UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

Securities registered pursuant to Section 12(b) of the Exchange Act:

 As of May 6,August 1, 2019, there were 35,125,202 Series A Preferred Units and 40,714,85740,813,488 common units outstanding.   

PART I. FINANCIAL INFORMATION

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements. 

BLUEKNIGHT ENERGY PARTNERS, L.P.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1.    ORGANIZATION AND NATURE OF BUSINESS

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. 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.

2.    BASIS OF CONSOLIDATION AND PRESENTATION

Certain reclassifications have been made in the consolidated balance sheet as of December 31, 2018, and the consolidated statement of cash flows for the threesix months ended March 31,June 30, 2018, to conform to the 2019 financial statement presentation. These reclassifications relate to items included in “Other current assets” and “Other noncurrent assets.” Reclassifications on the consolidated statement of cash flows were limited to the “Cash flows from operating activities” section. The reclassifications have no impact on net income.

3.    REVENUE

activities as directed by the customer, and revenue is recognized on a straight-line basis over time as the customer receives and

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. In accordance with ASC 842, 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. Additionally, under ASC 842, when variable consideration contains both a lease and non-lease service component, the service component cannot be recognized until the period in which the changes in facts and circumstances on which the variable payment is based occur. At that time, it can be recognized in accordance with ASC 606. The service component of variable throughput fees is treated as a change in estimate in the period in when the changes in facts and circumstances on which the variable payment is based occur and is then recognized on a straight-line basis over time as the customer receives and consumes benefits. Payment on variable throughput consideration is due within 30 days of billing.

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, 2019, the Partnership has serviceThe following table includes revenue associated with contractual commitments in place related to future performance obligations satisfied over time under asphalt storage, throughput and handling contracts thatas of the end of the reporting period, which are wholly or partially unsatisfied. The service revenue relatedexpected to these performance obligations will be recognized as followsin revenue in the specified periods (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 its 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 andCustomers are 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 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 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 revenues as the right to consideration corresponds directly with the value to the customer of performance completed to date.

Disaggregation 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 and unearned revenue (contract liabilities) on the unaudited condensed consolidated balance sheets as noted in the contract discussions above. Accounts receivable are reflected in the line items “Accounts receivable” and “Receivables from related parties” on the unaudited condensed consolidated balance sheets. 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 sheets.

Billed accounts receivable from contracts with customers were $34.6 million and $25.8$23.8 million at December 31, 2018, and March 31,June 30, 2019, respectively.

The Partnership records unearned revenues when cash payments are received in advance of performance. Unearned revenue related to contracts with customers was $5.9 million and $10.1$6.4 million at December 31, 2018, and March 31,June 30, 2019, respectively. The change in the unearned revenue balance for the threesix months ended March 31,June 30, 2019, is driven by $7.3$3.7 million in cash payments received in advance of satisfying performance obligations, partially offset by $3.1$3.2 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 services segments.

4.     RESTRUCTURING CHARGES

During the fourth quarter of 2015, the Partnership recognized certain restructuring charges in its crude oil trucking services segment pursuant to an approved plan to exit the trucking market in West Texas. The restructuring charges included an accrual related to leased vehicles that were idled as part of the restructuring plan. This accrual was being amortized over the remaining lease term of the vehicles. In June 2018, the Partnership purchased the vehicles off lease and resold them to a third party, paying off the remaining liability.

5.    EQUITY METHOD INVESTMENT

 

The Partnership’s investment in Advantage Pipeline, L.L.C. (“Advantage Pipeline”), over which the Partnership had significant influence but not control, was accounted for by the equity method. The Partnership did not consolidate any part of the assets or liabilities of Advantage Pipeline. 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). As of March 31,June 30, 2019, the Partnership had no equity investments.

6.    PROPERTY, PLANT AND EQUIPMENT

 

Plant, propertyProperty, plant and equipment under operating leases at March 31,June 30, 2019, in which the Partnership is the lessor, had a cost basis of $282.1$284.9 million and accumulated depreciation of $173.3$175.7 million.

Depreciation expense for the three months ended March 31,June 30, 2018 and 2019, was $7.0$6.7 million and $6.0$5.5 million, respectively. Depreciation expense for the six months ended June 30, 2018 and 2019, was $13.7 million and $11.4 million, respectively.

During the threesix months ended March 31,June 30, 2019, the Partnership recognized asset impairment expense of $1.1$2.2 million. A change in estimate of the push-down impairment related to Cimarron Express Pipeline, LLC (“Cimarron Express”) resulted in additional impairment expense of $0.8$1.9 million. This impairment is recorded at the corporate level and the estimate is based on the expected amount due to Ergon, Inc. (“Ergon”) if the Put (as defined in Note 10) is exercised (see Note 10 for more information). In addition, a floodflooding at anseveral asphalt terminalplants in Wolcott, Kansas,the Midwest led to an impairment of $0.3 million.

During the threesix months ended March 31,June 30, 2019, the Partnership sold various surplus assets, including the sale of three truck stations for $1.6 million, which resulted in a gain of $1.5 million, and the sale of pipeline linefill for $1.6 million, which resulted in a gain of $0.2 million. In addition, proceeds received during the threesix months ended March 31,June 30, 2019, included $2.6 million related to a sale of pipeline linefill in December 2018, for which the proceeds were received in January 2019.

On July 12, 2018, the Partnership sold certain asphalt terminals, storage tanks and related real property, contracts, permits, assets and other interests located in Lubbock and Saginaw, Texas and Memphis, Tennessee (the “Divestiture”) to Ergon Asphalt & Emulsion, Inc. for a purchase price of $90.0 million, subject to customary adjustments. The Divestiture does not qualify as discontinued operations as it does not represent a strategic shift that will have a major effect on the Partnership’s operations or financial results. The Partnership used the proceeds from the sale to prepay revolving debt under its credit agreement.

In April 2018, the Partnership sold its producer field services business. The Partnership received cash proceeds at closing of approximately $3.0 million and recorded a gain of $0.4 million. The sale of the producer field services business does not qualify as discontinued operations as it does not represent a strategic shift that will have a major effect on the Partnership’s operations or financial results. The Partnership used the proceeds from the sale to prepay revolving debt under its credit agreement.

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.

7.    DEBT

As of May 6,August 1, 2019, approximately $251.6$256.6 million of revolver borrowings and $1.0 million of letters of credit were outstanding under the credit agreement, leaving the Partnership with approximately $147.4$142.4 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.

Management evaluates whether conditions and/or events raise substantial doubt about the Partnership’s ability to continue as a going concern within one year after the date that the consolidated financial statements are issued (the “assessment period”). In performing this assessment, management considered the risk associated with its ongoing ability to meet the financial covenants.

Based on the Partnership’s forecasted credit agreement EBITDA during the assessment period, management believes that it will meetremain in compliance with these financial covenants (as described below). However, there are certain inherent risks associated with our continued ability to comply with our consolidated total leverage ratio covenant. These risks relate, among other things, to potential future (a) decreases in storage volumes and rates as well as throughput and transportation rates realized; (b) weather phenomenon that may potentially hinder the Partnership’s asphalt business activity; and (c) other items affecting forecasted levels of expenditures and uses of cash resources. Violation of the consolidated total leverage ratio covenant would be an event of default under the credit agreement, which would cause our $252.6$261.6 million in outstanding debt, as of March 31,June 30, 2019, to become immediately due and payable. If this were to occur, the Partnership would not expect to have sufficient liquidity to repay these outstanding amounts then due, which could cause the lenders under the credit facility to pursue other remedies. Such remedies could include exercising their collateral rights to the Partnership’s assets.

Based on management’s current forecasts, management believes the Partnership will be able to comply with the consolidated total leverage ratio during the assessment period. However, the Partnership cannot make any assurances that it will be able to achieve management’s forecasts. If the Partnership is unable to achieve management’s forecasts, further actions may be necessary to remain in compliance with the Partnership’s consolidated total leverage ratio covenant including, but not limited to, cost reductions, common and preferred unitholder distribution curtailments, and/or asset sales. The Partnership can make no assurances that it would be successful in undertaking these actions or that the Partnership will remain in compliance with the consolidated total leverage ratio during the assessment period.

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, 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 sufficient cash from operations after establishment of cash reserves as determined by the Board of Directors (the “Board”) of Blueknight Energy Partners G.P., L.L.C. (the “general partner”) in accordance with the Partnership’s cash distribution policy, including the establishment of any reserves for the proper conduct of the Partnership’s business.  See Note 9 for additional information regarding distributions.

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 first amendment to its credit agreement in June 2018, the Partnership expensed $0.4 million of debt issuance costs due to the reduction in available borrowing capacity. The Partnership capitalized $0.3 million of debt issuance costs during each of the three and six months ended June 30, 2018. 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,June 30, 2018 and 2019, was $0.3 million. Interest expense related to debt issuance cost amortization for each of the six months ended June 30, 2018 and 2019, was $0.5 million.

  

During the three months ended March 31,June 30, 2018 and 2019, the weighted average interest rate under the Partnership’s credit agreement, excluding the $0.4 million of debt issuance costs in 2018 that were expensed as described above, was 4.96%5.39% and 6.43%6.27%, respectively, resulting in interest expense of approximately $3.94.7 million and $4.3$4.1 million, respectively. During the six months ended June 30, 2018 and 2019, the weighted average interest rate under the Partnership’s credit agreement, excluding the $0.4 million of debt issuance costs in 2018 that were expensed as described above, was 5.18% and 6.35%, respectively, resulting in interest expense of approximately $8.6 million and $8.4 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):

8.    NET INCOME PER LIMITED PARTNER UNIT

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): 

9.    PARTNERS’ CAPITAL AND DISTRIBUTIONS

  

10.    RELATED-PARTY TRANSACTIONS

Transactions with Ergon

The Partnership leases asphalt facilities and provides asphalt terminalling services to Ergon. For the three months ended March 31,June 30, 2018 and 2019, the Partnership recognized related-party revenues of $14.0$13.5 million and $9.1$8.8 million, respectively, for services provided to Ergon. For the six months ended June 30, 2018 and 2019, the Partnership recognized related-party revenues of $27.5 million and $17.9 million, respectively, for services provided to Ergon. As of December 31, 2018, and March 31,June 30, 2019, the Partnership had receivables from Ergon of $1.0 million and $0.9$1.1 million, respectively, net of allowance for doubtful accounts. As of December 31, 2018, and March 31,June 30, 2019, the Partnership had unearned revenues from Ergon of $6.5 million and $16.8$9.3 million, respectively.

Effective April 1, 2018, the Partnership entered into an agreement with Ergon under which the Partnership purchases crude oil in connection with its crude oil marketing operations. For the three months ended March 31,June 30, 2018 and 2019, the Partnership

made purchases of crude oil under this agreement totaling $30.5 million and $36.1 million, respectively. For the six months ended June 30, 2018 and 2019, the Partnership made purchases of crude oil under this agreement totaling $29.7 million.$30.5 million and $65.8 million, respectively. As of March 31,June 30, 2019, the Partnership had payables to Ergon related to this agreement of $11.9$10.2 million related to the MarchJune crude oil settlement cycle, and this balance was paid in full on AprilJuly 19, 2019.

The Partnership and Ergon have an agreement (the “Agreement”) that gives each party rights concerning the purchase or sale of Ergon’s interest in Cimarron Express, subject to certain terms and conditions. Cimarron Express was planned to be a new 16-inch diameter, 65-mile crude oil pipeline running from northeastern Kingfisher County, Oklahoma to the Partnership’s Cushing, Oklahoma crude oil terminal, with an originally anticipated in-service date in the second half of 2019. Ergon formed a Delaware limited liability company, Ergon - Oklahoma Pipeline, LLC (“DEVCO”), which holds Ergon’s 50% membership interest in Cimarron Express. Under the Agreement, the Partnership has the right, at any time, to purchase 100% of the authorized and outstanding member interests in DEVCO from Ergon for the Purchase Price (as defined in the Agreement), which shall be computed by taking Ergon’s total investment in the Cimarron Express plus interest, by giving written notice to Ergon (the “Call”). Ergon has the right to require the Partnership to purchase 100% of the authorized and outstanding member interests of DEVCO for the Purchase Price (the “Put”) at any time beginning the earlier of (i) 18 months from the formation, May 9, 2018, of the joint venture company to build the pipeline, (ii) six months after completion of the pipeline, or (iii) the event of dissolution of Cimarron Express. Upon exercise of the Call or the Put, the Partnership and Ergon will execute the Member Interest Purchase Agreement, which is attached to the Agreement as Exhibit B. Upon receipt of the Purchase Price, Ergon shall be obligated to convey 100% of the authorized and outstanding member interests in DEVCO to the Partnership or its designee. As of March 31,June 30, 2019, neither Ergon nor the Partnership has exercised their options under the Agreement.

In December 2018, the Partnership and Ergon were informed that Kingfisher Midstream made the decision to suspend future investments in Cimarron Express as Kingfisher Midstream determined that the anticipated volumes from the currently dedicated acreage, and the resultant project economics, did not support additional investment from Kingfisher Midstream. As of December 31, 2018, Cimarron Express had spent approximately $30.6 million on the pipeline project, primarily related to the purchase of steel pipe and equipment, rights of way and engineering and design services. Cimarron Express recorded a $20.9 million impairment charge in the fourth quarter of 2018 to reduce the carrying amount of its assets to their estimated fair value. In addition to its capital contributions to Cimarron Express, Ergon’s interest in DEVCO includes internal Ergon labor and capitalized interest that bring its investment in DEVCO to approximately $17.8 million through March 31, 2019. Ergon recorded a $10.0 million other-than-temporary impairment on its investment in Cimarron Express as of December 31, 2018, to reduce its investment to its estimated fair value. As a result, the Partnership considered the SEC staff’s opinions outlined in SAB 107 Topic 5.T Accounting for Expenses or Liabilities Paid by Principal Stockholders. The Agreement was designed to have the Partnership, ultimately and from the onset, bear any risk of loss on the construction of the pipeline project and eventually own a 50% interest in the pipeline. As a result, the Partnership recorded on a push downpush-down basis a $10.0 million impairment of Ergon’s investment in Cimarron Express in its consolidated results of operations during the year ended December 31, 2018, and a contingent liability payable to Ergon as of December 31, 2018. In April 2019, certain assets from the project were sold to a third-partythird party for approximately $1.4 million over the fair market value that was estimated at December 31, 2018. As a result,2018, and the Partnership will record in April 2019,recorded its share, on a push downpush-down basis, a gain on the sale based on Ergon’s 50% interest in the assets. Ergon’s interest in DEVCO includes its capital contributions, its share of the cash received for the assets sale discussed above, internal Ergon labor costs and capitalized interest, which brings its investment in DEVCO to approximately $10.7 million through June 30, 2019. During the six months ended June 30, 2019, a change in estimate and accrued interest resulted in the Partnership recording additional impairment expense of $1.9 million. The Partnership’s contingent liability as of June 30, 2019, consists of Ergon’s $10.7 million investment plus accrued interest of $1.3 million, of which $0.4 million of interest relates to the three months ended June 30, 2019.

11.    LONG-TERM INCENTIVE PLAN

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:

_________________

In addition, the independent directors received common unit grants that have no vesting requirement as part of their compensation. The following table includes information on grants made to the directors under the LTIP that have no vesting requirement:

_________________

_________________

The Partnership’s equity-based incentive compensation expense for the three months ended March 31,June 30, 2018 and 2019, was $0.5$0.6 million and $0.3 million, respectively. The Partnership’s equity-based incentive compensation expense for the six months ended June 30, 2018 and 2019, was $1.1 million and $0.6 million, respectively.

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

12.    EMPLOYEE BENEFIT PLANS

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 less than $0.1 million and $0.2$0.1 million for the three months ended March 31,June 30, 2018 and 2019, respectively, for discretionary profit sharing contributions under the 401(k) Plan. The Partnership recognized expense of $0.1 million and $0.3 million for the six months ended June 30, 2018 and 2019, respectively, for discretionary profit sharing contributions under the 401(k) Plan.

Under the Partnership’s Employee Unit Purchase Plan (the “Unit Purchase Plan”), which was instituted in January 2015, employees have the opportunity to acquire or increase their ownership of common units representing limited partner interests in the Partnership. Eligible employees who enroll in the Unit Purchase Plan may elect to have a designated whole percentage, up to a specified maximum, of their eligible compensation for each pay period withheld for the purchase of common units at a discount to the then current market value. A maximum of 1,000,000 common units may be delivered under the Unit Purchase Plan, subject to adjustment for a recapitalization, split, reorganization, or similar event pursuant to the terms of the Unit Purchase Plan. The Partnership recognized compensation expense of less than $0.1 million for the each of the three and six months ended March 31,June 30, 2018 and 2019, in connection with the Unit Purchase Plan.

 

13.    FAIR VALUE MEASUREMENTS

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 threesix months ended March 31,June 30, 2019. 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): 

As of March 31,June 30, 2019, the Partnership had no interest rate swap agreements.

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,June 30, 2019, 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,June 30, 2019, 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.

14.    LEASES

Adoption of the new standard resulted in the recording of additional net right of use operating lease assets and operating lease liabilities of approximately $11.8 million and $11.9 million, respectively, as of January 1, 2019. The standard did not materially impact the consolidated statement of operations and had no impact on cash flows.

The Partnership leases certain office space, land and equipment. Leases with an initial term of 12 months or less are not recorded on the balance sheet; lease expense for these leases is recognized as paid over the lease term. For real property leases, the Partnership has elected the practical expedient to not separate nonlease components (e.g., common-area maintenance costs)

Some real property and equipment leases contain options to renew, with renewal terms that can extend indefinitely. The exercise of such lease renewal options is at the Partnership’s sole discretion. Certain equipment leases also contain purchase options and residual value guarantees. The Partnership determines the lease term at the lease commencement date as the non-cancellable period of the lease, including options to extend or terminate the lease when such an option is reasonably certain to be exercised. The Partnership uses various data to analyze these options, including historical trends, current expectations and useful lives of assets related to the lease.

Future commitments, including options to extend lease terms that are reasonably certain of being exercised, related to leases at March 31,June 30, 2019, are summarized below (in thousands):

Future non-cancellable commitments related to operating leases at December 31, 2018, are summarized below (in thousands):  

The Partnership also incurs costs associated with acquiring and maintaining rights-of-way. The contracts for these generally either extend beyond one year but can be cancelled at any time should they no longer be required for operations or have no contracted term but contain perpetual annual or monthly renewal options. Rights-of-way generally do not provide for exclusive use of the land and as such are not accounted for as leases.

15.    OPERATING SEGMENTS

 

 

The Partnership’s management evaluates segment 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. 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, excluding depreciation and amortization by using amounts that are determined in accordance with GAAP. The Partnership accounts for intersegment product sales as if the sales were to third parties, that is, at current market prices. A reconciliation of operating margin, excluding depreciation and amortization to income before income taxes, which is its nearest comparable GAAP financial measure, is included in the following table. The Partnership believes that investors benefit from having access to the same financial measures being utilized by management. Operating margin, excluding depreciation and amortization is an important measure of the economic performance of the Partnership’s core operations. This measure forms the basis of the Partnership’s internal financial reporting and is used by its management in deciding how to allocate capital resources among segments. Income before income taxes, alternatively, includes expense items, such as depreciation and amortization, general and administrative expenses and interest expense, which management does not consider when evaluating the core profitability of the Partnership’s operations.

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