HOLLY ENERGY PARTNERS LP - Quarter Report: 2005 June (Form 10-Q)

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

      (Mark One)

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

FOR THE QUARTERLY PERIOD ENDED June 30, 2005

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

FOR THE TRANSITION PERIOD FROM ______ TO ______.

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.)

100 Crescent Court, Suite 1600
Dallas, Texas 75201

(214) 871-3555

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 þ            No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Yes o           No þ

The number of the registrant’s outstanding common units at July 29, 2005 was 8,170,000.

 

 

HOLLY ENERGY PARTNERS, L.P.

INDEX

PART I. FINANCIAL INFORMATION			3
FORWARD-LOOKING STATEMENTS			3
Item 1. Financial Statements (Unaudited, except December 31, 2004 Balance Sheet)			4
Consolidated Balance Sheets			4
Consolidated Statements of Income			5
Consolidated Statements of Cash Flows			6
Consolidated Statement of Partners’ Equity (Deficit)			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			37
Item 4. Controls and Procedures			37
PART II. OTHER INFORMATION			38
Item 1. Legal proceedings			38
Item 6. Exhibits			38
SIGNATURES			40
Waiver and Amendment
Computation of Ratio of Earnings to Fixed Charges
Certification of CEO Pursuant to Section 302
Certification of CFO Pursuant to Section 302
Certification of CEO Pursuant to Section 906
Certification of CFO Pursuant to Section 906

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 the 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. These statements are based on management’s beliefs and assumptions 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 believe that the expectations reflected in these forward-looking statements are reasonable, we cannot assure you that our expectations will prove correct. Therefore, actual outcomes and results could materially differ from what is expressed, implied or forecast in these statements. Any differences could be caused by a number of factors, including, but not limited to:

	•		Risks and uncertainties with respect to the actual quantities of refined petroleum products shipped on our pipelines and/or terminalled in our terminals;
	•		The future performance of the intermediate pipelines acquired from Holly Corporation in July 2005 and of the pipelines and terminals acquired from Alon in February 2005;
	•		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 any future acquired operations;
	•		The availability and cost of our financing;
	•		The possibility of inefficiencies or shutdowns of 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, operations 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 in conjunction with the forward-looking statements included in the Form 10-Q 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, 2004 in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” 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.

Consolidated Balance Sheets

		June 30, 2005				December 31,
		(Unaudited)				2004
		(In thousands, except unit data)
ASSETS
Current assets:
Cash and cash equivalents		$	54,310			$	19,104
Accounts receivable:
Trade			4,325				807
Affiliates			2,191				2,052
			6,516				2,859
Prepaid and other current assets			737				570
Total current assets			61,563				22,533
Properties and equipment, net			157,825				74,626
Transportation agreements, net			62,707				4,718
Other assets			4,489				1,881
Total assets		$	286,584			$	103,758
LIABILITIES AND PARTNERS’ EQUITY
Current liabilities:
Accounts payable		$	2,766			$	1,716
Accrued interest			3,006				51
Other accrued liabilities			1,771				1,646
Total current liabilities			7,543				3,413
Commitments and contingencies							—
Long-term debt			182,957				25,000
Other long-term liabilities			390				585
Minority interest			12,015				13,232
Partners’ equity (deficit):
Common unitholders (7,000,000 units issued and outstanding as of June 30, 2005 and December 31, 2004)			142,794				144,318
Subordinated unitholder (7,000,000 units issued and outstanding as of June 30, 2005 and December 31, 2004)			(61,018	)			(59,470	)
Class B subordinated unitholder (937,500 units issued and outstanding as of June 30, 2005)			24,674				—
General partner (2% interest)			(22,771	)			(23,320	)
Total partners’ equity			83,679				61,528
Total liabilities and partners’ equity		$	286,584			$	103,758

See accompanying notes.

Holly Energy Partners, L.P.

Consolidated Statements of Income
(Unaudited)

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2005				2004				2005				2004
		(In thousands, except per unit data)
Revenues:
Affiliates		$	9,941			$	13,370			$	19,371			$	25,783
Third parties			9,580				5,151				16,663				11,509
			19,521				18,521				36,034				37,292
Operating costs and expenses:
Operations			6,448				6,208				11,836				12,660
Depreciation and amortization			3,849				1,691				6,212				3,737
General and administrative			990				—				1,967				—
			11,287				7,899				20,015				16,397
Operating income			8,234				10,622				16,019				20,895
Other income (expense):
Interest income			145				37				233				72
Interest expense			(2,365	)			—				(3,483	)			—
			(2,220	)			37				(3,250	)			72
Income before minority interest			6,014				10,659				12,769				20,967
Minority interest in Rio Grande Pipeline Company			27				(307	)			(402	)			(995	)
Net income			6,041				10,352				12,367				19,972
Less:
Net income attributable to Predecessor			—				10,352				—				19,972
General partner interest in net income			121				—				247				—
Limited partners’ interest in net income		$	5,920			$	—			$	12,120			$	—
Net income per limited partner unit — Basic and diluted		$	0.40			$	—			$	0.83			$	—
Weighted average limited partners’ units outstanding			14,938								14,637

See accompanying notes.

Holly Energy Partners, L.P.

Consolidated Statements of Cash Flows
(Unaudited)

		Six Months Ended June 30,
		2005				2004
		(In thousands)
Cash flows from operating activities
Net income		$	12,367			$	19,972
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			6,212				3,737
Minority interest in Rio Grande Pipeline Company			402				995
Equity based compensation expense			33				—
(Increase) decrease in current assets:
Accounts receivable — trade			(3,587	)			(95	)
Accounts receivable — affiliates			(140	)			(19,900	)
Prepaid and other current assets			(388	)			(44	)
Increase (decrease) in current liabilities:
Accounts payable			1,050				(1,810	)
Accounts payable — affiliates			—				(2,506	)
Accrued interest			2,955				—
Accrued liabilities			125				(113	)
Other, net			223				—
Net cash provided by operating activities			19,252				236
Cash flows from investing activities
Acquisition of pipeline and terminal assets			(121,853	)			—
Additions to properties and equipment			(710	)			(2,672	)
Cash distributions to minority interest			(1,620	)			(2,250	)
Other			(211	)			—
Net cash used for investing activities			(124,394	)			(4,922	)
Cash flows from financing activities
Proceeds from issuance of senior notes, net of discount			181,238				—
Net decrease in borrowings under revolving credit agreement			(25,000	)			—
Distributions to partners			(15,526	)			—
Additional capital contribution from general partner			612				—
Deferred debt issuance costs			(967	)			—
Other			(9	)			—
Net cash provided by financing activities			140,348				—
Cash and cash equivalents Increase (decrease) for period			35,206				(4,686	)
Beginning of period			19,104				6,694
End of period		$	54,310			$	2,008

See accompanying notes.

Holly Energy Partners, L.P.

Consolidated Statement of Partners’ Equity (Deficit)
(Unaudited)

										Class B				General
		Common				Subordinated				Subordinated				Partner
		Units				Units				Units				Interest				Total
										(In thousands)
Balance December 31, 2004		$	144,318			$	(59,470	)		$	—			$	(23,320	)		$	61,528
Issuance of Class B subordinated units			—				—				24,674				—				24,674
Capital contribution			—				—				—				612				612
Distributions			(7,350	)			(7,350	)			(516	)			(310	)			(15,526	)
Amortization of restricted units			33				—				—				—				33
Other			(9	)			—				—				—				(9	)
Net income			5,802				5,802				516				247				12,367
Balance June 30, 2005		$	142,794			$	(61,018	)		$	24,674			$	(22,771	)		$	83,679

See accompanying notes.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1: Organization, Basis of Presentation, and Principles of Consolidation

Holly Energy Partners, L.P. (“HEP”) together with its consolidated subsidiaries, is a publicly held master limited partnership, currently 45.0% owned by Holly Corporation (“Holly”). HEP commenced operations July 13, 2004. Concurrently with the completion of its initial public offering, Navajo Pipeline Co., L.P. (Predecessor) (“NPL”) and its affiliates, a wholly owned subsidiary of Holly, contributed a substantial portion of its assets to HEP. In this document, the words “we”, “our”, “ours” and “us” refer to HEP and NPL collectively unless the context otherwise indicates. See Note 2 for a further description of these transactions.

NPL constitutes HEP’s predecessor. The transfer of ownership of assets from NPL to HEP represented a reorganization of entities under common control and was recorded at historical cost. Accordingly, our financial statements include the historical results of operations of NPL prior to the transfer to HEP.

We operate in one business segment — the operation of common carrier and proprietary petroleum pipeline and terminal facilities.

The consolidated financial statements include our accounts and those of our subsidiaries. All significant inter-company transactions and balances have been eliminated. In addition, the consolidated financial statements also include financial data, at historical cost, related to the assets owned by Holly and its wholly-owned subsidiaries through July 12, 2004, other than HEP, that were not contributed to us upon completion of our initial public offering, all accounted for as entities under common control. The distributions paid to Holly upon formation of HEP were in excess of the historical cost of the assets contributed.

The consolidated financial statements for the three and six months ended June 30, 2005 and 2004 included herein have been prepared without audit, pursuant to the rules and regulations of the United States Securities and Exchange Commission (the “SEC”). The consolidated statements of income, cash flows and partners’ equity (deficit) include the accounts of NPL through July 12, 2004 and HEP thereafter. The interim financial statements reflect all adjustments which are, in the opinion of management, 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 accounting principles generally accepted in the United States of America 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 2004 Form 10-K. Results of operations for the three and six months ended June 30, 2005 are not necessarily indicative of the results of operations that will be realized for the year ending December 31, 2005. Certain reclassifications have been made to prior reported amounts to conform to current classifications.

Recent Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) 123 (revised), “Share-Based Payment.” This revision prescribes the accounting for a wide range of share-based compensation arrangements, including share options, restricted share plans, performance-based awards, share appreciation rights and employee share purchase plans, and generally requires the fair value of share-based awards to be expensed on the income statement. This standard was to become effective for us for the first interim period beginning after June 15, 2005, however in April 2005, the Securities and Exchange Commission allowed for the delay in the implementation of this standard, with the result that we are now required to adopt this standard for our 2006 year. SFAS 123 (revised) allows for either modified prospective recognition of compensation expense or modified retrospective recognition, which may be back to the original issuance of SFAS 123 or only to interim periods in the year of adoption. We are still evaluating the impact and method of adoption. However, we do not believe the adoption of this standard will have a material effect

on our financial condition, results of operations or cash flows.

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections — a replacement of APB Opinion No. 20 and FASB Statement No. 3.” This statement changes the requirements for accounting for and reporting a change in accounting principles and applies to all voluntary changes in accounting principles. It also applies to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. When a pronouncement includes specific transition provisions, those provisions should be followed. This statement requires retrospective application to prior periods’ financial statements of changes in accounting principles, unless it is impracticable to determine either the period-specific effects or the cumulative effect of change. This statement becomes effective for fiscal years beginning after December 15, 2005.

Note 2: Initial Public Offering of HEP

On March 15, 2004, a Registration Statement on Form S-1 was filed with the SEC relating to a proposed underwritten initial public offering of limited partnership interests in HEP. HEP was formed to acquire, own and operate substantially all of the refined product pipeline and terminalling assets that support Holly’s refining and marketing operations in West Texas, New Mexico, Utah and Arizona and a 70% interest in Rio Grande.

On July 7, 2004, we priced 6,100,000 common units for the initial public offering; and on July 8, 2004, our common units began trading on the New York Stock Exchange under the symbol “HEP.” On July 13, 2004, we closed our initial public offering of 7,000,000 common units at a price of $22.25 per unit, which included a 900,000 unit over-allotment option that was exercised by the underwriters. Total proceeds from the sale of the units were $145.5 million, net of $10.3 million underwriting commissions. After the offering, Holly, through a subsidiary, owned a 51% interest in HEP, including the general partner interest. The initial public offering represented the sale of a 49% interest in HEP.

All of our initial assets were contributed by Holly and its subsidiaries in exchange for: a) an aggregate of 7,000,000 subordinated units, representing 49% limited partner interests in HEP, b) incentive distribution rights (as set forth in HEP’s partnership agreement), c) the 2% general partner interest, and d) an aggregate cash distribution of $125.6 million.

The following table presents the assets and liabilities of our predecessor immediately prior to contributing assets to HEP, the assets and liabilities contributed to HEP, and the predecessor’s assets and liabilities that were not contributed to HEP:

		Navajo Pipeline				Contributed to
		Co., L.P.				Holly Energy
		(Predecessor)				Partners, L.P.				Not
		July 12, 2004				July 13, 2004				Contributed
						(In thousands)
Cash		$	2,268			$	2,268			$	—
Accounts receivable — trade			850				800				50
Accounts receivable — affiliates			51,934				—				51,934
Prepaid and other current assets			292				173				119
Properties and equipment, net			95,337				76,605				18,732
Transportation agreement, net			5,692				5,692				—
Total assets			156,373				85,538				70,835
Accounts payable — trade			1,452				339				1,113
Accounts payable — affiliates			18,819				—				18,819
Accrued liabilities			1,018				534				484
Short-term debt			30,082				30,082				—
Non-current liabilities			1,775				1,138				637
Minority interest			13,263				13,263				—
Total liabilities			66,409				45,356				21,053
Net Assets		$	89,964			$	40,182			$	49,782

We used the proceeds of the public offering and $25 million drawn under our credit facility agreement to: establish $9.9 million working capital for HEP, distribute $125.6 million to Holly, repay $30.1 million of short-term debt to Holly, pay $13.8 million underwriting commissions and other offering costs, and pay $1.4 million of deferred debt issuance costs related to the credit facility.

In connection with the offering, we entered into a 15-year pipelines and terminals agreement with Holly and several of its subsidiaries (the “Holly PTA”) under which they agreed generally to transport or terminal volumes on certain of our initial facilities that will result in revenues to HEP that will equal or exceed a specified minimum revenue amount annually (which is initially $35.4 million and will adjust upward based on the producer price index) over the term of the agreement.

We also entered into an omnibus agreement with Holly and certain of its subsidiaries that became effective July 13, 2004 (the “Omnibus Agreement”) and determines the services that Holly will provide to us. Under the Omnibus Agreement, Holly is charging us $2.0 million annually for general and administrative services that it provides, including but not limited to: executive, finance, legal, information technology and administrative services.

Note 3: Acquisitions

Alon Transaction

On February 28, 2005, we closed on a contribution agreement with Alon USA, Inc. and several of its wholly-owned subsidiaries (collectively, “Alon”) that provided for our acquisition of four refined products pipelines aggregating approximately 500 miles, an associated tank farm and two refined products terminals with aggregate storage capacity of approximately 347,000 barrels. These pipelines and terminals are located primarily in Texas and transport approximately 70% of the light refined products for Alon’s 65,000 bpd capacity refinery in Big Spring, Texas.

The total consideration paid for these pipeline and terminal assets was $120 million in cash and 937,500 of our Class B subordinated units which, subject to certain conditions, will convert into an equal number of common units in five years. We financed the Alon transaction through our private offering of $150 million principal amount of 6.25% senior notes due 2015. We used the proceeds of the offering to fund the $120 million cash portion of the consideration for the Alon transaction, and used the balance to repay $30 million of outstanding indebtedness under our revolving credit agreement, including $5 million drawn shortly before the closing of the Alon transaction. In connection with the Alon transaction, we entered into a 15-year pipelines and terminals agreement with Alon. Under this agreement, Alon agreed to transport on the pipelines and throughput volumes through the terminals, a volume of refined products that would result in minimum revenues to us of $20.2 million per year in the first year. The agreed upon tariffs at the minimum volume commitment will increase or decrease each year at a rate equal to the percentage change in the producer price index (“PPI”), but not below the initial tariffs. Alon’s minimum volume commitment was calculated based on 90% of Alon’s recent usage of these pipelines and terminals taking into account a 5,000 bpd expansion of Alon’s Big Spring Refinery completed in February 2005. At revenue levels above 105% of the base revenue amount, as adjusted for changes in the PPI, Alon will receive an annual 50% discount on incremental revenues. Alon’s obligations under the pipelines and terminals agreement may be reduced or suspended under certain circumstances. We granted Alon a second mortgage on the pipelines and terminals to secure certain of Alon’s rights under the pipelines and terminals agreement. Alon will have a right of first refusal to purchase the pipelines and terminals if we decide to sell them in the future. Additionally, we entered into an environmental agreement with Alon with respect to pre-closing environmental costs and liabilities relating to the pipelines and terminals acquired from Alon, where Alon will indemnify us subject to a $100,000 deductible and a $20 million maximum liability cap.

The consideration for the Alon pipeline and terminal assets was preliminarily allocated to the individual assets acquired based on their estimated fair values. The final allocation of the consideration is pending an independent appraisal, which is currently expected to be completed by year-end. The aggregate consideration amounted to $146.6 million, which consisted of $24.7 million fair value of our Class B subordinated units, $120 million in cash and $1.9 million of transaction costs. In accounting for this

acquisition, we preliminarily recorded pipeline and terminal assets of $86.9 million and an intangible asset of $59.7 million, representing the value of the 15-year pipelines and terminals agreement.

Holly Intermediate Pipelines Transaction

On July 6, 2005, we entered into a definitive purchase agreement (the “Purchase Agreement”) with Holly to acquire Holly’s two 65-mile parallel intermediate feedstock pipelines (the “Intermediate Pipelines”) which connect its Lovington, NM and Artesia, NM refining facilities. On July 8, 2005, we closed on the acquisition for $81.5 million, which consisted of approximately $77.7 million in cash, 70,000 common units of HEP and a capital account credit of $1.0 million to maintain Holly’s existing general partner interest in the Partnership. We financed the cash portion of the consideration for the Intermediate Pipelines with the proceeds raised from (i) the private sale of 1,100,000 of our common units for $45.1 million to a limited number of institutional investors which closed simultaneously with the acquisition and (ii) the recently completed offering of an additional $35.0 million in principal amount of our 6.25% senior notes due 2015. This acquisition was made pursuant to an option to purchase these pipelines granted by Holly to us at the time of our initial public offering in July 2004.

In connection with this transaction, we entered into a 15-year pipelines agreement with Holly. Under this agreement, Holly agreed to transport volumes of intermediate products on the Intermediate Pipelines that, at the agreed tariff rates, will result in minimum revenues to us of approximately $11.8 million per calendar year. The minimum commitment and the full base tariff will be adjusted each year at a rate equal to the percentage change in the PPI, but the minimum commitment will not decrease as a result of a decrease in the PPI. Holly’s minimum revenue commitment will apply only to the Intermediate Pipelines, and Holly will not be able to spread its minimum revenue commitment among pipeline assets HEP already owns or subsequently acquires. If Holly fails to meet its minimum revenue commitment 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 may be applied as a credit in the following four quarters after Holly’s minimum obligations are met. The pipelines agreement may be extended by the mutual agreement of the parties.

We have agreed to expend up to $3.5 million to expand the capacity of the Intermediate Pipelines to meet the needs of Holly’s previously announced expansion of their Navajo Refinery. If new laws or regulations are enacted that require us to make substantial and unanticipated capital expenditures with regard to the Intermediate Pipelines, we have the right to amend the tariff rates to recover our costs of complying with these new laws or regulations (including a reasonable rate of return). Under certain circumstances, either party may temporarily suspend its obligations under the pipelines agreement. We granted Holly a second mortgage on the Intermediate Pipelines to secure certain of Holly’s rights under the pipelines agreement. Holly has agreed to provide $2.5 million of additional indemnification above that previously provided in the Omnibus Agreement for environmental noncompliance and remediation liabilities occurring or existing before the closing date of the Purchase Agreement, bringing the total indemnification provided to us from Holly to $17.5 million. Of this total, indemnification above $15 million relates solely to the Intermediate Pipelines.

As this transaction is among entities under common control, we anticipate recording the acquired assets at Holly’s historic book value of $6.8 million, resulting in a deemed distribution to Holly for financial accounting purposes. Since this acquisition closed after June 30, 2005, these consolidated financial statements do not reflect the effects of such acquisition.

Note 4: Properties and Equipment

		June 30,				December 31,
		2005				2004
		(In thousands)
Pipelines and terminals		$	181,064			$	104,095
Land and right of way			14,938				4,865
Other			4,885				4,436
Construction in progress			450				201
			201,337				113,597
Less accumulated depreciation			43,512				38,971
		$	157,825			$	74,626

During the three — and six-month periods ended June 30, 2005 and 2004, we did not capitalize any interest related to major construction projects.

Note 5: Employees, Retirement and Benefit 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 the Omnibus Agreement.

These employees participate in the retirement and benefit plans of Holly. Our share of retirement and benefits costs for the three months ended June 30, 2005 and 2004 was $0.2 million and for the six months ended June 30, 2005 and 2004 was $0.4 million.

We have a Long-Term Incentive Plan for employees, consultants and 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. The Long-Term Incentive Plan currently permits the granting of awards covering an aggregate of 350,000 units.

In the last half of 2004, we granted 4,614 restricted common units to our outside directors and 1,875 restricted common units to an executive officer who also serves as a director, under the provisions of our Long-Term Incentive Plan. These common units were purchased in the open market in November 2004 and will vest in August 2007. During the first quarter of 2005, we authorized the grant of 11,735 restricted common units to officers and employees of Holly Logistic Services, L.L.C. These units vest one-third in January 2008, one-third in January 2009, and the final one-third in January 2010 (with later performance-based vesting in the case of one executive). These units will be purchased in the open market during the third quarter of 2005. Ownership in all restricted units is subject to restrictions until the vesting date, but recipients have distribution and voting rights from the date of grant. The cost of these grants is being expensed over their corresponding vesting periods and $49,000 and $76,000 has been expensed in the three and six months ended June 30, 2005, respectively.

During the first quarter of 2005, we authorized 1,515 performance units to employees of Holly Logistic Services, L.L.C. These units will vest and be settled in cash in January 2008, based on our unit price and shareholder return during the period as compared to the return of our peer group of pipeline companies. We are recording the cost of these units over the vesting period and have expensed $6,000 and $8,000 for the three and six months ended June 30, 2005.

Note 6: Debt

Credit Agreement

In conjunction with our initial public offering on July 13, 2004, we entered into a four-year, $100 million senior secured revolving credit agreement (the “Credit Agreement”). Union Bank of California, N.A. is a lender and serves as administrative agent under this agreement. Upon closing of our initial public offering, we drew $25 million under the Credit Agreement, which was outstanding at December 31, 2004.

We amended the Credit Agreement effective February 28, 2005 to allow for the closing of the Alon

transaction and the related senior notes offering as well as to amend certain of the restrictive covenants. With a portion of the proceeds from the senior note offering, we repaid $30 million of outstanding indebtedness under the Credit Agreement, including $5 million drawn shortly before the closing of the Alon transaction. As of June 17, 2005, we amended the Credit Agreement to restate the definition of certain terms used in the restrictive covenants. As of June 30, 2005, we had no amounts outstanding under the Credit Agreement. We amended the Credit Agreement effective July 8, 2005 to allow for the closing of the Holly intermediate pipelines transaction as well as to amend certain of the restrictive covenants.

The Credit Agreement is available to fund capital expenditures, acquisitions, and working capital and for general partnership purposes. Advances under the Credit Agreement that are designated for working capital are short-term liabilities. Other advances under the Credit Agreement are classified as long-term liabilities. In addition, the Credit Agreement is available to fund letters of credit up to a $50 million sub-limit. Up to $5 million is available to fund distributions to unit holders.

We have the right to request an increase in the maximum amount of the Credit Agreement, up to $175 million. Such request will become effective if (i) certain conditions specified in the Credit Agreement are met and (ii) existing lenders under the Credit Agreement or other financial institutions reasonably acceptable to the administrative agent commit to lend such increased amounts under the agreement.

Our obligations under the Credit Agreement are secured by substantially all of our assets. Indebtedness under the Credit Agreement is recourse to our general partner and guaranteed by our wholly-owned subsidiaries.

We may prepay all loans at any time without penalty. We are required to reduce all working capital borrowings under the Credit Agreement to zero for a period of at least 15 consecutive days once each twelve-month period prior to the maturity date of the agreement. The initial $25 million borrowing was not a working capital borrowing under the Credit Agreement and was classified as a long-term liability at December 31, 2004.

Indebtedness under the Credit Agreement bears interest, at our option, at either (i) the base rate as announced by the administrative agent plus an applicable margin (ranging from 0.25% to 1.00%) or (ii) at a rate equal to LIBOR plus an applicable margin (ranging from 1.50% to 2.25%). In each case, the applicable margin is based upon the ratio of our funded debt (as defined in the 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 a rate of 0.375% or 0.500% based upon the ratio of our funded debt to EBITDA for the four most recently completed fiscal quarters. The agreement matures in July 2008. At that time, the agreement will terminate and all outstanding amounts thereunder will be due and payable.

The Credit Agreement imposes certain requirements, 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 EBITDA to interest expense ratio and debt to EBITDA ratio. If an event of default exists under the agreement, the lenders will be able to accelerate the maturity of the debt and exercise other rights and remedies.

Senior Notes Due 2015

We financed the $120 million cash portion of the Alon transaction through our private offering on February 28, 2005 of $150 million principal amount of 6.25% senior notes due 2015 (“Senior Notes”). We used the balance to repay $30 million of outstanding indebtedness under our Credit Agreement, including $5 million drawn shortly before the closing of the Alon transaction.

We financed a portion of the cash consideration for the Intermediate Pipelines transaction with the private offering in June 2005 of an additional $35.0 million in principal amount of the Senior Notes.

The Senior Notes mature on March 1, 2015 and bear interest at 6.25%. The Senior Notes are unsecured and impose certain restrictive covenants, including limitations on our ability to incur additional indebtedness, make investments, sell assets, incur certain liens, pay distributions, enter into transactions with affiliates, and enter into mergers. 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.

On July 28, 2005, we filed a registration statement to allow the holders of the Senior Notes to exchange the Senior Notes for exchange notes registered with the SEC with substantially identical terms after such registration is declared effective. The exchange notes will generally be freely transferable but will be a new issue of securities for which certain of the initial purchasers have indicated they intend to make a market but for which there may not initially be a market.

The $185 million principal amount of Senior Notes is recorded at $183.0 million on our accompanying consolidated balance sheet at June 30, 2005. The difference of $2.0 million is due to $3.6 million of unamortized discount net of $1.6 million relating to the interest rate swap contract discussed below.

Interest Rate Risk Management

We have entered into an interest rate swap contract to effectively convert the interest expense associated with $60 million of our Senior Notes from a fixed rate to a variable rate. The interest rate on the $60 million notional amount is equal to three month LIBOR plus an applicable margin of 1.1575%, which equaled an effective interest rate of 4.5% on $60 million of the debt during the six months ended June 30, 2005. The maturity of the swap contract is March 1, 2015, matching the maturity of the Senior Notes.

This interest rate swap has been designated as a fair value hedge as defined by SFAS No. 133. Our interest rate swap meets the conditions required to assume no ineffectiveness under SFAS No. 133 and, therefore, we have used the “shortcut” method of accounting prescribed for fair value hedges by SFAS No. 133. Accordingly, we adjust the carrying value of the swap to its fair value each quarter, with an offsetting entry to adjust the carrying value of the debt securities whose fair value is being hedged. We record interest expense equal to the variable rate payments under the swaps.

The fair value of our interest rate swap of $1.6 million is included in “Other assets” in our accompanying consolidated balance sheet at June 30, 2005. The offsetting entry to adjust the carrying value of the debt securities whose fair value is being hedged is recognized as an increase of “Long-term debt” on our accompanying consolidated balance sheet at June 30, 2005.

Other Debt Information

For the six months ended June 30, 2005, interest expense includes: $3.0 million of interest on the outstanding debt, net of the impact of the interest rate swap; $0.2 million of commitment fees on the unused portion of the Credit Agreement; and $0.3 million of amortization of the discount on the Senior Notes and deferred debt issuance costs. We made cash payments of $0.9 million for interest in the six months ended June 30, 2005.

The carrying amounts of our debt recorded on the balance sheet approximate fair value.

Note 7: Commitments and Contingencies

We lease certain facilities, pipelines and equipment under operating leases, most of which contain renewal options. As of June 30, 2005, the minimum future rental commitments under operating leases having non-cancelable lease terms in excess of one year total in the aggregate $11.2 million (not including a 10 year renewal option on a pipeline operating lease that is likely to be exercised), payable $5.6 million annually through June 2007. Rental expense charged to operations was $1.4 million and $1.3 million in the three-month periods ended June 30, 2005 and 2004, respectively, and $2.7 million and $2.6 million for the six-month periods ended June 30, 2005 and 2004, respectively.

We are a party to various legal and regulatory proceedings, none of which we believe will have a material adverse impact on our financial condition, results of operations or cash flows.

Note 8: Significant Customers

All revenues are domestic revenues, of which over 90% are currently generated from our three largest customers: Holly and two third-party customers. The major concentration of our petroleum products pipeline system’s revenues is derived from activities conducted in the southwest United States. The following table presents the percentage of total revenues generated by each of these three customers for the three and six months ended June 30, 2005 and 2004.

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2005				2004				2005				2004
Holly			51	%			72	%			54	%			69	%
Customer A			8	%			14	%			13	%			17	%
Customer B			37	%			9	%			29	%			9	%

Note 9: Related Party Transactions

We have related party transactions with Holly for pipeline and terminal revenues, certain employee costs, insurance costs, and administrative costs under the Holly PTA and Omnibus Agreement (see Note 2). Additionally, we received interest income from Holly during the year ended December 31, 2004, based on common treasury accounts prior to our initial public offering on July 13, 2004. Since that date, we maintain our own treasury accounts separate from Holly.

Pipeline and terminal revenues received from Holly were $9.9 million and $13.4 million for the three months ended June 30, 2005 and 2004, respectively, and $19.4 million and $25.8 million for the six months ended June 30, 2005 and 2004, respectively. Under the Omnibus Agreement, charges by Holly for the three and six months ended June 30, 2005 for general and administrative services were $0.5 million and $1 million, respectively, and for reimbursement of employee costs supporting our operations were $1.5 million and $2.9 million, respectively. In the three and six months ended June 30, 2005, we distributed $4.0 million and $7.7 million, respectively, to Holly as regular distributions on its subordinated units and general partner interest.

We have a 70% ownership interest in Rio Grande Pipeline Company. Due to the ownership interest and resulting consolidation, the other partner of Rio Grande is a related party to us. The other partner is the sole customer of Rio Grande, and we recorded revenues from the other partner of $1.6 million and $2.5 million in the three months ended June 30, 2005 and 2004 and $4.6 million and $6.3 million in six months ended June 30, 2005 and 2004, respectively. Distributions made to the other party were $1.6 million and $2.3 million in the six months ended June 30, 2005 and 2004, respectively. Included in our accounts receivable — trade at June 30, 2005 and December 31, 2004 were $0.5 million and $0.3 million, respectively, which represented the receivable balance of Rio Grande from the other party.

Alon owns all of our Class B subordinated units and is considered to be a related party. Subsequent to the issuance of these units, we recognized $6.6 million and $8.9 million of revenues for pipeline transportation, terminalling services, and a capacity lease for the three and six months ended June 30, 2005, respectively. At June 30, 2005, $4.2 million receivable from Alon was included in our accounts receivable — trade balance.

Note 10: Partners’ Equity and Cash Distributions

As partial consideration in the Alon transaction, we issued 937,500 of our Class B subordinated units at a fair value of $24.7 million. Additionally, our general partner contributed $0.6 million as an additional capital contribution to maintain its 2% general partner interest.

We financed a portion of the cash consideration paid for the Intermediate Pipelines with $45.1 million of proceeds raised from the private sale of 1,100,000 of our common units to a limited number of institutional investors which closed simultaneously with the closing of the acquisition of the Intermediate Pipelines on July 8, 2005. As this issuance did not occur until July, 2005, it is not reflected in our financial position at June 30, 2005. We have agreed to file a registration statement with the SEC by October 6, 2005 which, when it becomes effective, will allow the institutional investors to freely transfer their shares.

As a result of these transactions, Holly’s ownership interest has been reduced from 51% to 47.9% following the Alon transaction, including the 2% general partner interest. Holly’s ownership was further reduced to 45.0% in July 2005 following the Intermediate Pipelines transaction.

In February 2005, we paid a regular cash distribution for the fourth quarter of 2004 of $0.50 on all units, an aggregate amount of $7.1 million. In May 2005, we paid a regular cash distribution for the first quarter of 2005 of $0.55 on all units, an aggregate amount of $8.4 million. On July 29, 2005, we announced a cash distribution for the second quarter of 2005 of $0.575 per unit. The distribution is payable on all common, subordinated, and general partner units and will be paid August 15, 2005 to all unit holders of record on August 8, 2005. The aggregate amount of the distribution will be $9.5 million.

Note 11: Supplemental Guarantor/Non-Guarantor Financial Information

Obligations of Holly Energy Partners, L.P. (“Parent”) under the 6.25% 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. Rio Grande Pipeline Company (“Non-Guarantor”), in which we have a 70% ownership interest, is the only subsidiary which has not guaranteed these obligations.

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

Unaudited Condensed Consolidating Balance Sheets
June 30, 2005

		Holly Energy				Guarantor				Non-
		Partners, L.P.				Subsidiaries				Guarantor				Eliminations				Consolidated
										(in thousands)
ASSETS
Current assets:
Cash and cash equivalents		$	2			$	52,351			$	1,957			$	—			$	54,310
Accounts receivable — trade			—				6,221				295				—				4,325
Intercompany accounts receivable (payable)			39,011				(38,914	)			(97	)			—				2,191
Inventories and other current assets			23				714				—				—				737
Total current assets			39,036				20,372				2,155				—				61,563
Properties and equipment, net			—				123,002				34,823				—				157,825
Investment in subsidiaries			228,460				28,035				—				(256,495	)			—
Other assets, net			2,930				60,591				3,675				—				67,196
Total assets		$	270,426			$	232,000			$	40,653			$	(256,495	)		$	286,584
LIABILITIES AND PARTNERS’ EQUITY
Current liabilities:
Accounts payable		$	307			$	2,178			$	281			$	—			$	2,766
Accrued interest			3,006				—				—				—				3,006
Other accrued liabilities			477				972				322				—				1,771
Total current liabilities			3,790				3,150				603				—				7,543
Long-term debt			182,957				—				—				—				182,957
Non-current liabilities			—				390				—				—				390
Minority interest			—				—				—				12,015				12,015
Partner’s equity			83,679				228,460				40,050				(268,510	)			83,679
Total liabilities and partners’ equity		$	270,426			$	232,000			$	40,653			$	(256,495	)		$	286,584

Condensed Consolidating Balance Sheets
December 31, 2004

		Holly Energy				Guarantor				Non-
		Partners, L.P.				Subsidiaries				Guarantor				Eliminations				Consolidated
										(in thousands)
ASSETS
Current assets:
Cash and cash equivalents		$	2			$	15,143			$	3,959			$	—			$	19,104
Accounts receivable — trade			—				2,373				486				—				2,859
Intercompany accounts receivable (payable)			(5,658	)			5,658				—				—				—
Inventories and other current assets			180				338				52				—				570
Total current assets			(5,476	)			23,512				4,497				—				22,533
Properties and equipment, net			—				39,097				35,529				—				74,626
Investment in subsidiaries			67,551				30,876				—				(98,427	)			—
Other assets, net			—				1,881				4,718				—				6,599
Total assets		$	62,075			$	95,366			$	44,744			$	(98,427	)		$	103,758
LIABILITIES AND PARTNERS’ EQUITY
Current liabilities:
Accounts payable		$	—			$	1,467			$	249			$	—			$	1,716
Accrued liabilities			547				763				387				—				1,697
Total current liabilities			547				2,230				636				—				3,413
Long-term debt			—				25,000				—				—				25,000
Non-current liabilities			—				585				—				—				585
Minority interest			—				—				—				13,232				13,232
Partner’s equity			61,528				67,551				44,108				(111,659	)			61,528
Total liabilities and partners’ equity		$	62,075			$	95,366			$	44,744			$	(98,427	)		$	103,758

Unaudited Condensed Consolidating Statements of Income
Three Months Ended June 30, 2005

		Holly Energy				Guarantor				Non-
		Partners, L.P.				Subsidiaries				Guarantor				Eliminations				Consolidated
										(in thousands)
Revenues:
Affiliates		$	—			$	9,941			$	—			$	—			$	9,941
Third parties			—				8,213				1,646				(279	)			9,580
			—				18,154				1,646				(279	)			19,521
Operating costs and expenses:
Operations			—				5,819				908				(279	)			6,448
Depreciation and amortization			—				3,007				842				—				3,849
General and administrative			465				523				2				—				990
			465				9,349				1,752				(279	)			11,287
Operating income (loss)			(465	)			8,805				(106	)			—				8,234
Equity in earnings of subsidiaries			8,664				(62	)			—				(8,602	)			—
Interest income (expense)			(2,159	)			(79	)			18				—				(2,220	)
Minority interest			—				—				—				27				27
Net income (loss)		$	6,040			$	8,664			$	(88	)		$	(8,575	)		$	6,041

Unaudited Condensed Consolidating Statements of Income
Three Months Ended June 30, 2004

		Holly Energy				Guarantor				Non-
		Partners, L.P.				Subsidiaries				Guarantor				Eliminations				Consolidated
										(in thousands)
Revenues:
Affiliates		$	—			$	13,370			$	—			$	—			$	13,370
Third parties			—				2,621				2,530				—				5,151
			—				15,991				2,530				—				18,521
Operating costs and expenses:
Operations			—				5,543				665				—				6,208
Depreciation and amortization			—				845				846				—				1,691
			—				6,388				1,511				—				7,899
Operating income			—				9,603				1,019				—				10,622
Equity in earnings of subsidiaries			—				714				—				(714	)			—
Interest income (expense)			—				36				1				—				37
Minority interest			—				—				—				(307	)			(307	)
Net income		$	—			$	10,353			$	1,020			$	(1,021	)		$	10,352

Unaudited Condensed Consolidating Statements of Income
Six Months Ended June 30, 2005

		Holly Energy				Guarantor				Non-
		Partners, L.P.				Subsidiaries				Guarantor				Eliminations				Consolidated
										(in thousands)
Revenues:
Affiliates		$	—			$	19,371			$	—			$	—			$	19,371
Third parties			—				12,314				4,628				(279	)			16,663
			—				31,685				4,628				(279	)			36,034
Operating costs and expenses:
Operations			—				10,515				1,600				(279	)			11,836
Depreciation and amortization			—				4,523				1,689				—				6,212
General and administrative			920				1,032				15				—				1,967
			920				16,070				3,304				(279	)			20,015
Operating income (loss)			(920	)			15,615				1,324				—				16,019
Equity in earnings of subsidiaries			16,232				939				—				(17,171	)			—
Interest income (expense)			(2,946	)			(322	)			18				—				(3,250	)
Minority interest			—				—				—				(402	)			(402	)
Net income		$	12,366			$	16,232			$	1,342			$	(17,573	)		$	12,367

Unaudited Condensed Consolidating Statements of Income
Six Months Ended June 30, 2004

		Holly Energy				Guarantor				Non-
		Partners, L.P.				Subsidiaries				Guarantor				Eliminations				Consolidated
										(in thousands)
Revenues:
Affiliates		$	—			$	25,783			$	—			$	—			$	25,783
Third parties			—				5,202				6,307				—				11,509
			—				30,985				6,307				—				37,292
Operating costs and expenses:
Operations			—				11,355				1,305				—				12,660
Depreciation and amortization			—				2,049				1,688				—				3,737
			—				13,404				2,993				—				16,397
Operating income			—				17,581				3,314				—				20,895
Equity in earnings of subsidiaries			—				2,321				—				(2,321	)			—
Interest income (expense)			—				71				1				—				72
Minority interest			—				—				—				(995	)			(995	)
Net income		$	—			$	19,973			$	3,315			$	(3,316	)		$	19,972

Unaudited Condensed Consolidating Statements of Cash Flows
Six Months Ended June 30, 2005

		Holly Energy				Guarantor				Non-
		Partners, L.P.				Subsidiaries				Guarantor				Eliminations				Consolidated
										(in thousands)
Cash flows from operating activities		$	(45,611	)		$	61,465			$	3,398			$	—			$	19,252
Cash flows used for investing activities:
Acquisitions, net of cash acquired			(120,000	)			(1,853	)			—				—				(121,853	)
Additions to properties and equipment			—				(710	)			—				—				(710	)
Investments in subsidiaries, net			(1	)			3,780				—				(3,779	)			—
Cash distribution to minority interest			—				—				—				(1,620	)			(1,620	)
Other			—				(211	)			—				—				(211	)
			(120,001	)			1,006				—				(5,399	)			(124,394	)
Cash flows from financing activities:
Proceeds from issuance of senior notes, net of discount			181,238				—				—				—				181,238
Contributions from (distributions to) partners			(14,914	)			1				(5,400	)			5,399				(14,914	)
Borrowings (paydowns) of debt, net			—				(25,000	)			—				—				(25,000	)
Other financing activities, net			(712	)			(264	)			—				—				(976	)
			165,612				(25,263	)			(5,400	)			5,399				140,348
Cash and cash equivalents
Increase (decrease) for the period			—				37,208				(2,002	)			—				35,206
Beginning of period			2				15,143				3,959				—				19,104
End of period		$	2			$	52,351			$	1,957			$	—			$	54,310