vest over a three-year performance period ending December 31, 2013 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. The fair value of these performance units is based on the grant date closing unit price of $59.65 and will apply to the number of units ultimately awarded.

A summary of performance unit activity and changes during the three months ended March 31, 2011 is presented below:

		Payable
Performance Units		In Units
Outstanding at January 1, 2011 (nonvested)			59,415
Granted			12,113
Vesting and transfer of common units to recipients			(14,337	)
Forfeited			—
Outstanding at March 31, 2011 (nonvested)			57,191

The fair value of performance units vested and transferred to recipients during the three months ended March 31, 2011 and 2010 was $0.6 million and $0.5 million, respectively. Based on the weighted average fair value at March 31, 2011 of $36.72, there was $1.4 million of total unrecognized compensation cost related to nonvested performance units. That cost is expected to be recognized over a weighted-average period of 1.5 years.

Note 7: Debt

Credit Agreement

We have a $275 million Credit Agreement that 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 and to fund distributions to unitholders up to a $30 million sub-limit. In February 2011, we amended our previous credit agreement (expiring in August 2011), slightly, reducing the size of the credit facility from $300 million to $275 million. The size was reduced based on management’s review of past and forecasted utilization of the facility. The Credit Agreement expires in February 2016; however, in the event that the 6.25% Senior Notes are not repurchased, refinanced, extended or repaid prior to September 1, 2014, the Credit Agreement shall expire on that date.

During the quarter ended March 31, 2011, we received advances totaling $30 million and repaid $7 million, resulting in net borrowings of $23 million under the Credit Agreement and an outstanding balance of $182 million at March 31, 2011. As of March 31, 2011, we had no working capital borrowings.

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., our general partner, and guaranteed by our material, wholly-owned subsidiaries. Any recourse to HEP Logistics Holdings, L.P. 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.

Indebtedness under the Credit Agreement bears interest, at our option, at either (a) the reference rate as announced by the administrative agent plus an applicable margin (ranging from 1.00% to 2.00%) or (b) at a rate equal to LIBOR plus an applicable margin (ranging from 2.00% to 3.00%). In each case, the applicable margin is based upon the ratio of our funded debt (as defined in the Credit Agreement) to EBITDA (earnings before interest, taxes, depreciation and amortization, as defined in the Credit Agreement). We incur a commitment fee on the unused portion of the Credit Agreement at an annual rate ranging from 0.375% to 0.50% based upon the ratio of our funded debt to EBITDA for the four most recently completed fiscal quarters.

The Credit Agreement imposes certain requirements on us which we are subject to and 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 2010, we issued $150 million in aggregate principal amount outstanding of 8.25% Senior Notes maturing March 15, 2018. A portion of the $147.5 million in net proceeds received was used to fund our $93 million purchase of the Tulsa and Lovington storage assets from Holly on March 31, 2010. Additionally, we used a portion to repay $42 million in outstanding Credit Agreement borrowings, with the remaining proceeds available for general partnership purposes, including working capital and capital expenditures.

Our 6.25% Senior Notes having an aggregate principal amount outstanding of $185 million mature March 1, 2015 and are registered with the SEC. The 6.25% Senior Notes and 8.25% Senior Notes (collectively, the “Senior Notes”) are unsecured and have certain restrictive covenants, which we are subject to and 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 Holdings, L.P., our general partner, and guaranteed by our wholly-owned subsidiaries. However, any recourse to HEP Logistics Holdings, L.P. would be limited to the extent of its assets, which other than its investment in us, are not significant.

The carrying amounts of our debt are as follows:

		March 31,				December 31,
		2011				2010
		(In thousands)
Credit Agreement		$	182,000			$	159,000
6.25% Senior Notes
Principal			185,000				185,000
Unamortized discount			(1,489	)			(1,584	)
Unamortized premium — dedesignated fair value hedge			1,357				1,444
			184,868				184,860
8.25% Senior Notes
Principal			150,000				150,000
Unamortized discount			(2,135	)			(2,212	)
			147,865				147,788
Total long-term debt		$	514,733			$	491,648

Interest Rate Risk Management

We use interest rate swaps (derivative instruments) to manage our exposure to interest rate risk.

As of March 31, 2011, we have an interest rate swap that hedges our exposure to the cash flow risk caused by the effects of LIBOR changes on a $155 million Credit Agreement advance. This interest rate swap effectively converts $155 million of LIBOR based debt to fixed rate debt having an interest rate of 3.74% plus an applicable margin, currently 2.50%, which equals an effective interest rate of 6.24% as of March 31, 2011. This swap contract matures in February 2013.

We have designated this interest rate swap as a cash flow hedge. Based on our assessment of effectiveness using the change in variable cash flows method, we have determined that this interest rate swap is effective in offsetting the variability in interest payments on $155 million of our variable rate debt resulting from changes in LIBOR. Under hedge accounting, we adjust our cash flow hedge 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 $155 million of our variable rate debt. Any ineffectiveness is reclassified from accumulated other comprehensive loss to interest expense. To date, we have had no ineffectiveness on our cash flow hedge.

Additional information on our interest rate swap is as follows:

Balance Sheet

Location of Offsetting

Offsetting

Derivative Instrument

Location

Fair Value

Balance

Amount

(In thousands)

March 31, 2011

Interest rate swap designated as cash flow hedging instrument:

Variable-to-fixed interest rate swap contract ($155 million of LIBOR based debt interest)

Other long-term liabilities

$

8,743

Accumulated other comprehensive loss

$

8,743

December 31, 2010

Interest rate swap designated as cash flow hedging instrument:

Variable-to-fixed interest rate swap contract ($155 million of LIBOR based debt interest)

Other long-term liabilities

$

10,026

Accumulated other comprehensive loss

$

10,026

Interest Expense and Other Debt Information

Interest expense consists of the following components:

		March 31,				March 31,
		2011				2010
		(In thousands)
Interest on outstanding debt:
Credit Agreement, net of interest on interest rate swap		$	2,365			$	2,472
6.25% Senior Notes, net of interest on interest rate swaps			2,891				2,732
8.25% Senior Notes			3,094				722
Net fair value adjustments to interest rate swaps (1)			—				1,464
Net amortization of discount and deferred debt issuance costs			290				194
Commitment fees			113				77
Total interest incurred			8,753				7,661
Less capitalized interest			204				117
Net interest expense		$	8,549			$	7,544
Cash paid for interest (2)		$	14,439			$	10,587

(1)		Represents fair value adjustments to interest rate swap agreements settled during the first quarter of 2010.
(2)		Net of cash received under previous interest rate swap agreements of $1.9 million for the three months ended March 31, 2010.

Note 8: Significant Customers

All revenues are domestic revenues, of which 96% are currently generated from our two largest customers: Holly 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
		March 31,
		2011				2010
Holly			76	%			83	%
Alon			20	%			13	%

Note 9: Related Party Transactions

Holly Agreements

We serve Holly’s refineries in New Mexico, Utah and Oklahoma under the following long-term pipeline and terminal, tankage and throughput agreements:

•

Holly PTA (pipelines and terminals throughput agreement expiring in 2019 that relates to assets contributed to us by Holly upon our initial public offering in 2004);

•

Holly IPA (intermediate pipelines throughput agreement expiring in 2024 that relates to assets acquired from Holly in 2005 and 2009);

•

Holly CPTA (crude pipelines and tankage throughput agreement expiring in 2023 that relates to assets acquired from Holly in 2008);

•

Holly PTTA (pipeline, tankage and loading rack throughput agreement expiring in 2024 that relates to the Tulsa east facilities acquired from Sinclair in 2009 and from Holly in March 2010);

•

Holly RPA (pipeline throughput agreement expiring in 2024 that relates to the Roadrunner Pipeline acquired from Holly in 2009);

•

Holly ETA (equipment and throughput agreement expiring in 2024 that relates to the Tulsa west facilities acquired from Holly in 2009);

•

Holly NPA (natural gas pipeline throughput agreement expiring in 2024); and

•

Holly ATA (asphalt loading rack throughput agreement expiring in 2025 that relates to the Lovington rack facility acquired from Holly in March 2010).

Under these agreements, Holly 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 March 31, 2011, these agreements with Holly will result in minimum annualized payments to us of $133 million.

If Holly 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. A shortfall payment under the Holly PTA and Holly IPA may be applied as a credit in the following four quarters after minimum obligations are met.

Under certain provisions of an omnibus agreement we have with Holly (the “Omnibus Agreement”) we pay Holly an annual administrative fee for the provision by Holly 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 Holly. Also, we reimburse Holly and its affiliates for direct expenses they incur on our behalf.

Related party transactions with Holly are as follows:

•

Revenues received from Holly were $34.1 million and $33.6 million for the three months ended March 31, 2011 and 2010, respectively.

•

Holly charged general and administrative services under the Omnibus Agreement of $0.6 million for the three months ended March 31, 2011 and 2010.

•

We reimbursed Holly for costs of employees supporting our operations of $5 million and $4.2 million for the three months ended March 31, 2011 and 2010, respectively.

•

We distributed $9.7 million and $8.5 million for the three months ended March 31, 2011 and 2010, respectively, to Holly as regular distributions on its common units, and general partner interest, including general partner incentive distributions.

•

Accounts receivable from Holly were $20.4 million and $19 million at March 31, 2011 and December 31, 2010, respectively.

•

Accounts payable to Holly were $4.3 million and $3.9 million at March 31, 2011 and December 31, 2010, respectively.

•

Revenues for the three months ended March 31, 2011 include $1.1 million of shortfalls billed under the Holly IPA in 2010, as Holly did not exceed its minimum volume commitment in any of the subsequent four quarters. Deferred revenue in the consolidated balance sheets at March 31, 2011 and December 31, 2010, includes $3.8 million and $3.3 million, respectively, relating to the Holly IPA. It is possible that Holly may not exceed its minimum obligations under the Holly IPA to allow Holly to receive credit for any of the $3.8 million deferred at March 31, 2011.

•

We acquired certain storage assets and an asphalt loading rack facility from Holly in March 2010. See Note 2 for a description of this transaction.

Note 10: Partners’ Equity

Holly currently holds 7,290,000 of our common units and the 2% general partner interest, which together constitutes a 34% ownership interest in us.

In May 2010, all of the conditions necessary to end the subordination period for the 937,500 Class B subordinated units originally issued to Alon in connection with our acquisition of assets from Alon in 2005 were met and the units were converted into our common units on a one-for-one basis. These subordinated units were not publicly traded.

Under our registration statement filed with the SEC using a “shelf” registration process, we currently have the ability to raise $860 million through security offerings, 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.

Allocations of Net Income

Net income attributable to Holly Energy Partners, L.P. 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
		March 31,
		2011				2010
		(In thousands)
General partner interest in net income		$	237			$	169
General partner incentive distribution			3,325				2,477
Total general partner interest in net income attributable to HEP		$	3,562			$	2,646

Cash Distributions

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

On April 27, 2011, we announced our cash distribution for the first quarter of 2011 of $0.855 per unit. The distribution is payable on all common and general partner units and will be paid May 13, 2011 to all unitholders of record on May 6, 2011.

The following table presents the allocation of our regular quarterly cash distributions to the general and limited partners for the periods in which they apply. Our distributions are declared subsequent to quarter end; therefore, the amounts presented do not reflect distributions paid during the periods presented below.

		Three Months Ended
		March 31,
		2011				2010
		(In thousands, except per unit data)
General partner interest		$	453			$	418
General partner incentive distribution			3,325				2,477
Total general partner distribution			3,778				2,895
Limited partner distribution			18,877				17,994
Total regular quarterly cash distribution		$	22,655			$	20,889
Cash distribution per unit applicable to limited partners		$	0.855			$	0.815

As a master limited partnership, we distribute our available cash, which historically has exceeded our net income because depreciation and amortization expense represents a non-cash charge against income. The result is a decline in our equity since our regular quarterly distributions have exceeded our quarterly net income. Additionally, if the assets contributed and acquired from Holly had occurred while we were not a consolidated variable interest entity of Holly, our acquisition cost in excess of Holly’s historical basis in the transferred assets of $218 million 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.

Comprehensive Income

We have other comprehensive income resulting from fair value adjustments to our cash flow hedge. Our comprehensive income is as follows:

		Three Months Ended
		March 31,
		2011				2010
		(In thousands)
Net income		$	15,169			$	10,702
Other comprehensive income (loss):
Change in fair value of cash flow hedge			1,283				(1,361	)
Comprehensive income attributable to HEP unitholders		$	16,452			$	9,341

Note 11: Supplemental Guarantor/Non-Guarantor Financial Information

Obligations of Holly Energy Partners, L.P. (“Parent”) under the 6.25% Senior Notes and 8.25% 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 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.

Condensed Consolidating Balance Sheet

						Guarantor
March 31, 2011		Parent				Subsidiaries				Eliminations				Consolidated
		(In thousands)
ASSETS
Current assets:
Cash and cash equivalents		$	2			$	1,500			$	—			$	1,502
Accounts receivable			—				23,475				—				23,475
Intercompany accounts receivable (payable)			(127,271	)			127,271				—				—
Prepaid and other current assets			211				335				—				546
Total current assets			(127,058	)			152,581				—				25,523
Properties and equipment, net			—				440,523				—				440,523
Investment in subsidiaries			564,586				—				(564,586	)			—
Transportation agreements, net			—				106,753				—				106,753
Goodwill			—				49,109				—				49,109
Investment in SLC Pipeline			—				25,802				—				25,802
Other assets			1,209				3,231				—				4,440
Total assets		$	438,737			$	777,999			$	(564,586	)		$	652,150
LIABILITIES AND PARTNERS’ EQUITY
Current liabilities:
Accounts payable		$	—			$	10,325			$	—			$	10,325
Accrued interest			1,514				27				—				1,541
Deferred revenue			—				9,333				—				9,333
Accrued property taxes			—				1,738				—				1,738
Other current liabilities			600				479				—				1,079
Total current liabilities			2,114				21,902				—				24,016
Long-term debt			332,733				182,000				—				514,733
Other long-term liabilities			—				9,511				—				9,511
Partners’ equity			103,890				564,586				(564,586	)			103,890
Total liabilities and partners’ equity		$	438,737			$	777,999			$	(564,586	)		$	652,150

Condensed Consolidating Balance Sheet

						Guarantor
December 31, 2010		Parent				Subsidiaries				Eliminations				Consolidated
		(In thousands)
ASSETS
Current assets:
Cash and cash equivalents		$	2			$	401			$	—			$	403
Accounts receivable			—				22,508				—				22,508
Intercompany accounts receivable (payable)			(92,230	)			92,230				—				—
Prepaid and other current assets			235				540				—				775
Total current assets			(91,993	)			115,679				—				23,686
Properties and equipment, net			—				434,950				—				434,950
Investment in subsidiaries			541,262				—				(541,262	)			—
Transportation agreements, net			—				108,489				—				108,489
Goodwill			—				49,109				—				49,109
Investment in SLC Pipeline			—				25,437				—				25,437
Other assets			1,261				341				—				1,602
Total assets		$	450,530			$	734,005			$	(541,262	)		$	643,273
LIABILITIES AND PARTNERS’ EQUITY
Current liabilities:
Accounts payable		$	—			$	10,238			$	—			$	10,238
Accrued interest			7,498				19				—				7,517
Deferred revenue			—				10,437				—				10,437
Accrued property taxes			—				1,990				—				1,990
Other current liabilities			1,011				251				—				1,262
Total current liabilities			8,509				22,935				—				31,444
Long-term debt			332,649				158,999				—				491,648
Other long-term liabilities			—				10,809				—				10,809
Partners’ equity			109,372				541,262				(541,262	)			109,372
Total liabilities and partners’ equity		$	450,530			$	734,005			$	(541,262	)		$	643,273

Condensed Consolidating Statement of Income

						Guarantor
Three months ended March 31, 2011		Parent				Subsidiaries				Eliminations				Consolidated
		(In thousands)
Revenues:
Affiliates		$	—			$	34,107			$	—			$	34,107
Third parties			—				10,910				—				10,910
			—				45,017				—				45,017
Operating costs and expenses:
Operations			—				12,796				—				12,796
Depreciation and amortization			—				7,640				—				7,640
General and administrative			751				612				—				1,363
			751				21,048				—				21,799
Operating income (loss)			(751	)			23,969				—				23,218
Equity in earnings of subsidiaries			22,042				—				(22,042	)			—
Equity in earnings of SLC Pipeline			—				740				—				740
Interest income (expense)			(6,122	)			(2,427	)			—				(8,549	)
Other			—				(12	)			—				(12	)
			15,920				(1,699	)			(22,042	)			(7,821	)
Income (loss) before income taxes			15,169				22,270				(22,042	)			15,397
State income tax			—				(228	)			—				(228	)
Net income		$	15,169			$	22,042			$	(22,042	)		$	15,169

Condensed Consolidating Statement of Income

						Guarantor
Three months ended March 31, 2010		Parent				Subsidiaries				Eliminations				Consolidated
		(In thousands)
Revenues:
Affiliates		$	—			$	33,597			$	—			$	33,597
Third parties			—				7,099				—				7,099
			—				40,696				—				40,696
Operating costs and expenses:
Operations			—				13,060				—				13,060
Depreciation and amortization			—				7,210				—				7,210
General and administrative			1,801				762				—				2,563
			1,801				21,032								22,833
Operating income (loss)			(1,801	)			19,664				—				17,863
Equity in earnings of subsidiaries			17,485				—				(17,485	)			—
Equity in earnings of SLC Pipeline			—				481				—				481
Interest income (expense)			(4,982	)			(2,559	)			—				(7,541	)
Other			—				(7	)			—				(7	)
			12,503				(2,085	)			(17,485	)			(7,067	)
Income (loss) before income taxes			10,702				17,579				(17,485	)			10,796
State income tax			—				(94	)			—				(94	)
Net income		$	10,702			$	17,485			$	(17,485	)		$	10,702

Condensed Consolidating Statement of Cash Flows

						Guarantor
Three months ended March 31, 2011		Parent				Subsidiaries				Eliminations				Consolidated
		(In thousands)
Cash flows from operating activities		$	22,604			$	(7,382	)		$	—			$	15,222
Cash flows from investing activities
Additions to properties and equipment			—				(11,475	)			—				(11,475	)
Cash flows from financing activities
Net borrowings under credit agreement			—				23,000				—				23,000
Distributions to HEP unitholders			(22,205	)			—				—				(22,205	)
Purchase of units for restricted grants			(399	)			—				—				(399	)
Deferred financing costs			—				(3,044	)			—				(3,044	)
			(22,604	)			19,956				—				(2,648	)
Cash and cash equivalents
Increase (decrease) for the period			—				1,099				—				1,099
Beginning of period			2				401				—				403
End of period		$	2			$	1,500			$	—			$	1,502

Condensed Consolidating Statement of Cash Flows

						Guarantor
Three months ended March 31, 2010		Parent				Subsidiaries				Eliminations				Consolidated
		(in thousands)
Cash flows from operating activities		$	(69,523	)		$	88,246			$	—			$	18,723
Cash flows from investing activities
Additions to properties and equipment			—				(1,911	)			—				(1,911	)
Acquisition of assets from Holly Corporation			—				(37,234	)			—				(37,234	)
			—				(39,145	)			—				(39,145	)
Cash flows from financing activities
Net repayments under credit agreement			—				(35,000	)			—				(35,000	)
Net proceeds from issuance of senior notes			147,540				—								147,540
Distributions to HEP unitholders			(20,506	)			—				—				(20,506	)
Purchase price in excess of transferred basis in assets acquired from Holly Corporation			(55,766	)			—				—				(55,766	)
Purchase of units for restricted grants			(1,745	)			—				—				(1,745	)
			69,523				(35,000	)			—				34,523
Cash and cash equivalents
Increase (decrease) for the period			—				14,101				—				14,101
Beginning of period			2				2,506				—				2,508
End of period		$	2			$	16,607			$	—			$	16,609