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Blueknight Energy Partners, L.P. and subsidiaries (collectively, the “Partnership”) is a publicly traded master limited partnership with operations in 27 states. The Partnership provides integrated terminalling, gathering, transportation and marketing services for companies engaged in the production, distribution and marketing of crude oil and asphalt products. The Partnership manages its operations through four operating segments: (i) asphalt terminalling services, (ii) crude oil terminalling services, (iii) crude oil pipeline services and (iv) crude oil trucking services. On April 24, 2018, the Partnership sold the producer field services business. As a result of the sale of the producer field services business, the Partnership changed the name of the crude oil trucking and producer field services.services operating segment to crude oil trucking services during the second quarter of 2018. See Note 6 for additional information. The Partnership’s common units and preferred units, which represent limited partnership interests in the Partnership, are listed on the NASDAQ Global Market under the symbols “BKEP” and “BKEPP,” respectively. The Partnership was formed in February 2007 as a Delaware master limited partnership initially to own, operate and develop a diversified portfolio of complementary midstream energy assets.

The majority of the Partnership’s servicesservice revenue continues to be recognized as services are performed. Under the new revenue standard, the timing of revenue recognition on variable throughput fees will change, within a single reporting year, compared to the previous recognition.  The effect will be straight-line recognition of unconstrained estimated annual throughput volumes over each contract year.  See further discussion on variable throughput fees below. In addition, as a result of the adoption of the new revenue standard, revenue from leases is required to be presented separately from revenue from customers. As the Partnership applied the modified retrospective method, prior periods have not been reclassified.

Upon adoption of the new revenue standard, there was no cumulative adjustment to the balance sheet at January 1, 2018. Adoption of the new revenue standard resulted in recognition of an additional $0.1recognizing $1.6 million ofand $1.3 million less “Service revenue - Third-party revenue” in the unaudited condensed consolidated statementstatements of operations for the three and nine months ended March 31,September 30, 2018, respectively, and additional “Accounts receivable” of $0.2 million on the unaudited condensed consolidated balance sheet as of March 31,September 30, 2018, over what would have been recorded under ASC 605. While someThis represents a shift in revenue under storage, throughput and handling contracts in the asphalt terminalling segment will shiftrecognition between quarters within athe fiscal year, and the difference is anticipated to be recognized during the fourth quarter of 2018. The impact of adoption of the new revenue standard is not expected to be material to net income on an ongoing basis because the analysis of contracts under the new revenue standard supports the recognition of revenue as services are performed, which is consistent with the previous revenue recognition model.

Asphalt storage, throughput and handling contracts also contain variable consideration in the form of reimbursements of utility, fuel and power expenses and throughput fees. Utility, fuel and power reimbursements are allocated entirely to the service component of the contracts. Utility, fuel and power reimbursements relate directly to the distinct monthly service that makes up the overall performance obligation and revenue is recognized in the period in which the service takes place. Variable consideration related to reimbursements of utility, fuel and power expenses is billed in the month subsequent to the period of service, and payment is due within 30 days of billing. Throughput fees are allocated to both the lease and service component of the contracts using the allocation percentages from contract inception. Total throughput fees are estimated at contract inception and updated at the beginning of each reporting period based on historical trends, current year throughput activities at the facilities, and analysis with customers regarding expectations for the current year. This consideration can be constrained when there is a lack of historical data or other uncertainties exist regarding expected throughput volumes. The service component of throughput fees is recognized on a straight-line basis over time as the customer receives and consumes benefits. In accordance with ASC 840, the lease component of variable throughput fees is recognized in the period when the changes in facts and circumstances on which the variable payment is based occur. Fees related to actual throughput are billed in the month subsequent to the period of movement, which can result in the recognition of un-billed accounts receivable (contract assets) when there is a variance in the straight-line revenue recognition and actual throughput fees billed. Payment on variable throughput consideration is due within 30 days of billing. Changes in estimated throughput fees affect the total transaction price and will be recorded as an adjustment to revenue in the period in which the change is identified. There was no adjustmentThe Partnership recorded a decrease to revenue of $0.1 million related to changes in estimated throughput fees for the three months ended March 31,September 30, 2018.

Certain asphalt storage, throughput and handling contracts contain provisions for reimbursement of specified major maintenance costs above a specified threshold over the life of the contract. Reimbursements of specified major maintenance costs are allocated to both the lease and service component of the contracts using the allocation percentages from contract inception. Reimbursements of specified major maintenance costs are reviewed and paid quarterly, which may result in overpayments that must be paid back to the customer in future years. As such, the service component of this consideration is constrained and recorded in unearned revenue (contract liability) until facts and circumstances indicate it is probable that the minimum threshold will be met. In the event the minimum threshold is not met, the Partnership will return the reimbursement to the customer.

As of March 31,September 30, 2018, the Partnership has performance obligations satisfied over time under asphalt storage, throughput and handling contracts that are wholly or partially unsatisfied. The revenue related to these performance obligations will be recognized as follows (in thousands):

Crude oil terminalling services contracts can be either short- or long-term written contracts. The contracts contain a single performance obligation that consists of a series of distinct services provided over time. Customers are billed a month prior to the performance of terminalling services and payment is due by the first day of the month of service. Payments received in advance of the month of service are recorded as unearned revenue (contract liability) until the service is performed. These contracts also contain provisions under which customers are invoiced for product throughput in the month following the month in which the service is provided. Payment on product throughput is due within 30 days. The Partnership has elected to use the right-to-invoice expedient on crude oil terminalling services contracts as the right to consideration corresponds directly with the value to the customer of performance completed to date.

There are primarily two types of contracts in the crude oil pipeline segment: (i) monthly transportation contracts and (ii) product sales contracts.

Under crude oil pipeline services monthly transportation contracts, customers submit nominations for transportation monthly and a contract is created upon the Partnership’s acceptance of the nomination under ourits published tariffs. Crude oil pipeline services contracts have a single performance obligation to perform the transportation service. The transportation service is provided to the customer in the same month in which the customer makes the related nomination. Revenue is recorded in the month of service and invoiced in the following month. Payment is due within 30 days. The Partnership has elected to use the right-to-invoice expedient on crude oil pipeline services contracts as the right to consideration corresponds directly with the value to the customer of performance completed to date.

The Partnership also purchases crude oil and resells to third parties under written product sales contracts. Product sales contracts have a single performance obligation, and revenue is recognized at the point in time that control is transferred to the customer. Control is considered transferred to the customer on the day of the sale. Revenue is recorded in the month of service and invoiced in the following month. Payment is due within 30 days. The Partnership has elected to use the right-to-invoice expedient on product sales contracts as the right to consideration corresponds directly with the value to the customer of performance completed to date.

Services in the crude oil trucking and field services segment are provided under master service agreements with customers that include rate sheets. Contracts are initiated when a customer requests service and both parties are committed upon the Partnership’s acceptance of the customer’s request. Crude oil trucking and field services contracts have a single performance obligation to perform the service, which is completed in a day. Revenue is recorded in the month of service and invoiced in the following month. Payment is due within 30 days. The Partnership has elected to use the right-to-invoice expedient on crude oil trucking and field services revenues as the right to consideration corresponds directly with the value to the customer of performance completed to date.

The following table represents a disaggregationDisaggregation of revenue from contracts with customers for each operating segment by revenue type is presented as follows (in thousands):

The timing of revenue recognition, billings and cash collections result in billed accounts receivable, un-billed accounts receivable (contract assets) and unearned revenue (contract liabilities) on the unaudited condensed consolidated balance sheet as noted in the contract discussions above. Accounts receivable and un-billed accounts receivable are both reflected in the line items “Accounts receivable” and “Receivables from related parties” on the unaudited condensed consolidated balance sheet. Unearned revenue is included in the line items “Unearned revenue,” “Unearned revenue with related parties,” “Long-term unearned revenue with related parties” and “Other long-term liabilities” on the unaudited condensed consolidated balance sheet.

Billed accounts receivable from contracts with customers were $8.5 million and $8.4$44.9 million at December 31, 2017, and March 31,September 30, 2018, respectively.

Un-billed accounts receivable from contracts with customers were $0.1$0.2 million at March 31,September 30, 2018. There were no un-billed accounts receivable at December 31, 2017.

The Partnership records unearned revenues when cash payments are received in advance of performance. Unearned revenue related to contracts with customers was $3.7 million and $5.5$4.8 million at December 31, 2017, and March 31,September 30, 2018, respectively. The increasechange in the unearned revenue balance for the threenine months ended March 31,September 30, 2018, is driven by $3.3$2.8 million in cash payments received in advance of satisfying performance obligations, partially offset by $1.5$1.7 million of revenues recognized that were included in the unearned revenue balance at the beginning of the period.

The Partnership does not disclose the value of unsatisfied performance obligations for (i) contracts with an original expected length of one year or less and (ii) contracts for which revenue is recognized at the amount to which the Partnership has the right to invoice for services performed. The Partnership is using the right-to-invoice practical expedient on all contracts with customers in its crude oil terminalling services, crude oil pipeline services and crude oil trucking and producer field services segments.

On April 3, 2017, Advantage Pipeline was acquired by a joint venture formed by affiliates of Plains All American Pipeline, L.P. and Noble Midstream Partners LP. The Partnership received cash proceeds at closing from the sale of its approximate 30% equity ownership interest in Advantage Pipeline of approximately $25.3 million and recorded a gain on the sale of the investment of $4.2 million. Approximately 10% of the gross sale proceeds were held in escrow, subject to certain post-closing settlement terms and conditions. The Partnership received approximately $1.1 million of the funds held in escrow in August 2017, and approximately $2.2 million for its pro rata portion of the remaining net escrow proceeds in January 2018. The Partnership’s proceeds were used to prepay revolving debt (without a commitment reduction). The operating and administrative services agreement to which the Partnership and Advantage Pipeline were parties and under which the Partnership operated the 70-mile, 16-inch Advantage crude oil pipeline, located in the southern Delaware Basin in Texas, was terminated at closing. The Partnership and the Plains/Noble joint venture entered into a short-term transition services agreement under which the Partnership provided certain services through August 1, 2017.

Summarized financial information for Advantage Pipeline is set forth in the tables below for the periodsperiod indicated in which the Partnership held the investment in Advantage Pipeline (in thousands):

Depreciation expense for the three months ended March 31,September 30, 2017 and 2018, was $7.7$7.4 million and $7.0$6.5 million, respectively. Depreciation expense for the nine months ended September 30, 2017 and 2018, was $22.6 million and $20.2 million, respectively.

In March 2018, the Partnership acquired an asphalt terminalling facility in Oklahoma from a third party for approximately $22.0 million, consisting of property, plant and equipment of $11.5 million, intangible assets of $7.6 million and goodwill of $2.9 million.

On December 1, 2017, the Partnership issued 1.9 million common units to Ergon, Inc. (“Ergon”) in a private placement valued at $10.2 million in exchange for an asphalt terminalling facility in Bainbridge, Georgia.

In April 18, 2017, the Partnership sold its East Texas pipeline system, which was included in assets held for sale as of March 31, 2017.system. The Partnership received cash proceeds at closing of approximately $4.8 million and recorded a gain of less than $0.1 million. The Partnership used the proceeds received at closing to prepay revolving debt (without a commitment reduction).

As of May 3,October 25, 2018, approximately $328.6$257.6 million of revolver borrowings and $1.5$4.2 million of letters of credit were outstanding under the credit agreement, leaving the Partnership with approximately $119.9$138.2 million available capacity for additional revolver borrowings and letters of credit under the credit agreement, although the Partnership’s ability to borrow such funds may be limited by the financial covenants in the credit agreement.  The proceeds of loans made under the credit agreement may be used for working capital and other general corporate purposes of the Partnership.

The credit agreement is guaranteed by all of the Partnership’s existing subsidiaries. Obligations under the credit agreement are secured by first priority liens on substantially all of the Partnership’s assets and those of the guarantors.

 

 

The credit agreement will mature on May 11, 2022, and all amounts outstanding under the credit agreement will become due and payable on such date. The credit agreement requires mandatory prepayments of amounts outstanding thereunder with the net proceeds of certain asset sales, property or casualty insurance claims and condemnation proceedings, unless the Partnership reinvests such proceeds in accordance with the credit agreement, but these mandatory prepayments will not require any reduction of the lenders’ commitments under the credit agreement.

From and after the date on which the Partnership issues qualified senior notes in an aggregate principal amount (when combined with all other qualified senior notes previously or concurrently issued) that equals or exceeds $200.0 million, the maximum permitted consolidated total leverage ratio is 5.00 to 1.00; provided that from and after the fiscal quarter ending immediately preceding the fiscal quarter in which a specified acquisition occurs to and including the last day of the second full fiscal quarter following the fiscal quarter in which such acquisition occurred, the maximum permitted consolidated total leverage ratio will be 5.50 to 1.00.

The maximum permitted consolidated senior secured leverage ratio (as defined in the credit agreement, but generally computed as the ratio of consolidated total secured debt to consolidated earnings before interest, taxes, depreciation, amortization and certain other non-cash charges) is 3.50 to 1.00, but this covenant is only tested from and after the date on which the Partnership issues qualified senior notes in an aggregate principal amount (when combined with all other qualified senior notes previously or concurrently issued) that equals or exceeds $200.0 million.

The credit agreement permits the Partnership to make quarterly distributions of available cash (as defined in the Partnership’s partnership agreement) to unitholders so long as no default or event of default exists under the credit agreement on a pro forma basis after giving effect to such distribution.distribution, provided, however, commencing with the fiscal quarter ending September 30, 2018, in no event shall aggregate quarterly distributions in any individual fiscal quarter exceed $10.7 million through, and including, the fiscal quarter ending December 31, 2019. The Partnership is currently allowed to make distributions to its unitholders in accordance with this covenant; however, the Partnership will only make distributions to the extent it has

In addition to other customary events of default, the credit agreement includes an event of default if:

If an event of default relating to bankruptcy or other insolvency events occurs with respect to the general partner or the Partnership, all indebtedness under the credit agreement will immediately become due and payable.  If any other event of default exists under the credit agreement, the lenders may accelerate the maturity of the obligations outstanding under the credit agreement and exercise other rights and remedies.  In addition, if any event of default exists under the credit agreement, the lenders may commence foreclosure or other actions against the collateral.

 

If any default occurs under the credit agreement, or if the Partnership is unable to make any of the representations and warranties in the credit agreement, the Partnership will be unable to borrow funds or to have letters of credit issued under the credit agreement. 

Upon the execution of the amended and restated credit agreement in May 2017, the Partnership expensed $0.7 million of debt issuance costs related to the prior revolving loan facility, leaving a remaining balance of $0.9 million ascribed to those lenders with commitments under both the prior and the amended and restated credit agreement. Additionally, due to the reduction in available borrowing capacity, the Partnership expensed $0.4 million of debt issuance costs upon the execution of the first amendment to its credit agreement in June 2018. The Partnership capitalized $0.2 million and less than $0.1 million of debt issuance costs during the three months ended March 31, 2017.September 30, 2017 and 2018, respectively. The Partnership capitalized no$4.2 million and $0.4 million of debt issuance costs during the threenine months ended March 31, 2018.September 30, 2017 and 2018, respectively. Debt issuance costs are being amortized over the term of the credit agreement. Interest expense related to debt issuance cost amortization for each of the three months ended March 31,September 30, 2017 and 2018, was $0.3 million. Interest expense related to debt issuance cost amortization for the nine months ended September 30, 2017 and 2018, was $0.9 million and $0.8 million, respectively.

  

During the three months ended March 31,September 30, 2017 and 2018, the weighted average interest rate under the Partnership’s credit agreement was 4.11%4.54% and 4.96%5.65%, respectively, resulting in interest expense of approximately $3.3$3.5 million and $3.9$4.1 million, respectively.

The following provides information regarding the Partnership’s assets and liabilities related to its interest rate swap agreements as of the periods indicated (in thousands):

Changes in the fair value of the interest rate swaps are reflected in the unaudited condensed consolidated statements of operations as follows (in thousands):

For purposes of calculating earnings per unit, the excess of distributions over earnings or excess of earnings over distributions for each period are allocated to the Partnership’s general partner based on the general partner’s ownership interest at the time. The following sets forth the computation of basic and diluted net income per common unit (in thousands, except per unit data): 

On December 1, 2017, the Partnership issued 1,898,3801.9 million common units to Ergon in a private placement valued at $10.2 million in exchange for an asphalt terminalling facility in Bainbridge, Georgia.

The Partnership leases asphalt facilities to Ergon and provides asphalt terminalling services to Ergon. For the three months ended March 31,September 30, 2017 and 2018, the Partnership recognized related-party revenues of $13.3$14.5 million and $14.0$11.1 million, respectively, for services provided to Ergon. For the nine months ended September 30, 2017 and 2018, the Partnership recognized related-party revenues of $41.3 million and $38.6 million, respectively, for services provided to Ergon. As of December 31, 2017, and March 31,September 30, 2018, the Partnership had receivables from Ergon of $3.1 million and $2.1$1.6 million, respectively, net of allowance for doubtful accounts. As of December 31, 2017, and March 31,September 30, 2018, the Partnership had unearned revenues from Ergon of $1.6 million and $5.3$3.6 million, respectively.

The Partnership provided operating and administrative services to Advantage Pipeline. On April 3, 2017, the Partnership sold its investment in Advantage Pipeline. See Note 5 for additional information. For the threenine months ended March 31,September 30, 2017, the Partnership earned revenues of $0.3 million for services provided to Advantage Pipeline.

In July 2007, the general partner adopted the Long-Term Incentive Plan (the “LTIP”), which is administered by the compensation committee of the Board. Effective April 29, 2014, the Partnership’s unitholders approved an amendment to the LTIP to increase the number of common units reserved for issuance under the incentive plan to 4,100,000 common units, subject to adjustments for certain events.  Although other types of awards are contemplated under the LTIP, currently outstanding awards include “phantom” units, which convey the right to receive common units upon vesting, and “restricted” units, which are grants of common units restricted until the time of vesting. The phantom unit awards also include distribution equivalent rights (“DERs”).

 

Subject to applicable earning criteria, a DER entitles the grantee to a cash payment equal to the cash distribution paid on an outstanding common unit prior to the vesting date of the underlying award. Recipients of restricted and phantom units are entitled to receive cash distributions paid on common units during the vesting period which are reflected initially as a reduction of partners’ capital. Distributions paid on units which ultimately do not vest are reclassified as compensation expense.  Awards granted to date are equity awards and, accordingly, the fair value of the awards as of the grant date is expensed over the vesting period.  

In connection with each anniversary of joining the Board, restricted common units are granted to the independent directors. The units vest in one-third increments over three years. The following table includes information on outstanding grants made to the directors under the LTIP:

The Partnership’s equity-based incentive compensation expense for each of the three months ended March 31,September 30, 2017 and 2018, was $0.5 million.$0.6 million and $0.7 million, respectively. The Partnership’s equity-based incentive compensation expense for the nine months ended September 30, 2017 and 2018, was $1.7 million and $1.8 million, respectively.

Activity pertaining to phantom and restricted common unit awards granted under the LTIP is as follows: 

The Partnership may also make annual lump-sum contributions to the 401(k) Plan irrespective of the employee’s contribution match. The Partnership may make a discretionary annual contribution in the form of profit sharing calculated as a percentage of an employee’s eligible compensation. This contribution is retirement income under the qualified 401(k) Plan. Annual profit sharing contributions to the 401(k) Plan are submitted to and approved by the Board. The Partnership recognized expense of $0.2 million and less than $0.1 million for the three months ended March 31,September 30, 2017 and 2018, respectively, for discretionary profit sharing contributions under the 401(k) Plan. The Partnership recognized expense of $0.6 million and $0.1 million for the nine months ended September 30, 2017 and 2018, respectively, for discretionary profit sharing contributions under the 401(k) Plan.

The Partnership uses valuation techniques, such as the market approach (comparable market prices), the income approach (present value of future income or cash flow), and the cost approach (cost to replace the service capacity of an asset or replacement cost) to value assets and liabilities required to be measured at fair value, as appropriate. The Partnership uses an exit price when determining the fair value. The exit price represents amounts that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants.

 

The Partnership utilizes a three-tier fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The following is a brief description of those three levels:

 

This hierarchy requires the use of observable market data, when available, to minimize the use of unobservable inputs when determining fair value.  In periods in which they occur, the Partnership recognizes transfers into and out of Level 3 as of the end of the reporting period. There were no transfers during the threenine months ended March 31,September 30, 2018. Transfers out of Level 3 represent existing assets and liabilities that were classified previously as Level 3 for which the observable inputs became a more significant portion of the fair value estimates. Determining the appropriate classification of the Partnership’s fair value measurements within the fair value hierarchy requires management’s judgment regarding the degree to which market data is observable or corroborated by observable market data.

The Partnership’s recurring financial assets and liabilities subject to fair value measurements and the necessary disclosures are as follows (in thousands): 

The following disclosure of the estimated fair value of financial instruments is made in accordance with accounting guidance for financial instruments. The Partnership has determined the estimated fair values by using available market information and valuation methodologies. Considerable judgment is required in interpreting market data to develop the estimates of fair value. The use of different market assumptions or valuation methodologies may have a material effect on the estimated fair value amounts.

 

At March 31,September 30, 2018, the carrying values on the unaudited condensed consolidated balance sheets for cash and cash equivalents (classified as Level 1), accounts receivable, and accounts payable approximate their fair value because of their short-term nature.

 

Based on the borrowing rates currently available to the Partnership for credit agreement debt with similar terms and maturities and consideration of the Partnership’s non-performance risk, long-term debt associated with the Partnership’s credit agreement at March 31,September 30, 2018, approximates its fair value. The fair value of the Partnership’s long-term debt was calculated using observable inputs (LIBOR for the risk-free component) and unobservable company-specific credit spread information.   As such, the Partnership considers this debt to be Level 3.

 

 

The Partnership’s management evaluates performance based upon operating margin, excluding amortization and depreciation, which includes revenues from related parties and external customers and operating expense, excluding depreciation and amortization. The non-GAAP measure of operating margin, excluding depreciation and amortization (in the aggregate and by segment) is presented in the following table. The Partnership computes the components of operating margin,

The following table reflects certain financial data for each segment for the periods indicated (in thousands):