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HEP > SEC Filings for HEP > Form 10-K on 24-Feb-2014All Recent SEC Filings

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Form 10-K for HOLLY ENERGY PARTNERS LP


24-Feb-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

This Item 7, including but not limited to the sections on "Liquidity and Capital Resources," contains forward-looking statements. See "Forward-Looking Statements" at the beginning of Part I and Item 1A. "Risk Factors." In this document, the words "we," "our," "ours" and "us" refer to HEP and its consolidated subsidiaries or to HEP or an individual subsidiary and not to any other person.

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OVERVIEW

HEP is a Delaware limited partnership. We own and operate petroleum product and crude oil pipelines and terminal, tankage and loading rack facilities that support HFC's refining and marketing operations in the Mid-Continent, Southwest and Rocky Mountain regions of the United States and Alon's refinery in Big Spring, Texas. At December 31, 2013, HFC owned a 39% interest in us including the 2% general partnership interest. Additionally, we own a 75% interest in UNEV, the owner of a pipeline running from Woods Cross, Utah to Las Vegas, Nevada and related products terminals and a 25% joint venture interest in the SLC Pipeline, a 95-mile intrastate crude oil pipeline system that serves refineries in the Salt Lake City, Utah area.

We generate revenues by charging tariffs for transporting petroleum products and crude oil through our pipelines, by charging fees for terminalling and storing refined products and other hydrocarbons and providing other services at our storage tanks and terminals. We do not take ownership of products that we transport, terminal or store, and therefore we are not directly exposed to changes in commodity prices.

On January 16, 2013, a two-for-one unit split was paid in the form of a common unit distribution for each issued and outstanding common unit to all unitholders of record on January 7, 2013. All references to unit and per unit amounts in this document and related disclosures have been adjusted to reflect the effect of the unit split for all prior periods presented.

In March 2013, we closed on a public offering of 1,875,000 of our common units. Additionally, an affiliate of HFC, as a selling unitholder, closed on a public sale of 1,875,000 of its HEP common units for which we did not receive any proceeds. We used our net proceeds of $73.4 million to repay indebtedness incurred under our credit facility and for general partnership purposes. Amounts repaid under our credit facility may be reborrowed from time to time, and we intend to reborrow certain amounts to fund capital expenditures.

We believe the continuing growth of crude production in the Permian Basin and throughout the Mid-Continent and favorable refining economics should support high utilization rates for the refineries we serve, which in turn will support volumes in our product pipelines, crude gathering system and terminals.

UNEV Pipeline Interest Acquisition
On July 12, 2012, we acquired HFC's 75% interest in UNEV. We paid consideration consisting of $260.9 million in cash and 2,059,800 of our common units. Also under the terms of the transaction, we issued to HFC a Class B unit comprising a noncontrolling equity interest in a wholly-owned subsidiary subject to redemption to the extent that HFC is entitled to a 50% interest in our share of annual UNEV earnings before interest, income taxes, depreciation, and amortization above $30 million beginning July 1, 2016 and ending in June 2032, subject to certain limitations. However, to the extent earnings thresholds are not achieved, no redemption payments are required. Contemporaneously with this transaction, HFC (our general partner) agreed to forego its right to incentive distributions of up to $1.25 million per quarter over twelve consecutive quarterly periods following the closing of the transaction and up to an additional four quarters in certain circumstances. In connection with the transaction, we entered into 15-year throughput agreements with shippers containing minimum annual revenue commitments to us of $25 million.

Legacy Frontier Pipeline and Tankage Asset Transaction On November 9, 2011, we acquired from HFC certain tankage, loading rack and crude receiving assets located at HFC's El Dorado and Cheyenne refineries. We paid non-cash consideration consisting of promissory notes with an aggregate principal amount of $150 million and 7,615,230 of our common units. In connection with the transaction, we entered into 15-year throughput agreements with HFC containing minimum annual revenue commitments to us of $48.3 million.

Agreements with HFC and Alon
We serve HFC's refineries under long-term pipeline and terminal, tankage and throughput agreements expiring from 2019 to 2026. Under these agreements, HFC agreed to transport, store and throughput volumes of refined product and crude oil on our pipelines and terminal, tankage and loading rack facilities that result in minimum annual payments to us. Additionally, such agreements require HFC to reimburse us for certain costs. These minimum annual payments or revenues are subject to annual tariff rate adjustments on July 1, based on the PPI or FERC index. As of December 31, 2013, these agreements with HFC will result in minimum annualized payments to us of $225.5 million.

If HFC fails to meet its minimum volume commitments under the agreements in any quarter, it will be required to pay us in cash the amount of any shortfall by the last day of the month following the end of the quarter. Under certain of the agreements, a shortfall payment may be applied as a credit in the following four quarters after minimum obligations are met.

We have a pipelines and terminals agreement with Alon expiring in 2020 under which Alon has agreed to transport on our pipelines and throughput through our terminals volumes of refined products that result in a minimum level of annual revenue that also is

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subject to annual tariff rate adjustments. Also we have a capacity lease agreement under which we lease Alon space on our Orla to El Paso pipeline for the shipment of refined product. The terms under this lease agreement expire beginning in 2018 through 2022. As of December 31, 2013, these agreements with Alon will result in minimum annualized payments to us of $31.8 million.

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

Under certain provisions of the Omnibus Agreement that we have with HFC, we pay HFC an annual administrative fee, currently $2.3 million, for the provision by HFC or its affiliates of various general and administrative services to us on behalf of HLS. This fee does not include the salaries of personnel employed by HFC who perform services for us or the cost of their employee benefits, which are separately charged to us by HFC. We also reimburse HFC and its affiliates for direct expenses they incur on our behalf.

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RESULTS OF OPERATIONS

Income, Distributable Cash Flow and Volumes The following tables present income, distributable cash flow and volume information for the years ended December 31, 2013, 2012 and 2011.

                                                     Year Ended December 31,        Change from
                                                       2013             2012            2012
                                                       (In thousands, except per unit data)
Revenues
Pipelines:
Affiliates-refined product pipelines              $     66,441      $   67,682     $     (1,241 )
Affiliates-intermediate pipelines                       25,397          28,540           (3,143 )
Affiliates-crude pipelines                              48,749          45,888            2,861
                                                       140,587         142,110           (1,523 )
Third parties-refined product pipelines                 41,837          37,521            4,316
                                                       182,424         179,631            2,793
Terminals, tanks and loading racks:
Affiliates                                             111,781         103,472            8,309
Third parties                                           10,977           9,457            1,520
                                                       122,758         112,929            9,829
Total revenues                                         305,182         292,560           12,622
Operating costs and expenses
Operations (exclusive of depreciation and
amortization)                                           99,444          89,242           10,202
Depreciation and amortization                           65,423          57,461            7,962
General and administrative                              11,749           7,594            4,155
                                                       176,616         154,297           22,319
Operating income                                       128,566         138,263           (9,697 )
Equity in earnings of SLC Pipeline                       2,826           3,364             (538 )
Interest expense, including amortization               (47,010 )       (47,182 )            172
Interest income                                            161               -              161
Loss on early extinguishment of debt                         -          (2,979 )          2,979
Gain on sale of assets                                   1,810               -            1,810
Other                                                       61              10               51
                                                       (42,152 )       (46,787 )          4,635
Income before income taxes                              86,414          91,476           (5,062 )
State income tax                                          (333 )          (371 )             38
Net income                                              86,081          91,105           (5,024 )
Allocation of net loss attributable to
Predecessors                                                 -           4,200           (4,200 )
Allocation of net loss (income) attributable to
noncontrolling interests                                (6,632 )        (1,153 )         (5,479 )
Net income attributable to Holly Energy
Partners                                                79,449          94,152          (14,703 )
General partner interest in net income,
including incentive distributions (1)                  (27,523 )       (22,450 )         (5,073 )
Limited partners' interest in net income          $     51,926      $   71,702     $    (19,776 )
Limited partners' earnings per unit-basic and
diluted (1)                                       $       0.88      $     1.29     $      (0.41 )
Weighted average limited partners' units
outstanding                                             58,246          55,696            2,550
EBITDA (2)                                        $    192,054      $  194,242     $     (2,188 )
Distributable cash flow (3)                       $    146,579      $  153,125     $     (6,546 )

Volumes (bpd)
Pipelines:
Affiliates-refined product pipelines                   107,493         107,509              (16 )
Affiliates-intermediate pipelines                      128,475         127,169            1,306
Affiliates-crude pipelines                             161,391         171,040           (9,649 )
                                                       397,359         405,718           (8,359 )
Third parties-refined product pipelines                 63,337          63,152              185
                                                       460,696         468,870           (8,174 )
Terminals and loading racks:
Affiliates                                             255,108         271,549          (16,441 )
Third parties                                           63,791          53,456           10,335
                                                       318,899         325,005           (6,106 )
Total for pipelines and terminal assets (bpd)          779,595         793,875          (14,280 )

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                                                     Years Ended December 31,        Change from
                                                       2012              2011            2011
                                                        (In thousands, except per unit data)
Revenues
Pipelines:
Affiliates-refined product pipelines              $     67,682       $   46,649     $     21,033
Affiliates-intermediate pipelines                       28,540           21,948            6,592
Affiliates-crude pipelines                              45,888           47,542           (1,654 )
                                                       142,110          116,139           25,971
Third parties-refined product pipelines                 37,521           38,216             (695 )
                                                       179,631          154,355           25,276
Terminals, tanks and loading racks:
Affiliates                                             103,472           52,122           51,350
Third parties                                            9,457            7,791            1,666
                                                       112,929           59,913           53,016
Total revenues                                         292,560          214,268           78,292
Operating costs and expenses
Operations (exclusive of depreciation and
amortization)                                           89,242           64,521           24,721
Depreciation and amortization                           57,461           36,958           20,503
General and administrative                               7,594            6,576            1,018
                                                       154,297          108,055           46,242
Operating income                                       138,263          106,213           32,050
Equity in earnings of SLC Pipeline                       3,364            2,552              812
Interest expense, including amortization               (47,182 )        (35,959 )        (11,223 )
Other expense                                               10               17               (7 )
                                                       (46,787 )        (33,390 )        (13,397 )
Income before income taxes                              91,476           72,823           18,653
State income tax                                          (371 )           (234 )           (137 )
Net income                                              91,105           72,589           18,516
Allocation of net loss attributable to
Predecessors                                             4,200            6,351           (2,151 )
Allocation of net loss attributable to
noncontrolling interests                                (1,153 )            859           (2,012 )
Net income attributable to Holly Energy
Partners                                                94,152           79,799           14,353
General partner interest in net income,
including incentive distributions (1)                  (22,450 )        (16,806 )         (5,644 )
Limited partners' interest in net income          $     71,702       $   62,993     $      8,709
Limited partners' earnings per unit-basic and
diluted (1)                                       $       1.29       $     1.38     $      (0.09 )
Weighted average limited partners' units
outstanding                                             55,696           45,672           10,024
EBITDA (2)                                        $    194,242       $  149,766     $     44,476
Distributable cash flow (3)                       $    153,125       $  100,295     $     52,830

Volumes (bpd)
Pipelines:
Affiliates-refined product pipelines                   107,509           90,782           16,727
Affiliates-intermediate pipelines                      127,169           93,419           33,750
Affiliates-crude pipelines                             171,040          161,789            9,251
                                                       405,718          345,990           59,728
Third parties-refined product pipelines                 63,152           52,361           10,791
                                                       468,870          398,351           70,519
Terminals and loading racks:
Affiliates                                             271,549          193,645           77,904
Third parties                                           53,456           44,454            9,002
                                                       325,005          238,099           86,906
Total for pipelines and terminal assets (bpd)          793,875          636,450          157,425

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(1) Net income attributable to HEP is allocated between limited partners and the general partner interest in accordance with the provisions of the partnership agreement. HEP net income allocated to the general partner includes incentive distributions that are declared subsequent to quarter end. After the amount of incentive distributions is allocated to the general partner, the remaining net income attributable to HEP is allocated to the partners based on their weighted average ownership percentage during the period.

(2) EBITDA is calculated as net income attributable to Holly Energy Partners plus (i) interest expense, net of interest income, (ii) state income tax and (iii) depreciation and amortization, excluding amounts related to Predecessor. EBITDA is not a calculation based upon GAAP. However, the amounts included in the EBITDA calculation are derived from amounts included in our consolidated financial statements, with the exception of EBITDA from discontinued operations. EBITDA should not be considered as an alternative to net income or operating income, as an indication of our operating performance or as an alternative to operating cash flow as a measure of liquidity. EBITDA is not necessarily comparable to similarly titled measures of other companies. EBITDA is presented here because it is a widely used financial indicator used by investors and analysts to measure performance. EBITDA is also used by our management for internal analysis and as a basis for compliance with financial covenants. See our calculation of EBITDA under Item 6, "Selected Financial Data."

(3) Distributable cash flow is not a calculation based upon GAAP. However, the amounts included in the calculation are derived from amounts presented in our consolidated financial statements, with the general exceptions of a billed crude revenue settlement, maintenance capital expenditures and distributable cash flow from discontinued operations. Distributable cash flow should not be considered in isolation or as an alternative to net income or operating income as an indication of our operating performance or as an alternative to operating cash flow as a measure of liquidity. Distributable cash flow is not necessarily comparable to similarly titled measures of other companies. Distributable cash flow is presented here because it is a widely accepted financial indicator used by investors to compare partnership performance. Also it is used by management for internal analysis and for our performance units. We believe that this measure provides investors an enhanced perspective of the operating performance of our assets and the cash our business is generating. See our calculation of distributable cash flow under Item 6, "Selected Financial Data."

Results of Operations - Year Ended December 31, 2013 Compared with Year Ended December 31, 2012

Summary
Net income attributable to HEP for the year ended December 31, 2013 was $79.4 million, a $14.7 million decrease compared to the year ended December 31, 2012. This decrease in earnings is due principally to increased operating costs and expenses, including higher depreciation resulting from asset abandonment charges related to tankage permanently removed from service, combined with higher allocations of income to noncontrolling interests. Overall revenues increased but did not keep pace with the cost increases as pipeline volumes supporting HFC's Navajo refinery were reduced in 2013 as the refinery experienced a planned turnaround in the first quarter and unplanned refinery downtime in the fourth quarter. Limited partners' per unit interest in earnings decreased from $1.29 per unit in 2012 to $0.88 per unit in 2013 due to the income decreases combined with higher incentive distributions to the general partner.

Revenues for the year ended December 31, 2013 include the recognition of $7.8 million of prior shortfalls billed to shippers in 2012. As of December 31, 2013, deferred revenue on our consolidated balance sheet related to shortfalls billed was $12.0 million. Such deferred revenue will be recognized in earnings either as payment for shipments in excess of guaranteed levels, if and to the extent the pipeline system will not have necessary capacity to provide for shipments in excess of guaranteed levels, or when shipping rights expire unused.

Revenues
Total revenues for the year ended December 31, 2013 were $305.2 million, a $12.6 million increase compared to the year ended December 31, 2012. The revenue increase was due to the effect of annual tariff increases, higher cost reimbursement receipts from HFC and a $1.5 million increase in previously deferred revenue realized. Overall pipeline volumes were down 2% compared to the year ended December 31, 2012.

Revenues from our refined product pipelines were $108.3 million, an increase of $3.1 million compared to the year ended December 31, 2012, primarily due to the effects of a $3.3 million increase in previously deferred revenue realized and annual tariff increases. Shipments averaged 170.8 thousand barrels per day ("mbpd") compared to 170.7 mbpd for 2012.

Revenues from our intermediate pipelines were $25.4 million, a decrease of $3.1 million on shipments averaging 128.5 mbpd compared to 127.2 mbpd for the year ended December 31, 2012. The decrease in revenue is due to the effects of a $1.8 million decrease in deferred revenue realized and reduced volumes on certain high tariff pipeline segments.

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Revenues from our crude pipelines were $48.7 million, an increase of $2.9 million on shipments averaging of 161.4 mbpd compared to 171.0 mbpd for the year ended December 31, 2012. Although crude oil pipeline shipments were down, revenues increased due to the annual tariff increases and minimum billings on certain pipeline segments.

Revenues from terminal, tankage and loading rack fees were $122.8 million, an increase of $9.8 million compared to year ended December 31, 2012. The increase in revenues is due to annual fee increases and higher tank cost reimbursement receipts from HFC. Refined products terminalled in our facilities increased an average of 318.9 mbpd compared to 325.0 mbpd for 2012.

Operations Expense
Operations expense for the year ended December 31, 2013 increased by $10.2 million compared to the year ended December 31, 2012. This increase is due to higher maintenance costs, environmental accruals, employee costs and property taxes, offset by a $3.5 million net tax refund related to payroll costs covering a multi-year period.

Depreciation and Amortization
Depreciation and amortization for the year ended December 31, 2013 increased by $8.0 million compared to the year ended December 31, 2012 due principally to asset abandonment charges related to tankage permanently removed from service.

General and Administrative
General and administrative costs for the year ended December 31, 2013 increased by $4.2 million compared to the year ended December 31, 2012 due to increased employee costs.

Equity in Earnings of SLC Pipeline
Our equity in earnings of the SLC Pipeline was $2.8 million and $3.4 million for the years ended December 31, 2013 and 2012.

Interest Expense
Interest expense for the year ended December 31, 2013 totaled $47.0 million, a decrease of $0.2 million compared to the year ended December 31, 2012. Our aggregate effective interest rate was 5.7% and 6.5% for the years ended December 31, 2013 and 2012, respectively.

Loss on Early Extinguishment of Debt
We recognized a charge of $3.0 million upon the early extinguishment of our 6.25% senior notes for the year ended December 31, 2012. This charge related to the premium paid to noteholders upon their tender of an aggregate principal amount of $185.0 million and related financing costs that were previously deferred.

Gain on Sale of Assets
The gain on the sale of assets for the year ended December 31, 2013 of $1.8 million is comprised of a gain of $2.0 million on the sale of property in El Paso, Texas, partially offset by a $0.2 million loss from the sale of our 50% ownership interest in product terminals located in Boise and Burley, Idaho.

State Income Tax
We recorded state income tax expense of $333,000 and $371,000 for the years ended December 31, 2013 and 2012 which is solely attributable to the Texas margin tax. We are subject to the Texas margin tax that is based on our Texas sourced taxable margin. Due to a statutory change that was enacted in June 2013, we are now able to deduct additional expenses which will result in lower cash taxes to HEP in the current and future years.

Results of Operations-Year Ended December 31, 2012 Compared with Year Ended December 31, 2011

Summary
Net income attributable to HEP for the year ended December 31, 2012 was $94.2 million, a $14.4 million increase compared to the year ended December 31, 2011. This increase in earnings was due principally to increased pipeline shipments, earnings attributable to our November 2011 acquisition and annual tariff increases. These factors were offset partially by increased operating costs and expenses, higher interest expense and a loss on the early extinguishment of debt. Although net income attributable to HEP increased, limited partners' per unit interest in earnings decreased from $1.38 per unit in 2011 to $1.29 per unit in 2012. The principal factors that caused the decrease in limited partners' per unit interest, relative to the overall net income attributable to HEP increase, were higher incentive distributions to the general partner and the UNEV acquisition not yet being accretive to earnings, although it was accretive to distributable cash flow.

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Revenues for the year ended December 31, 2012 include the recognition of $4.0 million of prior shortfalls billed to shippers in 2011. Deficiency payments of $7.8 million associated with certain guaranteed shipping contracts were deferred during the year ended December 31, 2012.

Revenues
Total revenues for the year ended December 31, 2012 were $292.6 million, a $78.3 million increase compared to the year ended December 31, 2011. This was due principally to increased pipeline shipments, revenues attributable to our recent acquisitions and the effect of annual tariff increases partially offset by a $4.6 million decrease in previously deferred revenue realized under our guaranteed shipping contracts. Overall pipeline volumes were up 18% compared to the year ended December 31, 2011.

Revenues from our refined product pipelines were $105.2 million, an increase of $20.3 million compared to the year ended December 31, 2011. This included $15.0 million in revenues attributable to UNEV pipeline throughputs which commenced . . .

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