Document
 
 
 
 
 
 
 
 
 
 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
 
(Mark One)
ý    Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended September 30, 2017
OR 
¨    Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from             to             
 Commission file number 1-9356 
 
Buckeye Partners, L.P.
(Exact name of registrant as specified in its charter)
 
Delaware
 
23-2432497
(State or other jurisdiction of incorporation or organization)
 
(IRS Employer Identification number)
 
 
 
One Greenway Plaza
 
 
Suite 600
 
 
Houston, TX
 
77046
(Address of principal executive offices)
 
(Zip Code)
 Registrant’s telephone number, including area code: (832) 615-8600
 
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 ý No ¨ 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý  No ¨ 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
ý
 
Accelerated filer ¨ 
Non-accelerated filer
¨ 
 
Smaller reporting company ¨ 
(Do not check if a smaller reporting company)
 
Emerging growth company
¨
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨ 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No ý 
As of October 27, 2017, there were 146,643,955 limited partner units outstanding.
 
 
 
 
 

Table of Contents

TABLE OF CONTENTS
 
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
1.
 
 
 
2.
 
 
 
3.
 
 
 
4.
 
 
 
5.
 
 
 
6.

 
 
7.
 
 
 
8.
 
 
 
9.
 
 
 
10.
 
 
 
11.
 
 
 
12.
 
 
 
13.
 
 
 
14.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


Table of Contents

PART I.  FINANCIAL INFORMATION 
Item 1.  Financial Statements 
BUCKEYE PARTNERS, L.P.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per unit amounts)
(Unaudited) 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2017
 
2016
 
2017
 
2016
Revenue:
 

 
 

 
 

 
 

Product sales
$
517,461

 
$
337,092

 
$
1,482,686

 
$
1,086,180

Transportation, storage and other services
405,158

 
429,513

 
1,219,407

 
1,238,141

Total revenue
922,619

 
766,605

 
2,702,093

 
2,324,321

 
 
 
 
 
 
 
 
Costs and expenses:
 

 
 

 
 

 
 

Cost of product sales
506,780

 
326,718

 
1,447,408

 
1,049,315

Operating expenses
157,820

 
149,867

 
482,008

 
446,671

Depreciation and amortization
65,661

 
63,472

 
195,987

 
188,220

General and administrative
23,904

 
20,321

 
69,987

 
63,737

Other, net
501

 
—

 
(3,921
)
 
—

Total costs and expenses
754,666

 
560,378

 
2,191,469

 
1,747,943

Operating income
167,953

 
206,227

 
510,624

 
576,378

 
 
 
 
 
 
 
 
Other income (expense):
 

 
 

 
 

 
 

Earnings from equity investments
9,232

 
2,901

 
22,710

 
8,459

Interest and debt expense
(56,561
)
 
(48,476
)
 
(168,870
)
 
(144,093
)
Other income (expense)
48

 
(74
)
 
157

 
(102
)
Total other expense, net
(47,281
)
 
(45,649
)
 
(146,003
)
 
(135,736
)
 
 
 
 
 
 
 
 
Income before taxes
120,672

 
160,578

 
364,621

 
440,642

Income tax expense
(448
)
 
(308
)
 
(1,709
)
 
(896
)
Net income
120,224

 
160,270

 
362,912

 
439,746

Less: Net income attributable to noncontrolling interests
(4,037
)
 
(3,896
)
 
(10,427
)
 
(11,803
)
Net income attributable to Buckeye Partners, L.P.
$
116,187

 
$
156,374

 
$
352,485

 
$
427,943

 
 
 
 
 
 
 
 
Earnings per unit attributable to Buckeye Partners, L.P.:
 
 

 
 

 
 

Basic
$
0.82

 
$
1.19

 
$
2.50

 
$
3.28

Diluted
$
0.81

 
$
1.19

 
$
2.49

 
$
3.26

 
 
 
 
 
 
 
 
Weighted average units outstanding:
 

 
 

 
 

 
 

Basic
142,088

 
131,113

 
141,104

 
130,439

Diluted
142,818

 
131,940

 
141,781

 
131,076

 
See Notes to Unaudited Condensed Consolidated Financial Statements.

1
Table of Contents

BUCKEYE PARTNERS, L.P.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
(Unaudited)
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2017
 
2016
 
2017
 
2016
Net income
$
120,224

 
$
160,270

 
$
362,912

 
$
439,746

Other comprehensive income:
 
 
 
 
 

 
 

Unrealized (losses) gains on derivative instruments
(5,764
)
 
1,052

 
(11,995
)
 
1,052

Reclassification of derivative losses to net income
3,038

 
3,037

 
9,113

 
7,846

Recognition of costs related to benefit plans to net income
50

 
252

 
66

 
756

Other comprehensive income from equity method investments
11,933

 
—

 
39,679

 
—

Total other comprehensive income
9,257

 
4,341

 
36,863

 
9,654

Comprehensive income
129,481

 
164,611

 
399,775

 
449,400

Less: Comprehensive income attributable to noncontrolling interests
(4,037
)
 
(3,896
)
 
(10,427
)
 
(11,803
)
Comprehensive income attributable to Buckeye Partners, L.P.
$
125,444

 
$
160,715

 
$
389,348

 
$
437,597

 
See Notes to Unaudited Condensed Consolidated Financial Statements.

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BUCKEYE PARTNERS, L.P.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except unit amounts)
(Unaudited)
 
September 30,
2017
 
December 31,
2016
Assets:
 

 
 

Current assets:
 

 
 

Cash and cash equivalents
$
7,922

 
$
640,340

Accounts receivable, net
210,476

 
236,416

Construction and pipeline relocation receivables
15,082

 
17,276

Inventories
233,413

 
356,803

Derivative assets
50,884

 
1,526

Prepaid and other current assets
40,553

 
66,536

Total current assets
558,330

 
1,318,897

 
 
 
 
Property, plant and equipment
7,806,102

 
7,523,774

Less: Accumulated depreciation
(1,172,872
)
 
(1,040,492
)
Property, plant and equipment, net
6,633,230

 
6,483,282

 
 
 
 
Equity investments
1,495,952

 
89,564

Goodwill
1,004,545

 
1,004,545

 
 
 
 
Intangible assets
616,286

 
616,286

Less: Accumulated amortization
(242,678
)
 
(192,983
)
Intangible assets, net
373,608

 
423,303

 
 
 
 
Other non-current assets
46,835

 
101,512

Total assets
$
10,112,500

 
$
9,421,103

 
 
 
 
Liabilities and partners’ capital:
 

 
 

Current liabilities:
 

 
 

Line of credit
$
185,410

 
$
—

Accounts payable
82,412

 
107,383

Derivative liabilities
3,568

 
26,272

Accrued and other current liabilities
237,884

 
265,893

Total current liabilities
509,274

 
399,548

 
 
 
 
Long-term debt
4,593,635

 
4,217,695

Other non-current liabilities
96,566

 
105,437

Total liabilities
5,199,475

 
4,722,680

 
 
 
 
Commitments and contingent liabilities (Note 3)
—

 
—

 
 
 
 
Partners’ capital:
 

 
 

Buckeye Partners, L.P. capital:
 

 
 

Limited Partners (146,641,503 and 140,263,787 units outstanding as of September 30, 2017 and December 31, 2016, respectively)
4,619,262

 
4,437,316

Accumulated other comprehensive income (loss)
11,270

 
(25,593
)
Total Buckeye Partners, L.P. capital
4,630,532

 
4,411,723

Noncontrolling interests
282,493

 
286,700

Total partners’ capital
4,913,025

 
4,698,423

Total liabilities and partners’ capital
$
10,112,500

 
$
9,421,103

 
See Notes to Unaudited Condensed Consolidated Financial Statements.

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BUCKEYE PARTNERS, L.P.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited) 
 
Nine Months Ended
September 30,
 
2017
 
2016
Cash flows from operating activities:
 

 
 

Net income
$
362,912

 
$
439,746

Adjustments to reconcile net income to net cash provided by (used in) operating activities:
 

 
 

Depreciation and amortization
195,987

 
188,220

Amortization of debt issuance costs and discount
3,940

 
3,532

Amortization of losses on terminated interest rate swaps
9,113

 
9,112

Non-cash unit-based compensation expense
25,935

 
22,977

Gains on property damage recoveries
(4,621
)
 
(5,700
)
Net changes in fair value of derivatives
(25,421
)
 
98,917

Amortization of unfavorable storage contracts
—

 
(5,979
)
Earnings from equity investments
(22,710
)
 
(8,459
)
Distributions of earnings from equity investments
25,902

 
2,418

Other non-cash items
1,024

 
3,772

Change in assets and liabilities, net of amounts related to acquisitions:
 

 
 

Accounts receivable
25,548

 
(40,109
)
Construction and pipeline relocation receivables
2,109

 
(4,334
)
Inventories
123,390

 
(101,016
)
Prepaid and other current assets
18,956

 
(45,841
)
Accounts payable
(30,850
)
 
9,332

Accrued and other current liabilities
(17,045
)
 
(10,088
)
Other non-current assets
(2,118
)
 
138

Other non-current liabilities
(4,741
)
 
(6,865
)
Net cash provided by operating activities
687,310

 
549,773

Cash flows from investing activities:
 

 
 

Capital expenditures
(303,689
)
 
(380,072
)
Equity investment in VTTI B.V.
(1,387,844
)
 
—

Acquisitions, net of working capital settlement
—

 
(25,941
)
Proceeds from asset disposals
429

 
2,235

Escrow deposits
—

 
19,850

Recoveries on property damages
4,621

 
5,700

Distributions in excess of earnings from equity investments
16,951

 
—

Net cash used in investing activities
(1,669,532
)
 
(378,228
)
Cash flows from financing activities:
 

 
 

Net proceeds from issuance of LP Units
345,955

 
108,422

Net proceeds from exercise of Unit options
481

 
300

Payment of tax withholding on issuance of LTIP awards
(8,487
)
 
(5,123
)
Repayment of long-term debt
(125,000
)
 
—

Debt issuance costs
(29
)
 
(1,240
)
Borrowings under BPL Credit Facility
1,544,972

 
978,700

Repayments under BPL Credit Facility
(1,047,372
)
 
(1,136,800
)
Net borrowings under BMSC Credit Facility
185,410

 
106,852

Borrowings under Term Loan
—

 
250,000

Contributions from noncontrolling interests
7,700

 
3,760

Distributions to noncontrolling interests
(24,657
)
 
(11,531
)
Distributions to unitholders
(529,169
)
 
(469,764
)
Net cash provided by (used in) financing activities
349,804

 
(176,424
)
Net decrease in cash and cash equivalents
(632,418
)
 
(4,879
)
Cash and cash equivalents — Beginning of period
640,340

 
4,881

Cash and cash equivalents — End of period
$
7,922

 
$
2

 
See Notes to Unaudited Condensed Consolidated Financial Statements.

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BUCKEYE PARTNERS, L.P.
CONDENSED CONSOLIDATED STATEMENTS OF PARTNERS’ CAPITAL
(In thousands)
(Unaudited)
 
 
 
 
Accumulated
 
 
 
 
 
 
 
Other
 
 
 
 
 
Limited
 
Comprehensive
 
Noncontrolling
 
 
 
Partners
 
Income (Loss)
 
Interests
 
Total
Partners’ capital - January 1, 2017
$
4,437,316

 
$
(25,593
)
 
$
286,700

 
$
4,698,423

Net income
352,485

 
—

 
10,427

 
362,912

Distributions paid to unitholders
(531,351
)
 
—

 
2,182

 
(529,169
)
Net proceeds from issuance of LP Units
345,955

 
—

 
—

 
345,955

Amortization of unit-based compensation awards
25,935

 
—

 
—

 
25,935

Net proceeds from exercise of Unit options
481

 
—

 
—

 
481

Payment of tax withholding on issuance of LTIP awards
(8,487
)
 
—

 
—

 
(8,487
)
Distributions paid to noncontrolling interests
—

 
—

 
(24,657
)
 
(24,657
)
Contributions from noncontrolling interests
—

 
—

 
7,700

 
7,700

Other comprehensive income
—

 
36,863

 
—

 
36,863

Accrual of distribution equivalent rights
(2,931
)
 
—

 
—

 
(2,931
)
Other
(141
)
 
—

 
141

 
—

Partners’ capital - September 30, 2017
$
4,619,262

 
$
11,270

 
$
282,493

 
$
4,913,025

 
 
 
 
 
 
 
 
Partners’ capital - January 1, 2016
$
3,833,230

 
$
(97,841
)
 
$
281,352

 
$
4,016,741

Net income
427,943

 
—

 
11,803

 
439,746

Distributions paid to unitholders
(472,056
)
 
—

 
2,292

 
(469,764
)
Net proceeds from issuance of LP Units
108,422

 
—

 
—

 
108,422

Amortization of unit-based compensation awards
22,977

 
—

 
—

 
22,977

Net proceeds from exercise of Unit options
300

 
—

 
—

 
300

Payment of tax withholding on issuance of LTIP awards
(5,123
)
 
—

 
—

 
(5,123
)
Distributions paid to noncontrolling interests
—

 
—

 
(11,531
)
 
(11,531
)
Contributions from noncontrolling interests
—

 
—

 
3,760

 
3,760

Other comprehensive income
—

 
9,654

 
—

 
9,654

Accrual of distribution equivalent rights
(2,248
)
 
—

 
—

 
(2,248
)
Other
(44
)
 
—

 
44

 
—

Partners’ capital - September 30, 2016
$
3,913,401

 
$
(88,187
)
 
$
287,720

 
$
4,112,934

 
See Notes to Unaudited Condensed Consolidated Financial Statements.


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Table of Contents

BUCKEYE PARTNERS, L.P.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
1. ORGANIZATION AND BASIS OF PRESENTATION
 
Organization
 
Buckeye Partners, L.P. is a publicly traded Delaware master limited partnership (“MLP”), and its limited partnership units representing limited partner interests (“LP Units”) are listed on the New York Stock Exchange (“NYSE”) under the ticker symbol “BPL.”  Buckeye GP LLC (“Buckeye GP”) is our general partner.  As used in these Notes to Unaudited Condensed Consolidated Financial Statements, “we,” “us,” “our” and “Buckeye” mean Buckeye Partners, L.P. and, where the context requires, includes our subsidiaries.
 
We own and operate, or own a significant interest in, a diversified global network of integrated assets providing midstream logistic solutions, primarily consisting of the transportation, storage, processing and marketing of liquid petroleum products.  We are one of the largest independent liquid petroleum products pipeline operators in the United States in terms of volumes delivered and miles of pipeline. We also use our service expertise to operate and/or maintain third-party pipelines and perform certain engineering and construction services for our customers. Our global terminal network, including through our interest in VTTI B.V. (“VTTI”), comprises active product terminals across our portfolio of pipelines, inland terminals and marine terminals located primarily in key petroleum logistics hubs in the East Coast, Midwest and Gulf Coast regions of the United States as well as in the Caribbean, Northwest Europe, the Middle East and Southeast Asia.  Our global network of marine terminals enables us to facilitate global flows of crude oil and refined petroleum products, offering our customers connectivity between supply areas and market centers through some of the world’s most important bulk liquid storage and blending hubs.  Our flagship marine terminal in The Bahamas, Buckeye Bahamas Hub Limited (“BBH”), is one of the largest marine crude oil and refined petroleum products storage facilities in the world and provides an array of logistics and blending services for the global flow of petroleum products. Our Gulf Coast regional hub, Buckeye Texas Partners LLC (“Buckeye Texas”), offers world-class marine terminalling, storage and processing capabilities. Through our 50% equity interest in VTTI, our global terminal network offers premier storage and marine terminalling services for petroleum product logistics in key international energy hubs. We are also a wholesale distributor of refined petroleum products in certain areas served by our pipelines and terminals.
 
Basis of Presentation and Principles of Consolidation
 
The unaudited condensed consolidated financial statements and the accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and the rules of the U.S. Securities and Exchange Commission.  Accordingly, our financial statements reflect all normal and recurring adjustments that are, in the opinion of management, necessary for a fair presentation of our results of operations for the interim periods.  The unaudited condensed consolidated financial statements include the accounts of our subsidiaries controlled by us and variable interest entities of which we are the primary beneficiary. Intercompany transactions are eliminated in consolidation.
 
We believe that the disclosures in these unaudited condensed consolidated financial statements are adequate to make the information presented not misleading.  These interim financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto contained in our Annual Report on Form 10-K for the year ended December 31, 2016.

Recent Accounting Developments

Derivatives and Hedging. In August 2017, the Financial Accounting Standards Board (“FASB”) issued guidance which amends and simplifies existing guidance in order to improve the financial reporting of hedging relationships to better align risk management activities in financial statements and make targeted improvements to simplify the application of current guidance related to the assessment of hedge effectiveness. The amendments are effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years, with early application permitted. We are currently evaluating the impact the adoption of this guidance will have on our consolidated financial statements.
    

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Modifications to Share-Based Payment Awards. In May 2017, the FASB issued guidance to clarify when changes in the terms or conditions of share-based payment awards must be accounted for as modifications under Topic 718. The guidance requires that entities apply modification accounting unless the award’s fair value, vesting conditions and classification as an equity or liability instrument are the same immediately before and after the change. The amendments are effective for interim and annual periods beginning after December 15, 2017, with early adoption permitted. The amendments should be applied prospectively to awards modified on or after the adoption date. We expect to adopt this guidance on January 1, 2018, and it will be applied to modifications of our unit-based awards prospectively, if any.

Retirement Benefits. In March 2017, the FASB issued guidance to amend the presentation of net periodic pension cost and net periodic postretirement benefit cost. The guidance requires that the service cost component of net periodic pension and postretirement benefit cost be presented in the same income statement line item as other employee compensation costs, while the other components are required to be presented separately within non-operating income. The guidance also allows only the service cost component to be eligible for capitalization when applicable. The amendments are effective for interim and annual periods beginning after December 15, 2017. The amendments should be applied retrospectively for the presentation of the service cost component and the other components of net periodic pension cost and net periodic postretirement benefit cost in the income statement and prospectively, on and after the effective date, for the capitalization of the service cost component of net periodic pension cost and net periodic postretirement benefit in assets. We are currently evaluating the impact the adoption of this guidance will have on our consolidated financial statements.

Revenue from Contracts with Customers. In May 2014, the FASB issued Accounting Standards Update No. 2014-09, “Revenue from Contracts with Customers (Topic 606)” (“ASU 2014-09”), which amended existing accounting standards for revenue recognition, including industry-specific requirements, and provides entities with a single revenue recognition model for recognizing revenue from contracts with customers.  The core principle of ASU 2014-09 is that an entity should recognize revenue from contracts with customers when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.  Furthermore, additional disclosures will be required to describe the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts. The two permitted transition methods under ASU 2014-09 are the full retrospective method, which would be applied to each prior reporting period presented and the cumulative effect of applying the standard would be recognized at the earliest period shown, or the modified retrospective method, in which the cumulative effect of applying the standard would be recognized at the date of initial application.  In July 2015, the FASB deferred the effective date of ASU 2014-09 and is effective for annual and interim periods beginning after December 15, 2017, with early adoption permitted for annual and interim periods beginning after December 15, 2016.  In 2016, the FASB issued accounting standards updates that amended several aspects of ASU 2014-09.  We continue to evaluate the provisions of the standard through our implementation work team, consisting of representatives from all of our business segments, and to assess and implement changes to business processes, systems and controls, as necessary. In addition, we have implemented training on the new standard’s revenue recognition model and are continuing our contract review and documentation. We will adopt this guidance on January 1, 2018, and we are currently evaluating the impact that it will have on our consolidated financial statements, including our disclosures, under the elected modified retrospective transition method. To date, we have not identified any customer arrangements which would require a significant change to the timing of our revenue recognition, although our analysis is not yet complete.

Equity-Based Compensation. In March 2016, the FASB issued guidance to simplify several aspects of the accounting for employee equity-based payment transactions, including the accounting for income taxes, forfeitures and statutory tax withholding requirements, as well as classification in the statement of cash flows and classification of awards as liabilities or equity. The guidance was effective for annual reporting periods beginning after December 15, 2016 and interim periods within those annual periods, with early adoption permitted. Amendments related to the timing of when excess tax benefits are recognized, statutory withholding requirements and forfeitures were to be applied using a modified retrospective transition method by means of a cumulative-effect adjustment to equity as of the beginning of the period in which the guidance is adopted. Amendments related to the presentation of employee taxes paid on the statement of cash flows were to be applied retrospectively. Amendments requiring recognition of excess tax benefits and tax deficiencies in the income statement were to be applied prospectively. Amendments related to the presentation of excess tax benefits on the statement of cash flows were to be applied using either a prospective transition method or a retrospective transition method. We adopted this guidance as of January 1, 2017 and did not recognize a retrospective transition adjustment. The adoption of this guidance did not have a material impact on our consolidated financial statements or on our disclosures.
 

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2. ACQUISITIONS
 
Business Combination

Indianola terminalling facility acquisition
 
In August 2016, we acquired a liquid petroleum products terminalling facility in Indianola, Pennsylvania from Kinder Morgan Transmix Company, LLC for $26.0 million. The operations of these assets are reported in our Domestic Pipelines & Terminals segment. The acquisition cost has been allocated on a preliminary basis to assets acquired based on estimated fair values at the acquisition date, with amounts exceeding the fair value recorded as goodwill, which represent expected synergies from combining the acquired assets with our existing operations. Fair values have been developed using recognized business valuation techniques. The purchase price has been allocated to tangible and intangible assets acquired as follows (in thousands):
Inventories
$
1,554

Property, plant and equipment
16,713

Goodwill
7,758

Allocated purchase price
$
26,025


We finalized the purchase price allocation during the third quarter of 2017 without significant adjustment.

Unaudited Pro forma Financial Results for the Indianola terminalling facility acquisition

Our consolidated statements of operations do not include earnings from the terminalling facility prior to August 4, 2016, the closing date of the acquisition. The preparation of unaudited pro forma financial information for the terminalling facility is impracticable due to the fact that meaningful historical revenue information is not available. The revenues and earnings impact of this acquisition was not significant to our financial results for the three and nine months ended September 30, 2017.

Equity Investment Transaction

VTTI Acquisition

In January 2017, we acquired an indirect 50% equity interest in VTTI for cash consideration of $1.15 billion (the “VTTI Acquisition”). We own VTTI jointly with Vitol S.A. (“Vitol”). VTTI is one of the largest independent global marine terminal businesses which, through its subsidiaries and partnership interests, owns and operates approximately 58 million barrels of petroleum products storage across 15 terminals located on five continents. These marine terminals are predominately located in key global energy hubs, including Northwest Europe, the United Arab Emirates and Singapore, and offer world-class storage and marine terminalling services for refined petroleum products, liquid petroleum gas and crude oil. We and VIP Terminals Finance B.V., a subsidiary of Vitol, have equal board representation and voting rights in the VTTI joint venture. We account for this investment using the equity method of accounting. Under this method, an investment is recorded at acquisition cost plus our equity in undistributed earnings or losses since acquisition, reduced by distributions received and amortization of excess net investment. The earnings from our equity investment in VTTI are reported in our Global Marine Terminals segment. In addition, we include our proportionate share of our equity method investments’ unrealized gains and losses in other comprehensive income in our unaudited condensed consolidated financial statements.
 
The estimated fair values used to calculate the excess net investment in VTTI were primarily developed using an income approach, with inputs classified as Level 3 within the fair value hierarchy. The excess net investment was $583.3 million at the acquisition date and was comprised of the following components: (i) $233.0 million related to the excess of the fair values of identifiable property, plant and equipment and intangible assets over their carrying values, which is being amortized on a straight-line basis over the estimated useful lives of these underlying assets of approximately 28 years; and (ii) $350.3 million of implied goodwill, which is not subject to amortization. The amortization of the excess net investment is included in earnings from equity investments on our unaudited condensed consolidated statements of operations.

In September 2017, VTTI acquired all of the outstanding publicly held common units of VTTI Energy Partners LP, formerly a publicly traded master limited partnership (“VTTI MLP”), for an aggregate cash consideration of $473.6 million (the “VTTI Merger”). In connection with the VTTI Merger, VTTI MLP merged with and into a direct wholly owned subsidiary of VTTI. We funded our 50% share of the aggregate cash consideration, in the amount of $236.8 million, through a capital contribution to VTTI, using borrowings under our Credit Facility.


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3. COMMITMENTS AND CONTINGENCIES
 
Claims and Legal Proceedings
 
In the ordinary course of business, we are involved in various claims and legal proceedings, some of which are covered by insurance.  We are generally unable to predict the timing or outcome of these claims and proceedings.  Based upon our evaluation of existing claims and proceedings and the probability of losses relating to such contingencies, we have accrued certain amounts relating to such claims and proceedings, none of which are considered material.

Environmental Contingencies
 
At September 30, 2017 and December 31, 2016, we had $41.9 million and $44.3 million, respectively, of environmental remediation liabilities unrelated to claims and legal proceedings.  Costs ultimately incurred may be in excess of our estimates, which may have a material impact on our financial condition, results of operations or cash flows.  At September 30, 2017 and December 31, 2016, we had $5.7 million and $7.2 million, respectively, of receivables related to these environmental remediation liabilities covered by insurance or third-party claims.

4. INVENTORIES
 
Our inventory amounts were as follows at the dates indicated (in thousands):
 
September 30,
2017
 
December 31,
2016
Liquid petroleum products (1)
$
210,747

 
$
337,424

Materials and supplies
22,666

 
19,379

Total inventories
$
233,413

 
$
356,803

                                                      
(1)
Ending inventory was 122.3 million and 198.2 million gallons of liquid petroleum products as of September 30, 2017 and December 31, 2016, respectively.
 
At September 30, 2017 and December 31, 2016, approximately 86% and 88% of our liquid petroleum products inventory volumes were designated in a fair value hedge relationship, respectively.  Because we generally designate inventory as a hedged item upon purchase, hedged inventory is valued at current market prices with the change in value of the inventory reflected in our unaudited condensed consolidated statements of operations.  Our inventory volumes that are not designated as the hedged item in a fair value hedge relationship are economically hedged to reduce our commodity price exposure.  Inventory not accounted for as a fair value hedge is accounted for at the lower of weighted average cost method or net realizable value.

5. PREPAID AND OTHER CURRENT ASSETS
 
Prepaid and other current assets consist of the following at the dates indicated (in thousands):
 
September 30,
2017
 
December 31,
2016
Prepaid insurance
$
13,446

 
$
7,609

Margin deposits
8,184

 
43,912

Unbilled revenue
9,003

 
1,615

Prepaid taxes
5,212

 
7,357

Vendor prepayments
767

 
1,863

Other
3,941

 
4,180

Total prepaid and other current assets
$
40,553

 
$
66,536



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6. EQUITY INVESTMENTS
 
The following table presents earnings from equity investments for the periods indicated (in thousands): 
 
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
Segment
 
2017
 
2016
 
2017
 
2016
VTTI B.V. (1)
Global Marine Terminals
 
$
6,396

 
$
—

 
$
15,111

 
$
—

West Shore Pipe Line Company
Domestic Pipelines & Terminals
 
1,772

 
1,784

 
4,913

 
5,680

Muskegon Pipeline LLC
Domestic Pipelines & Terminals
 
501

 
544

 
1,303

 
1,340

Transport4, LLC
Domestic Pipelines & Terminals
 
206

 
204

 
650

 
577

South Portland Terminal LLC
Domestic Pipelines & Terminals
 
357

 
369

 
733

 
862

Total earnings from equity investments
 
 
$
9,232

 
$
2,901

 
$
22,710

 
$
8,459

                                                      
(1) We acquired an indirect 50% equity interest in VTTI in January 2017.  For additional information, see Note 2.

Summarized combined income statement data for our equity method investments are as follows for the periods indicated (amounts represent 100% of investee income statement data in thousands): 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2017
 
2016
 
2017
 
2016
Revenue
$
143,946

 
$
22,831

 
$
403,985

 
$
65,877

Operating income
52,766

 
12,805

 
138,195

 
35,411

Net income
30,874

 
8,663

 
84,807

 
23,986

Net income attributable to investee
23,565

 
8,663

 
63,347

 
23,986


7. LONG-TERM DEBT

Extinguishment of Debt

In July 2017, we repaid in full the $125.0 million principal amount and $3.2 million of accrued interest outstanding under our 5.125% notes, using funds available under our $1.5 billion revolving credit facility.

Current Maturities Expected to be Refinanced

We have classified $300.0 million of 6.050% notes due on January 15, 2018 as long-term debt in the unaudited condensed consolidated balance sheet at September 30, 2017 because we have the intent and the ability to refinance these obligations on a long-term basis under our Credit Facility. At September 30, 2017, we had $814.6 million of additional borrowing capacity under our Credit Facility.

8. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

We are exposed to financial market risks, including changes in interest rates and commodity prices, in the course of our normal business operations.  We use derivative instruments to manage such risks.
 
Interest Rate Derivatives

From time to time, we utilize forward-starting interest rate swaps to hedge the variability of the forecasted interest payments on anticipated debt issuances that may result from changes in the benchmark interest rate until the expected debt is issued. When entering into interest rate swap transactions, we become exposed to both credit risk and market risk. We are subject to credit risk when the change in fair value of the swap instrument is positive and the counterparty may fail to perform under the terms of the contract. We are subject to market risk with respect to changes in the underlying benchmark interest rate that impacts the fair value of the swaps. We manage our credit risk by entering into swap transactions only with major financial institutions with investment-grade credit ratings. We manage our market risk by aligning the swap instrument with the existing underlying debt obligation or a specified expected debt issuance, generally associated with the maturity of an existing debt obligation. We designate the swap agreements as cash flow hedges at inception and expect the changes in values to be highly correlated with the changes in value of the underlying borrowings.

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During 2016, we entered into seven forward-starting interest rate swaps with a total aggregate notional amount of $350.0 million, which we entered into in anticipation of the issuance of debt on or before January 15, 2018, and eleven forward-starting interest rate swaps with a total aggregate notional amount of $500.0 million, which we entered into in anticipation of the issuance of debt on or before November 15, 2018. We expect to issue new fixed-rate debt on or before January 15, 2018 to repay the $300.0 million of 6.050% notes that are due on January 15, 2018, and on or before November 15, 2018 to repay the $400.0 million of 2.650% notes that are due on November 15, 2018, as well as to fund capital expenditures and other general partnership purposes, although no assurances can be given that the issuance of fixed-rate debt will be possible on acceptable terms.

During the three and nine months ended September 30, 2017, unrealized losses of $2.2 million and $12.7 million, respectively, were recorded in accumulated other comprehensive income (“AOCI”) to reflect the change in the fair values of the forward-starting interest rate swaps.

Commodity Derivatives

Our Merchant Services segment primarily uses exchange-traded refined petroleum product futures contracts to manage the risk of market price volatility on its refined petroleum product inventories and its physical derivative contracts, which we designated as fair value hedges, with changes in fair value of both the futures contracts and physical inventory reflected in earnings. Our Merchant Services segment also uses exchange-traded refined petroleum contracts to hedge expected future transactions related to certain gasoline inventory that we manage on behalf of a third party, which are designated as cash flow hedges, with the effective portion of the hedge reported in other comprehensive income (“OCI”) and reclassified into earnings when the expected future transaction affects earnings. Any gains or losses incurred on the derivative instruments that are not effective in offsetting changes in fair value or cash flows of the hedged item are recognized immediately in earnings.
Additionally, our Merchant Services segment enters into exchange-traded refined petroleum product futures contracts on behalf of our Domestic Pipelines & Terminals segment to manage the risk of market price volatility on the gasoline-to-butane pricing spreads associated with our butane blending activities managed by a third party. These futures contracts are not designated in a hedge relationship for accounting purposes. Physical forward contracts and futures contracts that have not been designated in a hedge relationship are marked-to-market.
The following table summarizes our commodity derivative instruments outstanding at September 30, 2017 (amounts in thousands of gallons):
 
 
Volume (1)
 
 
Derivative Purpose 
 
Current
 
Long-Term
 
 
Derivatives NOT designated as hedging instruments:
 
 

 
 

 
 
Physical fixed-price derivative contracts
 
7,115

 
1,110

 
 
Physical index derivative contracts
 
35,385

 
—

 
 
Futures contracts for refined petroleum products
 
241

 
6,090

 
 
 
 
 
 
 
 
Hedge Type
Derivatives designated as hedging instruments:
 
 

 
 

 
 
Physical fixed-price derivative contracts
 
1,050

 
—

 
Cash Flow Hedge
Cash flow hedge futures contracts
 
13,104

 
8,400

 
Cash Flow Hedge
Futures contracts for refined petroleum products
 
100,632

 
4,494

 
Fair Value Hedge
                                                     
(1)
Volume represents absolute value of net notional volume position. All volumes represent net short positions, except for the physical fixed-price derivative contracts designated as a cash flow hedge.

Our futures contracts designated as fair value hedges relate to our inventory portfolio and extend to the fourth quarter of 2018. Our futures contracts and physical fixed-priced derivative contracts designated as cash flow hedges relate to forecasted purchases and sales of refined petroleum products and extend to the third quarter of 2018.


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Effective January 2017, the Chicago Mercantile Exchange (“CME”) amended its rulebook, resulting in the characterization of variation margin transfers as settlement payments, as opposed to adjustments to collateral.  These amendments impacted the accounting treatment of our exchange-traded derivatives contracts, primarily comprised of our futures contracts, for which the CME serves as the central clearing party, and exchange-settled derivatives traded on the over-the-counter (“OTC”) market. As a result, commencing with the first quarter of 2017, we began reducing the corresponding derivative asset and liability balances for our exchange-settled derivative contracts to reflect the settlement of those positions via the variation margin. The variation margin is now considered partial settlement of the derivative contract and will result in realized gains or losses which, prior to January 1, 2017, were classified as unrealized gains or losses on derivatives. In addition, we maintain an initial margin deposit with the broker in an amount sufficient to cover the fair value of our open futures positions. This margin deposit is considered collateral and is included within prepaid and other current assets in our condensed consolidated balance sheets and is not offset against the fair values of our derivative instruments.

The following table sets forth the fair value of each classification of derivative instruments and the locations of the derivative instruments on our unaudited condensed consolidated balance sheets at the dates indicated (in thousands):
 
September 30, 2017
 
Derivatives NOT Designated as Hedging Instruments
 
Derivatives Designated as Hedging Instruments
 
Derivative Carrying Value
 
Netting Balance Sheet Adjustment (1)
 
Net Total
Physical fixed-price derivative contracts
$
816

 
$
—

 
$
816

 
$
(95
)
 
$
721

Physical index derivative contracts
226

 
—

 
226

 
(2
)
 
224

Interest rates derivatives
—

 
49,939

 
49,939

 
—

 
49,939

Total current derivative assets
1,042

 
49,939

 
50,981

 
(97
)
 
50,884

Physical fixed-price derivative contracts
2

 
—

 
2

 
—

 
2

Total non-current derivative assets
2

 
—

 
2

 
—

 
2

Physical fixed-price derivative contracts
(3,558
)
 
(104
)
 
(3,662
)
 
95

 
(3,567
)
Physical index derivative contracts
(3
)
 
—

 
(3
)
 
2

 
(1
)
Total current derivative liabilities
(3,561
)
 
(104
)
 
(3,665
)
 
97

 
(3,568
)
Physical fixed-price derivative contracts
(84
)
 
—

 
(84
)
 
—

 
(84
)
Total non-current derivative liabilities
(84
)
 
—

 
(84
)
 
—

 
(84
)
Net derivative (liabilities) assets
$
(2,601
)
 
$
49,835

 
$
47,234

 
$
—

 
$
47,234

 
                                                      
(1)
Amounts represent the netting of physical fixed and index contracts’ assets and liabilities when a legal right of offset exists.  Futures contracts are subject to settlement through margin requirements and are additionally presented on a net basis.



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December 31, 2016
 
Derivatives NOT Designated as Hedging Instruments
 
Derivatives Designated as Hedging Instruments
 
Derivative Carrying Value
 
Netting Balance Sheet Adjustment (1)
 
Net Total
Physical fixed-price derivative contracts
$
1,499

 
$
—

 
$
1,499

 
$
(306
)
 
$
1,193

Physical index derivative contracts
334

 
—

 
334

 
(1
)
 
333

Futures contracts for refined products
51,431

 
21

 
51,452

 
(51,452
)
 
—

Total current derivative assets
53,264

 
21

 
53,285

 
(51,759
)
 
1,526

Physical fixed-price derivative contracts
164

 
—

 
164

 
(5
)
 
159

Futures contracts for refined products
226

 
—

 
226

 
(226
)
 
—

Interest rates derivatives
—

 
62,609

 
62,609

 
—

 
62,609

Total non-current derivative assets
390

 
62,609

 
62,999

 
(231
)
 
62,768

Physical fixed-price derivative contracts
(4,517
)
 
—

 
(4,517
)
 
306

 
(4,211
)
Physical index derivative contracts
(1
)
 
—

 
(1
)
 
1

 
—

Futures contracts for refined products
(57,828
)
 
(15,685
)
 
(73,513
)
 
51,452

 
(22,061
)
Total current derivative liabilities
(62,346
)
 
(15,685
)
 
(78,031
)
 
51,759

 
(26,272
)
Physical fixed-price derivative contracts
(61
)
 
—

 
(61
)
 
5

 
(56
)
Futures contracts for refined products
(4,384
)
 
—

 
(4,384
)
 
226

 
(4,158
)
Total non-current derivative liabilities
(4,445
)
 
—

 
(4,445
)
 
231

 
(4,214
)
Net derivative (liabilities) assets
$
(13,137
)
 
$
46,945

 
$
33,808

 
$
—

 
$
33,808

                                                      
(1)
Amounts represent the netting of physical fixed and index contracts’ assets and liabilities when a legal right of offset exists.  Futures contracts are subject to settlement through margin requirements and are additionally presented on a net basis.
 
At September 30, 2017, open refined petroleum product derivative contracts (represented by the physical fixed-price contracts, physical index contracts, and futures contracts for refined products contracts noted above) varied in duration in the overall portfolio, but did not extend beyond December 2018.  In addition, at September 30, 2017, we had refined petroleum product inventories that we intend to use to satisfy a portion of the physical derivative contracts.
 
The gains and losses on our derivative instruments recognized in income were as follows for the periods indicated (in thousands):
 
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
Location
 
2017
 
2016
 
2017
 
2016
Derivatives NOT designated as hedging instruments:
 
 
 

 
 

 
 

 
 

Physical fixed-price derivative contracts
Product sales
 
$
(7,209
)
 
$
301

 
$
(257
)
 
$
(7,263
)
Physical index derivative contracts
Product sales
 
57

 
142

 
58

 
130

Physical fixed-price derivative contracts
Cost of product sales
 
1,462

 
479

 
1,380

 
7,965

Physical index derivative contracts
Cost of product sales
 
115

 
30

 
453

 
193

Futures contracts for refined products
Cost of product sales
 
15,861

 
(307
)
 
15,061

 
4,326

 
 
 
 
 
 
 
 
 
 
Derivatives designated as fair value hedging instruments:
 
 
 
 
 

 
 

 
 

Futures contracts for refined products
Cost of product sales
 
$
(51,093
)
 
$
(635
)
 
$
1,758

 
$
(27,590
)
Physical inventory - hedged items
Cost of product sales
 
48,236

 
3,620

 
7,536

 
43,627

 
 
 
 
 
 
 
 
 
 
Ineffectiveness excluding the time value component on fair value hedging instruments:
 
 
 
 
 

 
 

 
 

Fair value hedge ineffectiveness (excluding time value)
Cost of product sales
 
$
(3,299
)
 
$
(4,262
)
 
$
(5,929
)
 
$
(4,275
)
Time value excluded from hedge assessment
Cost of product sales
 
442

 
7,247

 
15,223

 
20,312

Net (loss) gain in income
 
 
$
(2,857
)
 
$
2,985

 
$
9,294

 
$
16,037


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The change in value recognized in OCI and the gains and losses reclassified from AOCI to income attributable to our derivative instruments designated as cash flow hedges were as follows for the periods indicated (in thousands):
 
(Loss) Gain Recognized in OCI on Derivatives for the
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2017
 
2016
 
2017
 
2016
Derivatives designated as cash flow hedging instruments:
 

 
 

 
 

 
 

Interest rate contracts
$
(2,207
)
 
$
1,052

 
$
(12,670
)
 
$
1,052

Commodity derivatives
(3,557
)
 
—

 
675

 
—

Total
$
(5,764
)
 
$
1,052

 
$
(11,995
)
 
$
1,052


 
 
 
(Loss) Gain Reclassified from AOCI to Income (Effective Portion) for the
 
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
Location
 
2017
 
2016
 
2017
 
2016
Derivatives designated as cash flow hedging instruments:
 
 
 

 
 

 
 

 
 

Interest rate contracts
Interest and debt expense
 
$
(3,038
)
 
$
(3,037
)
 
$
(9,113
)
 
$
(9,112
)
Commodity derivatives
Product Sales
 
—

 
—

 
—

 
1,266

Total
 
 
$
(3,038
)
 
$
(3,037
)
 
$
(9,113
)
 
$
(7,846
)

Over the next twelve months, we expect to reclassify $9.8 million of net losses attributable to interest rate derivatives from AOCI to earnings as an increase to interest and debt expense. These net losses consist of $11.5 million of amortization of hedge losses on our settled forward-starting interest rate swaps, partially offset by $1.7 million of amortization of forecasted hedge gains on our forward-starting interest swaps that we expect to settle in late 2017. Additionally, $0.7 million of unrealized gains for refined petroleum products derivatives designated as cash flow hedges at September 30, 2017 are estimated to be realized and reclassified from AOCI to product sales over the next twelve months. The ineffective portion of the change in fair value of cash flow hedges was not material for the three and nine months ended September 30, 2017.


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9. FAIR VALUE MEASUREMENTS
 
We categorize our financial assets and liabilities using the three-tier fair value hierarchy as follows:
 
Recurring
 
The following table sets forth financial assets and liabilities measured at fair value on a recurring basis, as of the measurement dates indicated, and the basis for that measurement, by level within the fair value hierarchy (in thousands):
 
September 30, 2017
 
December 31, 2016
 
Level 1
 
Level 2
 
Level 1
 
Level 2
Financial assets:
 

 
 

 
 

 
 

Physical fixed-price derivative contracts
$
—

 
$
818

 
$
—

 
$
1,352

Physical index derivative contracts
—

 
226

 
—

 
333

Interest rate derivatives
—

 
49,939

 
—

 
62,609

 
 
 
 
 
 
 
 
Financial liabilities:
 

 
 

 
 

 
 

Physical fixed-price derivative contracts
—

 
(3,746
)
 
—

 
(4,267
)
Physical index derivative contracts
—

 
(3
)
 
—

 
—

Futures contracts for refined products
—

 
—

 
(26,219
)
 
—

Fair value
$
—

 
$
47,234

 
$
(26,219
)
 
$
60,027

 
The values of the Level 1 derivative assets and liabilities were based on quoted market prices obtained from the New York Mercantile Exchange. The values for exchange-settled commodity derivatives at September 30, 2017 are presented after the application of the CME rulebook amendment, which deems that these instruments are settled daily via variation margin payments. As a result of this rulebook amendment, CME-settled derivatives, primarily comprised of our futures contracts for refined petroleum products, are considered to have no fair value at the balance sheet date for financial reporting purposes; however, the derivatives remain outstanding and subject to future commodity price fluctuations until they are settled in accordance with their contractual terms.

The values of the Level 2 interest rate derivatives were determined using fair value estimates obtained from our counterparties, which are verified using other available market data, including cash flow models which incorporate market inputs, including the implied forward LIBOR yield curve for the same period as the future interest rate swap settlements. Credit value adjustments (“CVAs”), which are used to reflect the potential nonperformance risk of our counterparties, are considered in the fair value assessment of interest rate derivatives. We determined that the impact of CVAs is not significant to the overall valuation of interest rate derivatives.

The values of the Level 2 commodity derivative contracts were calculated using market approaches based on observable market data inputs, including published commodity pricing data, which is verified against other available market data, and market interest rate and volatility data.  Level 2 physical fixed-price derivative assets are net of CVAs determined using an expected cash flow model, which incorporates assumptions about the credit risk of the derivative contracts based on the historical and expected payment history of each customer, the amount of product contracted for under the agreement and the customer’s historical and expected purchase performance under each contract.  The Merchant Services segment determined CVAs are appropriate because few of the Merchant Services segment’s customers entering into these derivative contracts are large organizations with nationally recognized credit ratings.  The CVAs were nominal as of September 30, 2017 and December 31, 2016. As of September 30, 2017 and December 31, 2016, the Merchant Services segment did not hold any net liability derivative position containing credit contingent features.
 

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Financial instruments included in current assets and current liabilities are reported in the unaudited condensed consolidated balance sheets at amounts which approximate fair value due to the relatively short period to maturity of these financial instruments.  The fair values of our fixed-rate debt were estimated by observing market trading prices and by comparing the historic market prices of our publicly issued debt with the market prices of the publicly issued debt of other MLPs with similar credit ratings and terms.  The fair values of our variable-rate debt are their carrying amounts, as the carrying amount reasonably approximates fair value due to the variability of the interest rates.  The carrying value and fair value of our debt, using Level 2 input values, were as follows at the dates indicated (in thousands):
 
September 30, 2017
 
December 31, 2016
 
Carrying
Amount
 
Fair Value
 
Carrying
Amount
 
Fair Value
Fixed-rate debt
$
3,846,426

 
$
4,016,825

 
$
3,967,695

 
$
4,083,488

Variable-rate debt
932,619

 
933,010

 
250,000

 
250,000

Total debt
$
4,779,045

 
$
4,949,835

 
$
4,217,695

 
$
4,333,488

 
We recognize transfers between levels within the fair value hierarchy as of the beginning of the reporting period.  We did not have any transfers between Level 1 and Level 2 during the nine months ended September 30, 2017 and 2016, respectively.
 
Non-Recurring
 
Certain nonfinancial assets and liabilities are measured at fair value on a nonrecurring basis and are subject to fair value adjustments in certain circumstances, such as when there is evidence of impairment.  For the three and nine months ended September 30, 2017 and 2016, there were no significant fair value adjustments related to such assets or liabilities reflected in our unaudited condensed consolidated financial statements.

10. UNIT-BASED COMPENSATION PLANS
 
We award unit-based compensation to employees and directors primarily under the Buckeye Partners, L.P. 2013 Long-Term Incentive Plan (as amended and restated effective June 6, 2017, the “LTIP”).  We formerly awarded options to acquire LP Units to employees pursuant to the Buckeye Partners, L.P. Unit Option and Distribution Equivalent Plan (the “Option Plan”).  These compensation plans are further discussed below.
 
We recognized compensation expense related to the LTIP and the Option Plan, of $8.2 million and $8.9 million for the three months ended September 30, 2017 and 2016, respectively. For the nine months ended September 30, 2017 and 2016, we recognized compensation expense of $25.9 million and $23.0 million, respectively.

LTIP
 
As of September 30, 2017, there were 2,646,326 LP Units available for issuance under the LTIP.
 
Deferral Plan under the LTIP
 
We also maintain the Buckeye Partners, L.P. Unit Deferral and Incentive Plan, as amended and restated effective February 4, 2015 (the “Deferral Plan”), pursuant to which we issue phantom and matching units under the LTIP to certain employees in lieu of a portion of the cash payments such employees would be entitled to receive under the Buckeye Partners, L.P. Annual Incentive Compensation Plan, as amended and restated, effective January 1, 2012.  At December 31, 2016 and 2015, actual compensation awards deferred under the Deferral Plan were $4.4 million and $3.1 million, for which 145,138 and 139,526 phantom units (including matching units) were granted during the nine months ended September 30, 2017 and the year ended December 31, 2016, respectively.  These grants are included as granted in the LTIP activity table below.
 
Awards under the LTIP
 
During the nine months ended September 30, 2017, the Compensation Committee of the board of directors of Buckeye GP granted 316,490 phantom units to employees (including the 145,138 phantom units granted pursuant to the Deferral Plan, as discussed above), 18,000 phantom units to independent directors of Buckeye GP and 212,062 performance units to employees.


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The following table sets forth the LTIP activity for the periods indicated (in thousands, except per unit amounts):
 
Number of
LP Units
 
Weighted
Average
Grant Date
Fair Value
per LP Unit (1)
Unvested at January 1, 2017
1,296

 
$
63.54

Granted (2)
547

 
69.93

Performance adjustment (3)
32

 
71.50

Vested
(333
)
 
70.30

Forfeited
(32
)
 
64.48

Unvested at September 30, 2017
1,510

 
$
64.47

                                                      
(1)
Determined by dividing the aggregate grant date fair value of awards by the number of awards issued. The weighted-average grant date fair value per LP Unit for forfeited and vested awards is determined before an allowance for forfeitures.
(2)
Includes both phantom and performance awards. Performance awards are granted at a target amount but, depending on our performance during the vesting period with respect to certain pre-established goals, the number of LP Units issued upon vesting of such performance awards can be greater or less than the target amount.
(3)
Represents the LP Units issued in excess of target amounts for performance awards that vested during the nine months ended September 30, 2017 as a result of our above target performance with respect to applicable performance goals.

At September 30, 2017, $40.5 million of compensation expense related to the LTIP is expected to be recognized over a weighted average period of 1.8 years for the above awards.
 
Unit Option Plan
 
The following is a summary of the changes in the options outstanding (all of which are vested) under the Option Plan for the periods indicated (in thousands, except per unit amounts): 
 
Number of
LP Units
 
Weighted
Average
Strike Price
per LP Unit
 
Weighted
Average
Remaining
Contractual
Term (in years)
 
Aggregate
Intrinsic
Value (1)
Outstanding at January 1, 2017
10

 
$
50.36

 
0.1

 
$
151

Exercised
(10
)
 
—

 
 

 
 

Outstanding at September 30, 2017
—

 
—

 
—

 
$
—

 
 
 
 
 
 
 
 
Exercisable at September 30, 2017
—

 
$
—

 
—

 
$
—

                                                      
(1)
Aggregate intrinsic value reflects fully vested LP Unit options at the date indicated. Intrinsic value is determined by calculating the difference between our closing LP Unit price on the last trading day in September 2017 and the exercise price, multiplied by the number of exercisable, in-the-money options.
 
The total intrinsic value of options exercised during each of the nine months ended September 30, 2017 and 2016 was $0.2 million and $0.1 million, respectively.


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11. PARTNERS’ CAPITAL AND DISTRIBUTIONS

Our LP Units represent limited partner interests, which give the holders thereof the right to participate in distributions and to exercise the other rights and privileges available to them under our partnership agreement. The partnership agreement provides that, without prior approval of our limited partners holding an aggregate of at least two-thirds of the outstanding LP Units, we cannot issue any LP Units of a class or series having preferences or other special or senior rights over the LP Units.

At-the-Market Offering Program

In March 2016, we entered into an equity distribution agreement (the “Equity Distribution Agreement”) with J.P. Morgan Securities LLC, BB&T Capital Markets, a division of BB&T Securities, LLC, BNP Paribas Securities Corp., Deutsche Bank Securities Inc., Jefferies LLC, Morgan Stanley & Co. LLC, RBC Capital Markets, LLC, and SMBC Nikko Securities America, Inc. (collectively, the “ATM Underwriters”). Under the terms of the Equity Distribution Agreement, we may offer and sell up to $500.0 million in aggregate gross sales proceeds of LP Units from time to time through the ATM Underwriters, acting as agents of Buckeye or as principals, subject in each case to the terms and conditions set forth in the Equity Distribution Agreement. Sales of LP Units, if any, may be made by means of ordinary brokers’ transactions on the NYSE or otherwise at market prices prevailing at the time of sale, at prices related to prevailing market prices or at negotiated prices or as otherwise agreed with any of such firms.

During the nine months ended September 30, 2017, we sold approximately 6.2 million LP Units under the Equity Distribution Agreement, including a block sale of approximately 3.8 million LP Units on September 21, 2017, and received $346.0 million in net proceeds after deducting commissions and other related expenses, including $1.9 million of compensation fees paid in aggregate to the ATM Underwriters. We used the net proceeds from the block sale to reduce the indebtedness outstanding under our Credit Facility and for general partnership purposes.
 
Summary of Changes in Outstanding LP Units
 
The following is a summary of changes in Buckeye’s outstanding LP Units for the periods indicated (in thousands):
 
Limited
Partners
LP Units outstanding at January 1, 2017
140,264

LP Units issued pursuant to the Option Plan (1)
10

LP Units issued pursuant to the LTIP (1)
209

Issuance of LP Units through the Equity Distribution Agreement
6,159

LP Units outstanding at September 30, 2017
146,642

                                                      
(1) The number of LP Units issued represents issuance net of tax withholding.
 
Cash Distributions
 
We generally make quarterly cash distributions to unitholders of substantially all of our available cash, generally defined in our partnership agreement as consolidated cash receipts less consolidated cash expenditures and such retentions for working capital and maintenance capital, anticipated cash expenditures and contingencies as our general partner deems appropriate.  Actual cash distributions on our LP Units totaled $531.4 million ($3.75 per LP Unit) and $472.1 million ($3.60 per LP Unit) during the nine months ended September 30, 2017 and 2016, respectively.
 
On November 3, 2017, we announced a quarterly distribution of $1.2625 per LP Unit that will be paid on November 20, 2017 to unitholders of record on November 13, 2017.  Based on the LP Units and distribution equivalent rights with respect to certain unit-based compensation awards outstanding as of September 30, 2017, estimated cash to be distributed to unitholders on November 20, 2017 is $186.2 million.
 

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12. EARNINGS PER UNIT
 
The following table is a reconciliation of the weighted average units outstanding used in computing the basic and diluted earnings per unit for the periods indicated (in thousands, except per unit amounts):
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2017
 
2016
 
2017
 
2016
Net income attributable to Buckeye Partners, L.P.
$
116,187

 
$
156,374

 
$
352,485

 
$
427,943

 
 
 
 
 
 
 
 
Basic:
 

 
 

 
 

 
 

    Weighted average units outstanding - basic
142,088

 
131,113

 
141,104

 
130,439

 
 
 
 
 
 
 
 
Earnings per unit - basic
$
0.82

 
$
1.19

 
$
2.50

 
$
3.28

 
 
 
 
 
 
 
 
Diluted:
 

 
 

 
 

 
 

Weighted average units outstanding - basic
142,088

 
131,113

 
141,104

 
130,439

Dilutive effect of LP Unit options and LTIP awards granted
730

 
827

 
677

 
637

    Weighted average units outstanding - diluted
142,818

 
131,940

 
141,781

 
131,076

 
 
 
 
 
 
 
 
Earnings per unit - diluted
$
0.81

 
$
1.19

 
$
2.49

 
$
3.26


13. BUSINESS SEGMENTS
 
We operate and report in three business segments: (i) Domestic Pipelines & Terminals; (ii) Global Marine Terminals; and (iii) Merchant Services.  All inter-segment revenues, operating income and assets have been eliminated. 

 Domestic Pipelines & Terminals
 
The Domestic Pipelines & Terminals segment receives liquid petroleum products from refineries, connecting pipelines, vessels, and bulk and marine terminals, transports those products to other locations for a fee, and provides bulk liquid storage and terminal throughput services.  The segment also has butane blending capabilities and provides crude oil services, including train loading/unloading, storage and throughput. This segment owns and operates pipeline systems and liquid petroleum products terminals in the continental United States, including three terminals owned by the Merchant Services segment but operated by the Domestic Pipelines & Terminals segment, and two underground propane storage caverns.  Additionally, this segment provides turn-key operations and maintenance of third-party pipelines and performs pipeline construction management services typically for cost plus a fixed fee.
 
Global Marine Terminals
 
The Global Marine Terminals segment, including through its interest in VTTI, provides marine accessible bulk storage and blending services, rail and truck rack loading/unloading along with petroleum processing services in the New York Harbor on the East Coast and Corpus Christi, Texas in the Gulf Coast region of the United States, as well as The Bahamas, Puerto Rico and St Lucia in the Caribbean, Northwest Europe, the Middle East and Southeast Asia.  The segment owns and operates, or owns a significant interest in, 22 liquid petroleum product terminals, located in these key domestic and international energy hubs, that enable us to facilitate global flows of crude and refined petroleum products, offer connectivity between supply areas and market centers, and provide premier storage, marine terminalling, blending, and processing services to a diverse customer base.
 








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Merchant Services
 
The Merchant Services segment is a wholesale distributor of refined petroleum products in the United States and in the Caribbean. The segment’s products include gasoline, natural gas liquids, ethanol, biodiesel and petroleum distillates such as heating oil, diesel fuel, kerosene and fuel oil.  The segment owns three terminals, which are operated by the Domestic Pipelines & Terminals segment.  The segment’s customers consist principally of product wholesalers as well as major commercial users of these refined petroleum products.

Financial Information by Segment

The following table summarizes revenue by each segment for the periods indicated (in thousands):
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2017
 
2016
 
2017
 
2016
Revenue:
 

 
 

 
 

 
 

Domestic Pipelines & Terminals
$
254,277

 
$
265,036

 
$
761,438

 
$
752,968

Global Marine Terminals
155,281

 
170,072

 
487,613

 
509,653

Merchant Services
526,844

 
344,041

 
1,498,438

 
1,103,186

Intersegment
(13,783
)
 
(12,544
)
 
(45,396
)
 
(41,486
)
Total revenue
$
922,619

 
$
766,605

 
$
2,702,093

 
$
2,324,321

 
For the three and nine months ended September 30, 2017 and 2016, no customers contributed 10% or more of consolidated revenue.

The following table summarizes revenue by major geographic area for the periods indicated (in thousands):
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2017
 
2016
 
2017
 
2016
Revenue:
 

 
 

 
 

 
 

United States
$
855,795

 
$
683,850

 
$
2,474,562

 
$
2,072,893

International
66,824

 
82,755

 
227,531

 
251,428

Total revenue
$
922,619

 
$
766,605

 
$
2,702,093

 
$
2,324,321

 
Adjusted EBITDA
 
Adjusted EBITDA is a measure not defined by GAAP. We define Adjusted EBITDA as earnings before interest expense, income taxes, depreciation and amortization, further adjusted to exclude certain non-cash items, such as non-cash compensation expense; transaction, transition, and integration costs associated with acquisitions; certain gains and losses on foreign currency transactions and foreign currency derivative financial instruments, as applicable; and certain other operating expense or income items, reflected in net income, that we do not believe are indicative of our core operating performance results and business outlook, such as hurricane-related costs, gains and losses on property damage recoveries, and gains and losses on asset sales. The definition of Adjusted EBITDA is also applied to our proportionate share in the Adjusted EBITDA of significant equity method investments, such as that in VTTI, and is not applied to our less significant equity method investments. The calculation of our proportionate share of the reconciling items used to derive Adjusted EBITDA is based upon our 50% equity interest in VTTI, prior to adjustments related to noncontrolling interests in several of its subsidiaries and partnerships, which are immaterial. Adjusted EBITDA is a non-GAAP financial measure that is used by our senior management, including our Chief Executive Officer, to assess the operating performance of our business and optimize resource allocation. We use Adjusted EBITDA as a primary measure to: (i) evaluate our consolidated operating performance and the operating performance of our business segments; (ii) allocate resources and capital to business segments; (iii) evaluate the viability of proposed projects; and (iv) determine overall rates of return on alternative investment opportunities. 
 
We believe that investors benefit from having access to the same financial measures that we use and that these measures are useful to investors because they aid in comparing our operating performance with that of other companies with similar operations.  The Adjusted EBITDA data presented by us may not be comparable to similarly titled measures at other companies because these items may be defined differently by other companies.
 

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The following tables present Adjusted EBITDA by segment and on a consolidated basis and a reconciliation of net income, which is the most comparable financial measure under GAAP, to Adjusted EBITDA for the periods indicated (in thousands):
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2017
 
2016
 
2017
 
2016
Adjusted EBITDA:
 

 
 

 
 

 
 

Domestic Pipelines & Terminals
$
138,880

 
$
152,785

 
$
413,710

 
$
423,245

Global Marine Terminals
128,696

 
110,705

 
391,084

 
325,710

Merchant Services
9,742

 
8,159

 
19,224

 
23,909

Total Adjusted EBITDA
$
277,318

 
$
271,649

 
$
824,018

 
$
772,864

 
 
 
 
 
 
 
 
Reconciliation of Net Income to Adjusted EBITDA:
 

 
 

 
 

 
 

Net income
$
120,224

 
$
160,270

 
$
362,912

 
$
439,746

Less: Net income attributable to noncontrolling interests
(4,037
)
 
(3,896
)
 
(10,427
)
 
(11,803
)
Net income attributable to Buckeye Partners, L.P.
116,187

 
156,374

 
352,485

 
427,943

Add: Interest and debt expense
56,561

 
48,476

 
168,870

 
144,093

Income tax expense
448

 
308

 
1,709

 
896

 Depreciation and amortization (1)
65,661

 
63,472

 
195,987

 
188,220

 Non-cash unit-based compensation expense
8,176

 
8,853

 
25,756

 
22,912

 Acquisition and transition expense (2)
1,447

 
309

 
3,275

 
479

 Hurricane-related costs (3)
1,804

 
—

 
4,820

 
—

 Proportionate share of Adjusted EBITDA for the equity
 method investment in VTTI (4)
33,430

 
—

 
90,848

 
—

Less: Amortization of unfavorable storage contracts (5)
—

 
(443
)
 
—

 
(5,979
)
 Gains on property damage recoveries (6)
—

 
(5,700
)
 
(4,621
)
 
(5,700
)
 Earnings from the equity method investment in VTTI (4)
(6,396
)
 
—

 
(15,111
)
 
—