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

For the quarterly period ended June 30, 2007

OR

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

For the transition period from                      to                     .

Commission File Number: 1-32225

HOLLY ENERGY PARTNERS, L.P.

(Exact name of registrant as specified in its charter)

Delaware		20-0833098
(State or other jurisdiction of		(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 is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o		Accelerated filer þ		Non-accelerated filer 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 July 20, 2007 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, 2006 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			23
Item 3. Quantitative and Qualitative Disclosures About Market Risks			36
Item 4. Controls and Procedures			36
PART II. OTHER INFORMATION			37
Item 1. Legal Proceedings			37
Item 6. Exhibits			37
SIGNATURES			38
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 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. 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 differ materially 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 petroleum products 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 pending or contemplated acquisitions;
	•		The availability and cost of our 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, 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 this 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, 2006 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.

		June 30, 2007				December 31,
		(Unaudited)				2006
		(In thousands, except unit data)
ASSETS
Current assets:
Cash and cash equivalents		$	11,563			$	11,555
Accounts receivable:
Trade			4,575				7,339
Affiliates			3,891				3,518
			8,466				10,857
Prepaid and other current assets			938				1,212
Total current assets			20,967				23,624
Properties and equipment, net			156,671				160,484
Transportation agreements, net			55,272				56,821
Other assets			2,279				2,644
Total assets		$	235,189			$	243,573
LIABILITIES AND PARTNERS’ EQUITY
Current liabilities:
Accounts payable		$	1,872			$	3,781
Accrued interest			2,932				2,941
Deferred revenue			4,495				5,486
Accrued property taxes			614				868
Other current liabilities			721				1,098
Total current liabilities			10,634				14,174
Commitments and contingencies			—				—
Long-term debt			181,443				180,660
Other long-term liabilities			970				1,550
Minority interest			11,003				10,963
Partners’ equity (deficit):
Common unitholders (8,170,000 units issued and outstanding)			174,248				176,844
Subordinated unitholders (7,000,000 units issued and outstanding)			(72,131	)			(70,022	)
Class B subordinated unitholders (937,500 units issued and outstanding)			23,186				23,469
General partner interest (2% interest)			(94,164	)			(94,065	)
Total partners’ equity			31,139				36,226
Total liabilities and partners’ equity		$	235,189			$	243,573

See accompanying notes.

Holly Energy Partners, L.P.

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2007				2006				2007				2006
		(In thousands, except per unit data)
Revenues:
Affiliates		$	16,353			$	10,584			$	30,115			$	23,066
Third parties			10,778				7,943				20,888				17,899
			27,131				18,527				51,003				40,965
Operating costs and expenses:
Operations			8,263				7,429				16,040				14,538
Depreciation and amortization			3,208				3,781				7,279				7,574
General and administrative			1,275				1,289				2,562				2,513
			12,746				12,499				25,881				24,625
Operating income			14,385				6,028				25,122				16,340
Other income (expense):
Interest income			145				245				330				488
Interest expense			(3,371	)			(3,247	)			(6,729	)			(6,422	)
Gain on sale of assets			1				—				298				—
			(3,225	)			(3,002	)			(6,101	)			(5,934	)
Income before minority interest			11,160				3,026				19,021				10,406
Minority interest in Rio Grande Pipeline Company			(154	)			(28	)			(581	)			(273	)
Net income			11,006				2,998				18,440				10,133
Less general partner interest in net income			726				319				1,306				646
Limited partners’ interest in net income		$	10,280			$	2,679			$	17,134			$	9,487
Net income per limited partner unit - basic and diluted		$	0.64			$	0.17			$	1.06			$	0.59
Weighted average limited partners’ units outstanding			16,108				16,108				16,108				16,108

See accompanying notes.

Holly Energy Partners, L.P.

		Six Months Ended June 30,
		2007				2006
		(In thousands)
Cash flows from operating activities
Net income		$	18,440			$	10,133
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			7,279				7,574
Minority interest in Rio Grande Pipeline Company			581				273
Amortization of restricted and performance units			763				409
Gain on sale of assets			(298	)			—
(Increase) decrease in current assets:
Accounts receivable – trade			2,764				(759	)
Accounts receivable – affiliates			(373	)			333
Prepaid and other current assets			274				172
Increase (decrease) in current liabilities:
Accounts payable			(1,909	)			398
Accrued interest			(9	)			32
Deferred revenue			(991	)			3,916
Accrued property tax			(254	)			(188	)
Other current liabilities			(377	)			(12	)
Other, net			572				205
Net cash provided by operating activities			26,462				22,486
Cash flows from investing activities
Additions to properties and equipment			(1,933	)			(3,699	)
Proceeds from sale of assets			325				—
Net cash used for investing activities			(1,608	)			(3,699	)
Cash flows from financing activities
Distributions to partners			(23,382	)			(21,244	)
Purchase of units for restricted grants			(908	)			(512	)
Cash distributions to minority interest			(540	)			(1,200	)
Other			(16	)			—
Net cash used for financing activities			(24,846	)			(22,956	)
Cash and cash equivalents
Increase (decrease) for period			8				(4,169	)
Beginning of period			11,555				20,583
End of period		$	11,563			$	16,414

See accompanying notes.

Holly Energy Partners, L.P.

										Class B
		Common				Subordinated				Subordinated				General Partner
		Units				Units				Units				Interest				Total
		(In thousands)
Balance December 31, 2006		$	176,844			$	(70,022	)		$	23,469			$	(94,065	)		$	36,226
Distributions to partners			(11,142	)			(9,555	)			(1,280	)			(1,405	)			(23,382	)
Purchase of units for restricted grants			(908	)			—				—				—				(908	)
Amortization of restricted and performance units			763				—				—				—				763
Net income			8,691				7,446				997				1,306				18,440
Balance June 30, 2007		$	174,248			$	(72,131	)		$	23,186			$	(94,164	)		$	31,139

See accompanying notes.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1: Description of Business and Presentation of Financial Statements

Holly Energy Partners, L.P. (“HEP”) together with its consolidated subsidiaries, is a publicly held master limited partnership, currently 45% owned by Holly Corporation and its subsidiaries (collectively “Holly”). HEP commenced operations July 13, 2004 upon the completion of its initial public offering. In this document, 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 pipelines and terminal facilities.

One of Holly’s wholly-owned subsidiaries owns a refinery in Artesia, New Mexico, which Holly operates in conjunction with crude, vacuum distillation and other facilities situated in Lovington, New Mexico (collectively, the “Navajo Refinery”). In July 2005, we acquired the two parallel intermediate feedstock pipelines which connect the Lovington, New Mexico and Artesia, New Mexico refining facilities. The Navajo Refinery produces high-value refined products such as gasoline, diesel fuel and jet fuel and serves markets in the southwestern United States and northern Mexico. We operate refined product pipelines as part of the product distribution network of the Navajo Refinery. Our terminal operations serving the Navajo Refinery include a truck rack at the Navajo Refinery and five integrated refined product terminals located in New Mexico, Texas and Arizona.

Another of Holly’s wholly-owned subsidiaries owns a refinery located near Salt Lake City, Utah (the “Woods Cross Refinery”). Our operations serving the Woods Cross Refinery include a truck rack at the Woods Cross Refinery, a refined product terminal in Spokane, Washington and a 50% non-operating interest in product terminals in Boise and Burley, Idaho.

In February 2005, we acquired from Alon USA, Inc. and several of its wholly-owned subsidiaries (collectively, “Alon”) four refined products pipelines, an associated tank farm and two refined products terminals. These pipelines and terminals are located primarily in Texas and transport and terminal light refined products for Alon’s refinery in Big Spring, Texas.

Additionally, we own a refined product terminal in Mountain Home, Idaho, and a 70% interest in Rio Grande Pipeline Company (“Rio Grande”), which provides transportation of liquid petroleum gases to northern Mexico.

The consolidated financial statements for the three and six months ended June 30, 2007 and 2006 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 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 Form 10-K for the year ended December 31, 2006. 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, 2007. Certain reclassifications have been made to prior reported amounts to conform to current classifications.

Recent Accounting Pronouncements

Interpretation No. 48 “Accounting for Uncertainty in Income Taxes”

In June 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes. This interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements by prescribing a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This interpretation also provides guidance on

derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. We adopted this standard effective January 1, 2007. The adoption of this standard did not have a material impact on our financial condition, results of operations and cash flows.

Note 2: Properties and Equipment

		June 30,				December 31,
		2007				2006
		(In thousands)
Pipelines and terminals		$	196,308			$	195,688
Land and right of way			22,825				22,486
Other			5,294				5,267
Construction in progress			2,745				1,539
			227,172				224,980
Less accumulated depreciation			70,501				64,496
		$	156,671			$	160,484

During the three and six months ended June 30, 2007 and 2006, we did not capitalize any interest related to major construction projects.

Note 3: Transportation Agreements

Our transportation agreements consist of the following:

•		Costs incurred by Rio Grande in constructing certain pipeline and terminal facilities located in Mexico, which were then contributed to an affiliate of Pemex, the national oil company of Mexico. In exchange, Rio Grande received a 10-year transportation agreement from BP plc (“BP”). The initial 10-year term of this agreement expired in April 2007 and was extended for an additional year. This agreement will continue on a year-to-year basis unless cancelled by either party prior to the end of the previous contract year. The carrying amount of this asset was fully amortized and retired as of June 30, 2007.
•		A portion of the total purchase price of the Alon assets was allocated to the transportation agreement asset based on an estimated fair value derived under the income approach. This asset is being amortized over 30 years ending 2035, the 15-year initial term of the pipelines and terminals agreement with Alon plus the expected 15-year extension period.

The carrying amounts of our transportation agreements are as follows:

		June 30,				December 31,
		2007				2006
		(In thousands)
Rio Grande transportation agreement		$	—			$	20,836
Alon transportation agreement			59,933				59,933
			59,933				80,769
Less accumulated amortization			4,661				23,948
		$	55,272			$	56,821

Note 4: Debt

Credit Agreement

We have a four-year, $100.0 million senior secured revolving credit agreement (the “Credit Agreement”) expiring in July 2008. Union Bank of California, N.A. is one of the lenders and serves as administrative agent under this agreement. As of June 30, 2007 and December 31, 2006, we had no amounts outstanding under the Credit Agreement.

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 $50.0 million sub-limit. Up to $5.0 million is available to fund distributions to unitholders.

We have the right to request an increase in the maximum amount of the Credit Agreement, up to $175.0 million. Such request will become effective if (a) certain conditions specified in the Credit Agreement are met and (b) 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 HEP Logistics Holdings, L.P., 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.

Indebtedness under the Credit Agreement bears interest, at our option, at either (a) the base rate as announced by the administrative agent plus an applicable margin (ranging from 0.25% to 1.00%) or (b) at a rate equal to the London Interbank Offered Rate (“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. At June 30, 2007, we are subject to the 0.500% rate on the $100.0 million of the unused commitment on the Credit Agreement. 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

Our senior notes maturing March 1, 2015 are registered with the SEC and bear interest at 6.25% (“Senior Notes”). 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.

The $185.0 million principal amount of Senior Notes is recorded at $181.4 million on our consolidated balance sheets at June 30, 2007. The difference of $3.6 million is due to $2.9 million of unamortized discount and $0.7 million relating to the fair value of 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 $60.0 million of our 6.25% Senior Notes from a fixed rate to a variable rate. The interest rate on the $60.0 million notional amount is equal to three-month LIBOR plus an applicable margin of 1.1575%, which equaled an effective interest rate of 6.56% on $60.0 million of the debt during the six months ended June 30, 2007. 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 Statement of Financial Accounting Standard (“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 swap.

The fair value of our interest rate swap of $0.7 million and $1.2 million is included in “Other long-term liabilities” in our consolidated balance sheets at June 30, 2007 and December 31, 2006, respectively. The offsetting entry to adjust the carrying value of the debt securities whose fair value is being hedged is recognized as a reduction of “Long-term debt” on our consolidated balance sheets at June 30, 2007 and December 31, 2006.

Other Debt Information

		Six Months Ended
		June 30,
		2007				2006
		(In thousands)
Interest on outstanding debt:
Senior Notes, net of interest rate swap		$	5,874			$	5,690
Amortization of discount and deferred issuance costs			607				484
Commitment fees			248				248
Net interest expense		$	6,729			$	6,422
Cash paid for interest(1)		$	6,259			$	5,906

The estimated fair value of our Senior Notes was $173.0 million at June 30, 2007.

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 under certain provisions of an omnibus agreement we entered into with Holly in July 2004 (the “Omnibus Agreement”).

These employees participate in the retirement and benefit plans of Holly. Our share of retirement and benefits costs was $0.4 million for the three months ended June 30, 2007 and 2006 and $0.8 million and $0.6 million for the six months ended June 30 2007 and 2006, respectively.

We have adopted 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.

On June 30, 2007, we had two types of equity-based compensation, which are described below. The compensation cost charged against income for these plans was $0.5 million and $0.2 million for the three months ended June 30, 2007 and 2006, respectively, and $0.8 million and $0.4 million for the six months ended June 30, 2007 and 2006, respectively. It is currently our policy to purchase units in the open market instead of issuing new units for settlement of restricted unit grants. At June 30, 2007, 350,000 units were authorized to be granted under the equity-based compensation plans, of which 253,255 had not yet been granted.

Restricted Units

Under our Long-Term Incentive Plan, we grant restricted units to selected employees, consultants 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 vesting for certain key executives is contingent upon certain earnings per unit targets being realized. The fair value of each unit of restricted unit awards was measured at the market price as of the date of grant and is being amortized over the vesting period, including the units issued to the key executives, as we expect those units to fully vest.

A summary of restricted unit activity as of June 30, 2007, and changes during the six months ended June 30, 2007, is presented below:

										Weighted-
						Weighted-				Average				Aggregate
						Average				Remaining				Intrinsic
						Grant-Date				Contractual				Value
Restricted Units		Grants				Fair Value				Term				($000)
Outstanding January 1, 2007 (not vested)			36,597				40.21
Granted			19,687				46.12
Forfeited			(1,555	)			45.94
Vesting and transfer of full ownership to recipients			(4,170	)			39.45
Outstanding at June 30, 2007 (not vested)			50,559			$	42.02			1.1 years				$	2,573

There were 4,170 units vested and transferred to recipients during the six months ended June 30, 2007. As of June 30, 2007, there was $0.8 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 1.1 years.

Performance Units

Under our Long-Term Incentive Plan, we grant performance units to selected executives and employees who perform services for us. These performance units are payable upon meeting the performance criteria over a service period, and generally vest over a period of three years. The amount payable under the initial performance grant of 1,514 units in 2005 is based upon our unit price and upon our total unitholder return during the requisite period as compared to the total unitholder return of a selected peer group of partnerships. The amount payable under all other performance unit grants is based upon the growth in distributions per limited partner unit during the requisite period.

We granted 12,321 performance units to certain officers in February 2007. These units will vest over a three-year performance period ending December 31, 2009, and are payable in HEP common units. The number of units actually earned will be based on the growth of distributions to limited partners over the performance period, and can range from 50% to 150% of the number of performance units issued. The fair value of these performance units is based on the grant date closing unit price of $46.12 and will apply to the number of units ultimately awarded.

A summary of performance units activity as of June 30, 2007 and changes during the six months ended June 30, 2007 is presented below:

		Payable
Performance Units		In Units
Outstanding at January 1, 2007 (not vested)			14,015
Vesting and payment of cash benefit to recipients			—
Granted			12,321
Forfeited			(2,188	)
Outstanding at June 30, 2007 (not vested)			24,148

There were no payments for performance units vesting during the six months ended June 30, 2007. Based on the weighted average fair value at June 30, 2007 of $47.62, there was $0.6 million of total unrecognized compensation cost related to nonvested performance units. That cost is expected to be recognized over a weighted-average period of 1.9 years.

Note 6: Significant Customers

All revenues are domestic revenues, of which over 90% are currently generated from our three largest customers: Holly, Alon and BP. The major concentration of our petroleum products pipeline system’s revenue 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:

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2007				2006				2007				2006
Holly			60	%			57	%			59	%			56	%
Alon			29	%			30	%			28	%			30	%
BP			7	%			9	%			10	%			10	%

Note 7: Related Party Transactions

Holly

We serve Holly’s refineries in New Mexico and Utah under two 15-year pipeline and terminal agreements. One of these agreements relates to the pipelines and terminals contributed by Holly to us at the time of our initial public offering and expires in 2019 (“Holly PTA”). Our other agreement with Holly relates to the Intermediate Pipelines acquired from Holly in July 2005 and expires in 2020 (“Holly IPA”). The substantial majority of our business is devoted to providing transportation and terminalling services to Holly. The minimum revenue commitments under the Holly PTA and the Holly IPA increase each year at a rate equal to the percentage change in the producer price index (“PPI”), but will not decrease as a result of a decrease in the PPI.

Following the July 1, 2007 PPI rate adjustment, the volume commitments by Holly under the Holly PTA will produce at least $39.6 million of revenue for the twelve months ending June 30, 2008. Under the Holly IPA, Holly agreed to transport volumes of intermediate products on the Intermediate Pipelines that following the July 1, 2007 PPI rate adjustment, will result in minimum funds to us of $12.8 million for the twelve months ended June 30, 2008.

If Holly fails to meet its minimum revenue commitments in any quarter, it is 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.

Under certain provisions of the Omnibus Agreement that we entered with Holly in July 2004 and expires in 2019, we pay Holly an annual administrative fee, initially $2.0 million for each of the three years following the closing of our initial public offering, for the provision by Holly or its affiliates of various

general and administrative services to us. Effective July 1, 2007, the annual fee increased to $2.3 million in accordance with provisions under the agreement. This fee does not include the salaries of pipeline and terminal personnel or the cost of their employee benefits, such as 401(k), pension and health insurance benefits, which are separately charged to us by Holly. We also reimburse Holly and its affiliates for direct expenses they incur on our behalf.

•		Pipeline and terminal revenues received from Holly were $16.4 million and $10.6 million for the three months ended June 30, 2007 and 2006, respectively, and $30.1 million and $23.1 million for the six months ended June 30, 2007 and 2006, respectively. These amounts include the revenues received under the Holly PTA and Holly IPA.
•		Holly charged general and administrative services under the Omnibus Agreement of $0.5 million for the three months ended June 30, 2007 and 2006 and $1.0 million for the six months ended June 30, 2007 and 2006.
•		We reimbursed Holly for costs of employees supporting our operations of $2.3 million and $1.8 million for the three months ended June 30, 2007 and 2006, respectively, and $4.6 million and $3.7 million for the six months ended June 30, 2007 and 2006, respectively.
•		Holly reimbursed us $24,000 and $40,000 for certain costs paid on their behalf for the three months ended June 30, 2007 and 2006, respectively, and $98,000 and $96,000 for the six months ended June 30, 2007 and 2006, respectively.
•		In the three months ended June 30, 2007 and 2006, we distributed $5.6 million and $5.0 million, respectively, to Holly as regular distributions on its subordinated units, common units and general partner interest. We distributed $11.1 million and $9.8 million to Holly in the six months ended June 30, 2007 and 2006, respectively.
•		Our net accounts receivable from Holly were $3.9 million and $3.5 million at June 30, 2007 and December 31, 2006, respectively.
•		Holly has failed to meet its minimum revenue commitment for each of the first eight quarters of the Holly IPA. We have charged Holly $4.1 million for these shortfalls to date, $0.2 million of which is included in affiliate accounts receivable at June 30, 2007 and December 31, 2006.
•		For the three and six months ended June 30, 2007, our revenues from Holly included $1.1 million and $1.6 million, respectively, of shortfalls billed under the Holly IPA in 2006 as Holly did not exceed its minimum revenue obligation in any of the subsequent four quarters. Deferred revenue in the consolidated balance sheets at June 30, 2007 and December 31, 2006, includes $1.5 million and $2.4 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 $1.5 million deferred at June 30, 2007.

BP

We have a 70% ownership interest in Rio Grande and BP owns the other 30%. Due to the ownership interest and resulting consolidation, BP is a related party to us.

•		BP is the sole customer of Rio Grande. BP’s agreement to ship on the Rio Grande pipeline expired in April 2007 and was extended for an additional year. This agreement will continue on a year-to-year basis unless cancelled by either party prior to the end of the previous contract year. We recorded revenues from them of $1.8 million and $1.6 million for the three months ended June 30, 2007 and 2006, respectively, and $4.8 million and $4.0 million for the six months ended June 30, 2007 and 2006, respectively.
•		Rio Grande paid distributions to BP of $0.5 million and $0.6 million for the three months ended June 30, 2007 and 2006, respectively, and $0.5 million and $1.2 million for the six months ended June 30, 2007 and 2006, respectively.

•

Included in our accounts receivable – trade at June 30, 2007 and December 31, 2006 were $0.4 million and $2.1 million, respectively, which represented the receivable balance of Rio Grande from BP.

Alon

We have a 15-year pipelines and terminals agreement with Alon (the “Alon PTA”), expiring in 2020, under which Alon has agreed to transport on our pipelines and throughput through our terminals volumes of refined products that results in a minimum level of annual revenue. The agreed upon tariffs are increased or decreased annually at a rate equal to the percentage change in PPI, but not below the initial tariff rate. Following the March 1, 2007 PPI rate adjustment, Alon’s total minimum commitment for the twelve months ending December 31, 2007 is $20.8 million.

Alon became a related party when it acquired all of our Class B subordinated units in connection with our acquisition of assets from them on February 28, 2005.

•		We recognized $6.2 million and $5.6 million of revenues for pipeline transportation and terminalling services under the Alon PTA and $1.8 million and $1.7 million under a pipeline capacity lease for the three months ended June 30, 2007 and 2006, respectively. We recognized $10.7 million and $12.4 million of revenues for pipeline transportation and terminalling services under the Alon PTA and $3.5 million and $3.4 million under a pipeline capacity lease for the six months ended June 30, 2007 and 2006, respectively. The capacity lease agreements have remaining terms from less than a year up to three years.
•		We paid $0.7 million and $0.6 million to Alon for distributions on our Class B subordinated units for the three months ended June 30, 2007 and 2006, respectively, and $1.3 million and $1.2 million for the six months ended June 30, 2007 and 2006, respectively.
•		Included in our accounts receivable – trade at June 30, 2007 and December 31, 2006 were $4.4 million and $5.0 million, respectively, which represented the receivable balance from Alon.
•		For the three and six months ended June 30, 2007, our revenues from Alon included $1.5 million of shortfalls billed under the Alon PTA in 2006 as Alon did not exceed its minimum revenue obligation in any of the subsequent four quarters. Deferred revenue in the consolidated balance sheets at June 30, 2007 and December 31, 2006 includes $3.0 million and $3.1 million, respectively, relating to the Alon PTA. It is possible that Alon may not exceed its minimum obligations under the Alon PTA to allow Alon to receive credit for any of the $3.0 million deferred at June 30, 2007.

Note 8: Partners’ Equity and Cash Distributions

Issuances of units

Holly currently holds 7,000,000 of our subordinated units and 70,000 of our common units, which constitutes a 45% ownership interest in us, including the 2% general partner interest.

Holly’s subordinated units have the right to receive distributions of available cash from operating surplus in an amount equal to the minimum quarterly distribution of $0.50 per quarter, plus any arrearages in the payment of the minimum quarterly distribution on the common units from prior quarters, before any distributions of available cash from operating surplus may be made on the subordinated units. The purpose of the subordinated units is to increase the likelihood that cash is available for common unit distributions during the subordination period. The subordination period will extend until the first day of any quarter beginning after June 30, 2009 that each of the following tests are met: distributions of available cash from operating surplus on each of the outstanding common units and subordinated units equaled or exceeded the minimum quarterly distribution for each of the three consecutive, non-overlapping four-quarter periods immediately preceding that date; the “adjusted operating surplus” (as defined in its partnership agreement) generated during each of the three consecutive, non-overlapping

four-quarter periods immediately preceding that date equaled or exceeded the sum of the minimum quarterly distributions on all of the outstanding common units and subordinated units during those periods on a fully diluted basis and the related distribution on the 2% general partner interest during those periods; and there are no arrearages in payment of the minimum quarterly distribution on the common units. If the unitholders remove the general partner without cause, the subordination period may end before June 30, 2009. The Holly subordinated units may convert to common units on a one-for-one basis when certain conditions are met. The partnership agreement sets forth the calculation to be used to determine the amount and priority of cash distributions that the common unitholders, subordinated unitholders and general partner will receive.

Under our registration statement filed with the SEC using a “shelf” registration process, we may offer from time to time up to $800.0 million of our securities, through one or more prospectus supplements that would describe, among other things, the specific amounts, prices and terms of any securities offered and how the proceeds would be used. Any proceeds from the sale of securities would be used for general business purposes, which may include, among other things, funding acquisitions of assets or businesses, working capital, capital expenditures, investments in subsidiaries, the retirement of existing debt and/or the repurchase of common units or other securities.

Allocations of Net Income

Net income is allocated between limited partners and the general partner interest in accordance with the provisions of the partnership agreement. Net income allocated to the general partner includes any incentive distributions declared in the period. After the amount of incentive distributions is allocated to the general partner, the remaining net income for the period is generally allocated to the partners based on their weighted average ownership percentage during the period.

Cash Distributions

We consider regular cash distributions to unitholders on a quarterly basis, although there is no assurance as to the future cash distributions since they are dependent upon future earnings, cash flows, capital requirements, financial condition and other factors. Our Credit Agreement prohibits us from making cash distributions if any potential default or event of default, as defined in the Credit Agreement, occurs or would result from the cash distribution.

Within 45 days after the end of each quarter, we will distribute all of our available cash (as defined in our partnership agreement) to unitholders of record on the applicable record date. The amount of available cash generally is all cash on hand at the end of the quarter; less the amount of cash reserves established by our general partner to provide for the proper conduct of our business, comply with applicable law, any of our debt instruments, or other agreements; or provide funds for distributions to our unitholders and to our general partner for any one or more of the next four quarters; plus all cash on hand on the date of determination of available cash for the quarter resulting from working capital borrowings made after the end of the quarter. Working capital borrowings are generally borrowings that are made under our revolving Credit Agreement and in all cases are used solely for working capital purposes or to pay distributions to partners.

We make distributions of available cash from operating surplus for any quarter during any subordination period in the following manner: firstly, 98% to the common unitholders, pro rata, and 2% to the general partner, until we distribute for each outstanding common unit an amount equal to the minimum quarterly distribution for that quarter; secondly, 98% to the common unitholders, pro rata, and 2% to the general partner, until we distribute for each outstanding common unit an amount equal to any arrearages in payment of the minimum quarterly distribution on the common units for any prior quarters during the subordination period; thirdly, 98% to the subordinated unitholders, pro rata, and 2% to the general partner, until we distribute for each subordinated unit an amount equal to the minimum quarterly distribution for that quarter; and thereafter, cash in excess of the minimum quarterly distributions is distributed to the unitholders and the general partner based on the percentages below.

The 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 shown below:

				Marginal Percentage Interest in
		Total Quarterly Distribution		Distributions
		Target Amount		Unitholders				General Partner
Minimum Quarterly Distribution		$0.50			98	%			2	%
First Target Distribution		Up to $0.55			98	%			2	%
Second Target Distribution		above $0.55 up to $0.625			85	%			15	%
Third Target distribution		above $0.625 up to $0.75			75	%			25	%
Thereafter		Above $0.75			50	%			50	%

The following table presents the allocation of our regular quarterly cash distributions to the general and limited partners for each period in which declared.

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2007				2006				2007				2006
		(In thousands, except per unit data)
General partner interest		$	227			$	210			$	449			$	416
General partner incentive distribution			516				264				956				453
Total general partner distribution			743				474				1,405				869
Limited partner distribution			11,101				10,309				21,977				20,375
Total regular quarterly cash distribution		$	11,844			$	10,783			$	23,382			$	21,244
Cash distribution per unit applicable to limited partners		$	0.69			$	0.64			$	1.365			$	1.265

On July 26, 2007, we announced a cash distribution for the second quarter of 2007 of $0.705 per unit. The distribution is payable on all common, subordinated, and general partner units and will be paid August 14, 2007 to all unitholders of record on August 6, 2007. The aggregate amount of the distribution will be $12.2 million, including $0.6 million paid to the general partner as an incentive distribution.

As a master limited partnership, we distribute our available cash, which exceeds our net income because depreciation and amortization expense represents a non-cash charge against income. The result is a decline in partners’ equity since our regular quarterly distributions exceed our quarterly net income.

Note 9: 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 (“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.

Condensed Consolidating Balance Sheet
						Guarantor				Non-
June 30, 2007		Parent				Subsidiaries				Guarantor				Eliminations				Consolidated
		(in thousands)
ASSETS
Current assets:
Cash and cash equivalents		$	2			$	7,099			$	4,462			$	—			$	11,563
Accounts receivable			—				8,054				412				—				8,466
Intercompany accounts receivable (payable)			(109,671	)			109,878				(207	)			—				—
Prepaid and other current assets			6				932				—				—				938
Total current assets			(109,663	)			125,963				4,667				—				20,967
Properties and equipment, net			—				124,098				32,573				—				156,671
Investment in subsidiaries			324,956				25,675				—				(350,631	)			—
Transportation agreements, net			—				55,272				—				—				55,272
Other assets			1,378				901				—				—				2,279
Total assets		$	216,671			$	331,909			$	37,240			$	(350,631	)		$	235,189
LIABILITIES AND PARTNERS’ EQUITY
Current liabilities:
Accounts payable		$	—			$	1,480			$	392			$	—			$	1,872
Accrued interest			2,930				2				—				—				2,932
Deferred revenue			—				4,495				—				—				4,495
Accrued property taxes			—				527				87				—				614
Other current liabilities			516				122				83				—				721
Total current liabilities			3,446				6,626				562				—				10,634
Long-term debt			181,443				—				—				—				181,443
Other long-term liabilities			643				327				—				—				970
Minority interest			—				—				—				11,003				11,003
Partners’ equity			31,139				324,956				36,678				(361,634	)			31,139
Total liabilities and partners’ equity		$	216,671			$	331,909			$	37,240			$	(350,631	)		$	235,189

Condensed Consolidating Balance Sheet
						Guarantor				Non-
December 31, 2006		Parent				Subsidiaries				Guarantor				Eliminations				Consolidated
		(in thousands)
ASSETS
Current assets:
Cash and cash equivalents		$	2			$	9,819			$	1,734			$	—			$	11,555
Accounts receivable			—				8,772				2,085				—				10,857
Intercompany accounts receivable (payable)			(78,952	)			79,144				(192	)			—				—
Prepaid and other current assets			203				1,009				—				—				1,212
Total current assets			(78,747	)			98,744				3,627				—				23,624
Properties and equipment, net			—				127,357				33,127				—				160,484
Investment in subsidiaries			298,872				25,581				—				(324,453	)			—
Transportation agreements, net			—				56,271				550				—				56,821
Other assets			1,453				1,191				—				—				2,644
Total assets		$	221,578			$	309,144			$	37,304			$	(324,453	)		$	243,573
LIABILITIES AND PARTNERS’ EQUITY
Current liabilities:
Accounts payable		$	—			$	3,356			$	425			$	—			$	3,781
Accrued interest			2,941				—				—				—				2,941
Deferred revenue			—				5,486				—				—				5,486
Accrued property taxes			—				726				142				—				868
Other current liabilities			516				389				193				—				1,098
Total current liabilities			3,457				9,957				760				—				14,174
Long-term debt			180,660				—				—				—				180,660
Other long-term liabilities			1,235				315				—				—				1,550
Minority interest			—				—				—				10,963				10,963
Partners’ equity			36,226				298,872				36,544				(335,416	)			36,226
Total liabilities and partners’ equity		$	221,578			$	309,144			$	37,304			$	(324,453	)		$	243,573

Condensed Consolidating Statement of Income
						Guarantor				Non-
Three months ended June 30, 2007		Parent				Subsidiaries				Guarantor				Eliminations				Consolidated
		(in thousands)
Revenues:
Affiliates		$	—			$	16,353			$	—			$	—			$	16,353
Third parties			—				9,258				1,820				(300	)			10,778
			—				25,611				1,820				(300	)			27,131
Operating costs and expenses:
Operations			—				7,601				962				(300	)			8,263
Depreciation and amortization			—				2,851				357				—				3,208
General and administrative			739				515				21				—				1,275
			739				10,967				1,340				(300	)			12,746
Operating income (loss)			(739	)			14,644				480				—				14,385
Equity in earnings of subsidiaries			14,820				356				—				(15,176	)			—
Interest income (expense)			(3,075	)			(181	)			30				—				(3,226	)
Gain on sale of assets			—				1				—				—				1
Minority interest			—				—				—				(154	)			(154	)
Net income		$	11,006			$	14,820			$	510			$	(15,330	)		$	11,006

Condensed Consolidating Statement of Income
						Guarantor				Non-
Three months ended June 30, 2006		Parent				Subsidiaries				Guarantor				Eliminations				Consolidated
		(in thousands)
Revenues:
Affiliates		$	—			$	10,584			$	—			$	—			$	10,584
Third parties			—				6,607				1,637				(301	)			7,943
			—				17,191				1,637				(301	)			18,527
Operating costs and expenses:
Operations			—				7,006				724				(301	)			7,429
Depreciation and amortization			—				2,934				847				—				3,781
General and administrative			777				510				2				—				1,289
			777				10,450				1,573				(301	)			12,499
Operating income (loss)			(777	)			6,741				64				—				6,028
Equity in earnings of subsidiaries			6,788				65				—				(6,853	)			—
Interest income (expense)			(3,013	)			(18	)			29				—				(3,002	)
Minority interest			—				—				—				(28	)			(28	)
Net income		$	2,998			$	6,788			$	93			$	(6,881	)		$	2,998

Condensed Consolidating Statement of Income
						Guarantor				Non-
Six months ended June 30, 2007		Parent				Subsidiaries				Guarantor				Eliminations				Consolidated
		(in thousands)
Revenues:
Affiliates		$	—			$	30,115			$	—			$	—			$	30,115
Third parties			—				16,635				4,846				(593	)			20,888
			—				46,750				4,846				(593	)			51,003
Operating costs and expenses:
Operations			—				14,878				1,755				(593	)			16,040
Depreciation and amortization			—				6,074				1,205				—				7,279
General and administrative			1,505				1,035				22				—				2,562
			1,505				21,987				2,982				(593	)			25,881
Operating income (loss)			(1,505	)			24,763				1,864				—				25,122
Equity in earnings of subsidiaries			26,084				1,353				—				(27,437	)			—
Interest income (expense)			(6,139	)			(330	)			70				—				(6,399	)
Gain on sale of assets			—				298				—				—				298
Minority interest			—				—				—				(581	)			(581	)
Net income		$	18,440			$	26,084			$	1,934			$	(28,018	)		$	18,440

Condensed Consolidating Statement of Income
						Guarantor				Non-
Six months ended June 30, 2006		Parent				Subsidiaries				Guarantor				Eliminations				Consolidated
		(in thousands)
Revenues:
Affiliates		$	—			$	23,066			$	—			$	—			$	23,066
Third parties			—				14,488				4,006				(595	)			17,899
			—				37,554				4,006				(595	)			40,965
Operating costs and expenses:
Operations			—				13,676				1,457				(595	)			14,538
Depreciation and amortization			—				5,883				1,691				—				7,574
General and administrative			1,489				1,021				3				—				2,513
			1,489				20,580				3,151				(595	)			24,625
Operating income (loss)			(1,489	)			16,974				855				—				16,340
Equity in earnings of subsidiaries			17,577				637				—				(18,214	)			—
Interest income (expense)			(5,955	)			(34	)			55				—				(5,934	)
Minority interest			—				—				—				(273	)			(273	)
Net income		$	10,133			$	17,577			$	910			$	(18,487	)		$	10,133