S-1/A 1 d216692ds1a.htm S-1/A AMENDMENT NO. 6 S-1/A Amendment No. 6
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As filed with the Securities and Exchange Commission on December 1, 2011

Registration No. 333-176260

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Amendment No. 6

to

Form S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

ROSE ROCK MIDSTREAM, L.P.

(Exact Name of Registrant as Specified in its Charter)

 

 

 

Delaware   4610   45-2934823

(State or Other Jurisdiction

of Incorporation or Organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification Number)

Two Warren Place

6120 S. Yale Avenue, Suite 700

Tulsa, Oklahoma 74136-4216

(918) 524-8100

(Address, including Zip Code, and Telephone Number, including Area Code, of

Registrant’s Principal Executive Offices)

Candice L. Cheeseman

General Counsel

Two Warren Place

6120 S. Yale Avenue, Suite 700

Tulsa, Oklahoma 74136-4216

(918) 524-8100

(Name, Address, including Zip Code, and Telephone Number, including Area

Code, of Agent for Service)

 

 

Copies to:

 

G. Michael O’Leary

William J. Cooper

Andrews Kurth LLP

600 Travis, Suite 4200

Houston, Texas 77002

(713) 220-4200

 

Joshua Davidson

Baker Botts L.L.P.

One Shell Plaza

910 Louisiana Street

Houston, Texas 77002

(713) 229-1234

 

 

Approximate date of commencement of proposed sale to the public: As soon as practicable after this Registration Statement becomes effective.

If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  ¨

If this form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:

 

Large accelerated filer  ¨      Accelerated filer  ¨
Non-accelerated filer  x      Smaller reporting company  ¨
(Do not check if a smaller reporting company)   

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine.

 

 

 


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The information in this preliminary prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.

 

 

Subject to Completion, dated December 1, 2011

PROSPECTUS

 

 

LOGO

Rose Rock Midstream, L.P.

7,000,000 Common Units

Representing Limited Partner Interests

 

 

This is the initial public offering of our common units. We are offering 7,000,000 common units in this offering. We currently estimate that the initial public offering price will be between $19.00 and $21.00 per common unit. Prior to this offering, there has been no public market for our common units. We have been approved to list our common units on the New York Stock Exchange under the symbol “RRMS” subject to official notice of issuance.

Investing in our common units involves risks. Please read “Risk Factors” beginning on page 21.

These risks include the following:

 

   

We may not have sufficient cash from operations following the establishment of cash reserves and payment of fees and expenses, including cost reimbursements to our general partner, to enable us to pay the minimum quarterly distribution to holders of our common and subordinated units.

 

   

Because of the natural decline in production from existing wells, our success depends on our ability to obtain new sources of crude oil, which is dependent on certain factors beyond our control. Any decrease in the volumes of crude oil that we gather, transport, store and market could adversely affect our business and operating results.

 

   

Our profitability depends on the demand for crude oil in the markets we serve.

 

   

SemGroup Corporation, or SemGroup, owns and controls Rose Rock Midstream GP, LLC, our general partner, which has sole responsibility for conducting our business and managing our operations. SemGroup and our general partner will have conflicts of interest with us and may favor their own interests to your detriment.

 

   

SemGroup is not limited in its ability to compete with us and is not obligated to offer us the opportunity to acquire additional assets or businesses.

 

   

Our partnership agreement limits our general partner’s fiduciary duties to holders of our common and subordinated units.

 

   

Holders of our common units will have limited voting rights and will not be entitled to elect our general partner or its directors.

 

   

Even if holders of our common units are dissatisfied, they will not initially be able to remove our general partner without its consent.

 

   

Your share of our income will be taxable to you for U.S. federal income tax purposes even if you do not receive any cash distributions from us.

 

    

Per Common Unit

    

    Total    

 

Price to the public

   $                    $                

Underwriting discount and commissions(1)

   $         $     

Proceeds, before expenses, to us

   $         $     

 

(1) Excludes an aggregate structuring fee equal to 0.5% of the gross proceeds of this offering, or approximately $              , payable by us to Barclays Capital Inc. and LCT Capital, LLC. Please see “Underwriting” beginning on page 197.

We have granted the underwriters a 30-day option to purchase up to an additional 1,050,000 common units on the same terms and conditions as set forth above if the underwriters sell more than 7,000,000 common units in this offering.

Neither the Securities and Exchange Commission nor any other regulatory body has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

The underwriters expect to deliver the common units to purchasers on or about                     , 2011, through the book entry facilities of The Depository Trust Company.

 

 

 

Barclays Capital    Citigroup            Deutsche Bank Securities   

 

 

UBS Investment Bank

 

 

 

Baird   BNP PARIBAS   BOSC, Inc.   Credit Agricole CIB

 

Natixis   RBS   Scotia Capital

Prospectus dated                     , 2011


Table of Contents

LOGO


Table of Contents

Table of Contents

 

     Page  

Summary

     1   

Rose Rock Midstream, L.P.

     1   

Our Relationship with SemGroup

     5   

Risk Factors

     6   

Formation Transactions and Partnership Structure

     8   

Ownership of Rose Rock Midstream, L.P.

     9   

Our Management

     10   

Principal Executive Offices and Internet Address

     10   

Summary of Conflicts of Interest and Fiduciary Duties

     10   

The Offering

     12   

Summary Historical and Pro Forma Financial and Operating Data

     16   

Risk Factors

     21   

Risks Related to Our Business

     21   

Risks Inherent in an Investment in Us

     36   

Tax Risks to Common Unitholders

     46   

Use of Proceeds

     51   

Capitalization

     52   

Dilution

     53   

Our Cash Distribution Policy and Restrictions on Distributions

     54   

General

     54   

Our Minimum Quarterly Distribution

     55   

Unaudited Pro Forma Available Cash for the Year Ended December  31, 2010 and the Twelve Months Ended September 30, 2011

     57   

Estimated Adjusted EBITDA for the Year Ending December 31, 2012

     59   

Assumptions and Considerations

     62   

Provisions of our Partnership Agreement Relating to Cash Distributions

     67   

Distributions of Available Cash

     67   

Operating Surplus and Capital Surplus

     68   

Capital Expenditures

     70   

Subordination Period

     70   

Distributions of Available Cash from Operating Surplus During the Subordination Period

     72   

Distributions of Available Cash from Operating Surplus After the Subordination Period

     72   

General Partner Interest and Incentive Distribution Rights

     73   

Percentage Allocations of Available Cash from Operating Surplus

     74   

General Partner’s Right to Reset Incentive Distribution Levels

     74   

Distributions from Capital Surplus

     77   

Adjustment to the Minimum Quarterly Distribution and Target Distribution Levels

     77   

Distributions of Cash Upon Liquidation

     78   

Selected Historical and Pro Forma Financial and Operating Data

     81   

Non-GAAP Financial Measures

     85   

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     87   

Overview

     87   

How We Evaluate Our Operations

     87   

How We Generate Adjusted Gross Margin

     89   

Items Affecting the Comparability of Our Financial Results

     90   

General Trends and Outlook

     91   

Results of Operations

     93   

Liquidity and Capital Resources

     101   

Quantitative and Qualitative Disclosures about Market Risk

     106   

 

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     Page  

Impact of Seasonality

     108   

Critical Accounting Policies and Estimates

     108   

Industry Overview

     112   

General

     112   

Crude Oil Industry Overview

     112   

Overview of Cushing

     113   

Overview of the Williston and Denver-Julesburg (DJ) Basins

     115   

Overview of the Granite Wash and Mississippian Oil Trend

     116   

Business

     117   

Overview

     117   

How We Generate Adjusted Gross Margin

     117   

Business Strategies

     118   

Competitive Strengths

     118   

Our Relationship with SemGroup

     119   

Assets and Operations

     120   

Operational Hazards and Insurance

     124   

Regulation

     125   

Title to Properties

     129   

Office Facilities

     129   

Employees

     129   

Legal Proceedings

     129   

Risk Governance and Comprehensive Risk Management Policy

     131   

Management

     132   

Management of Rose Rock Midstream, L.P.

     132   

Directors and Executive Officers

     132   

Director Independence

     135   

Committees of the Board of Directors

     135   

Compensation of Directors

     136   

Compensation Discussion and Analysis

     136   

Security Ownership of Certain Beneficial Owners and Management

     149   

Certain Relationships And Related Party Transactions

     151   

Distributions and Payments to our General Partner and its Affiliates

     151   

Agreements with Affiliates

     152   

Procedures for Review, Approval and Ratification of Related Person Transactions

     154   

Conflicts of Interest and Fiduciary Duties

     155   

Conflicts of Interest

     155   

Fiduciary Duties

     160   

Description of the Common Units

     163   

The Units

     163   

Transfer Agent and Registrar

     163   

Transfer of Common Units

     163   

The Partnership Agreement

     165   

Organization and Duration

     165   

Purpose

     165   

Cash Distributions

     165   

Capital Contributions

     165   

Voting Rights

     166   

Limited Liability

     167   

Issuance of Additional Securities

     168   

Amendment of Our Partnership Agreement

     168   

Merger, Sale or Other Disposition of Assets

     170   

 

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     Page  

Termination and Dissolution

     171   

Liquidation and Distribution of Proceeds

     171   

Withdrawal or Removal of Our General Partner

     172   

Transfer of General Partner Interest

     173   

Transfer of Ownership Interests in Our General Partner

     173   

Transfer of Incentive Distribution Rights

     173   

Change of Management Provisions

     173   

Limited Call Right

     174   

Meetings; Voting

     174   

Status as Limited Partner

     175   

Ineligible Holders; Redemption

     175   

Indemnification

     176   

Reimbursement of Expenses

     176   

Books and Reports

     176   

Right to Inspect Our Books and Records

     177   

Registration Rights

     177   

Units Eligible for Future Sale

     178   

Material Federal Income Tax Consequences

     179   

Partnership Status

     179   

Limited Partner Status

     181   

Tax Consequences of Unit Ownership

     181   

Tax Treatment of Operations

     187   

Disposition of Common Units

     188   

Uniformity of Units

     190   

Tax-Exempt Organizations and Other Investors

     191   

Administrative Matters

     191   

Recent Legislative Developments

     194   

State, Local, Foreign and Other Tax Considerations

     194   

Investment in Rose Rock Midstream, L.P. by Employee Benefit Plans

     195   

Underwriting

     197   

Commissions and Expenses

     197   

Option to Purchase Additional Common Units

     198   

Lock-Up Agreements

     198   

Offering Price Determination

     199   

Indemnification

     199   

Stabilization, Short Positions and Penalty Bids

     199   

Directed Unit Program

     200   

Electronic Distribution

     200   

New York Stock Exchange

     201   

Discretionary Sales

     201   

Stamp Taxes

     201   

Relationships

     201   

FINRA

     202   

Selling Restrictions

     202   

Validity of The Common Units

     205   

Experts

     205   

Where You Can Find More Information

     205   

Forward-Looking Statements

     206   

Index to Financial Statements

     F-1   

Appendix A—Second Amended and Restated Agreement of Limited Partnership of Rose Rock Midstream, L.P.

     A-1   

Appendix B—Glossary of Terms

     B-1   

 

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You should rely only on the information contained in this prospectus or in any free writing prospectus we may authorize to be delivered to you. Neither we nor the underwriters have authorized anyone to provide you with additional or different information. We and the underwriters are offering to sell, and seeking offers to buy, our common units only in jurisdictions in which offers and sales are permitted.

Through and including                     , 2012 (the 25th day after the date of this prospectus), all dealers effecting transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to a dealer’s obligation to deliver a prospectus when acting as an underwriter and with respect to an unsold allotment or subscription.

Industry and Market Data

The data included in this prospectus regarding the midstream crude oil industry, including descriptions of trends in the market and our position and the position of our competitors within the industry, is based on a variety of sources, including independent industry publications, government publications and other published independent sources, information obtained from customers, distributors, suppliers and trade and business organizations and publicly available information, as well as our good faith estimates, which have been derived from management’s knowledge and experience in the industry in which our business operates.

 

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SUMMARY

This summary provides a brief overview of information contained elsewhere in this prospectus. Because it is abbreviated, this summary does not contain all of the information that you should consider before investing in our common units. You should read the entire prospectus carefully, including the historical combined financial statements, the pro forma financial statements and the related notes included elsewhere herein. The information presented in this prospectus assumes (1) an initial public offering price of $20.00 per common unit (the mid-point of the price range set forth on the cover page of this prospectus) and (2) unless otherwise indicated, that the underwriters’ option to purchase additional common units is not exercised. You should read “Risk Factors” beginning on page 21 for more information about important risks that you should consider carefully before investing in our common units. We include a glossary of some of the terms used in this prospectus as Appendix B.

Unless the context otherwise requires, references in this prospectus to (i) the “partnership,” “we,” “our,” “us” or like terms, when used in a historical context, refer to our predecessor, and when used in the present tense or prospectively, refer to Rose Rock Midstream, L.P. and its subsidiaries; (ii) “SemGroup” refer to SemGroup Corporation (NYSE: SEMG) and its subsidiaries and affiliates, other than our general partner and us; (iii) “Rose Rock Midstream GP” or our “general partner” refer to Rose Rock Midstream GP, LLC; and (iv) “unitholders” refer to our common and subordinated unitholders, and not our general partner. For a description of the entities comprising our “predecessor,” please see page 16.

Rose Rock Midstream, L.P.

Overview

We are a growth-oriented Delaware limited partnership recently formed by SemGroup to own, operate, develop and acquire a diversified portfolio of midstream energy assets. We are engaged in the business of crude oil gathering, transportation, storage and marketing in Colorado, Kansas, Montana, North Dakota, Oklahoma and Texas. We serve areas that are experiencing strong production growth and drilling activity through our exposure to the Bakken Shale in North Dakota and Montana, the Denver-Julesburg (DJ) Basin and the Niobrara Shale in the Rocky Mountain region, and the Granite Wash and the Mississippian oil trend in the Mid-Continent region. The majority of our assets are strategically located in or connected to the Cushing, Oklahoma crude oil marketing hub. Cushing is the designated point of delivery specified in all NYMEX crude oil futures contracts and is one of the largest crude oil marketing hubs in the United States. We believe that our connectivity in Cushing and our numerous interconnections with third-party pipelines, refineries and storage terminals provide our customers with the flexibility to access multiple points for the receipt and delivery of crude oil.

For the year ended December 31, 2010 and the nine months ended September 30, 2011, approximately 85% and 73% of our adjusted gross margin, respectively, was generated from fee-based services or fixed-margin transactions. For a definition of adjusted gross margin and a reconciliation of adjusted gross margin to operating income (loss), its most directly comparable financial measure calculated and presented in accordance with accounting principles generally accepted in the United States, or GAAP, please see “—Summary Historical and Pro Forma Financial and Operating Data—Non-GAAP Financial Measures” beginning on page 19.

Our Assets and Operations

Cushing Storage. We own and operate a storage terminal in Cushing with over 5.0 million barrels of crude oil storage capacity, approximately 95% of which is committed under long-term, third-party contracts which provide for fixed fees that are not dependent on actual usage. We are currently constructing an additional 1.95 million barrels of storage capacity that is scheduled to be placed into service before the end of 2012 and is

 

 

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backed by a third-party, five-year contract that will commence on the in-service date of the new storage capacity. Our storage terminal has interconnections with all of the other major storage terminals in Cushing and has a combined throughput capacity to receive or deliver 240,000 barrels of crude oil per day. Our existing storage contracts had a weighted average remaining life of 4.3 years as of September 30, 2011, and none of our third-party contracts expire before 2015.

Kansas and Oklahoma Pipelines and Storage. We own and operate an approximately 640-mile crude oil gathering and transportation pipeline system and 670,000 barrels of associated storage in Kansas and northern Oklahoma. This system gathers crude oil from multiple receipt points throughout the region and delivers it to pipelines, refineries and our Cushing terminal, thereby providing our customers with multiple delivery options. During 2010, we transported an average of approximately 31,000 barrels per day, and during the nine months ended September 30, 2011, we transported an average of approximately 34,800 barrels per day.

Bakken Shale Operations. We own and operate a crude oil gathering, storage, transportation and marketing business in the Bakken Shale area in western North Dakota and eastern Montana. Using our fleet of trucks and capacity on the Enbridge North Dakota System, we purchase crude oil at the wellhead and transport and market it to customers, primarily at the Clearbrook, Minnesota crude oil marketing hub. During the nine months ended September 30, 2011, we handled and marketed an average of approximately 6,200 barrels per day.

Platteville Facility. We own and operate a modern, ten-lane crude oil truck unloading facility in Platteville, Colorado, which connects to the origination point of SemGroup’s White Cliffs Pipeline. This facility is utilized by producers, marketers and refiners to deliver crude oil into the White Cliffs Pipeline for transport to our terminal in Cushing. The facility also includes 120,000 barrels of crude oil storage capacity. We currently have an additional 100,000 barrels of storage capacity under construction and expect to build six additional truck unloading lanes and 10,000 barrels of additional storage capacity at the facility by the end of 2012. Throughput at the facility averaged 25,800 barrels per day and 31,600 barrels per day for the year ended December 31, 2010 and the nine months ended September 30, 2011, respectively.

How We Generate Adjusted Gross Margin

We generate adjusted gross margin by providing fee-based services, by entering into fixed-margin transactions and through marketing activities.

Fee-Based Services. We charge a capacity or volume-based fee for the unloading, transportation and storage of crude oil and related ancillary services. Our fee-based services include substantially all of our operations in Cushing and Platteville and a portion of the transportation services we provide on our Kansas and Oklahoma pipeline system. For the year ended December 31, 2010 and the nine months ended September 30, 2011, approximately 79% and 59% of our adjusted gross margin, respectively, was generated by providing fee-based services to customers.

Fixed-Margin Transactions. We purchase crude oil from a producer or supplier at a designated receipt point at an index price less a transportation fee, and simultaneously sell an identical volume of crude oil at a designated delivery point to the same party at the same index price, thereby locking in a fixed margin that is in effect economically equivalent to a transportation fee. We refer to these arrangements as “fixed-margin” or “buy/sell” transactions. These fixed-margin transactions account for a portion of the adjusted gross margin we generate on our Kansas and Oklahoma pipeline system and through our Bakken Shale operations. For the year ended December 31, 2010 and the nine months ended September 30, 2011, approximately 6% and 14% of our adjusted gross margin, respectively, was generated through fixed-margin transactions.

Marketing Activities. We conduct marketing activities by purchasing crude oil for our own account from producers, aggregators and traders and selling crude oil to traders and refiners. We mitigate the commodity price

 

 

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exposure of our crude oil marketing operations by limiting our net open positions through (i) the concurrent purchase and sale of like quantities of crude oil to create “back-to-back” transactions intended to lock in positive margins based on the timing, location or quality of the crude oil purchased and delivered or (ii) derivative contracts. All of our marketing activities are subject to our comprehensive risk management policy, which establishes limits in order to manage risk and mitigate financial exposure. Our marketing activities account for a portion of the adjusted gross margin we generate on our Kansas and Oklahoma pipeline system and through our Bakken Shale operations. For the year ended December 31, 2010 and the nine months ended September 30, 2011, approximately 15% and 27% of our adjusted gross margin, respectively, was generated through marketing activities.

Industry Trends

According to the Energy Information Administration, or EIA, U.S. annual crude oil consumption is expected to grow by 13.8% between 2009 and 2035, from 17.1 million barrels per day to 19.4 million barrels per day. According to the EIA, Cushing shell storage capacity more than doubled to 57.9 million barrels, with working capacity of 48.0 million barrels, from 2004 to March 2011. At any given time, Cushing holds 5% to 10% of the total U.S. crude oil inventory.

Midstream assets like ours provide the vital link between producers and end users of crude oil. In particular, with its multiple inbound and outbound pipeline interconnections, Cushing serves as a significant source of refinery feedstock for Mid-Continent refiners and plays an integral role as a liquidity point in establishing and maintaining markets for many varieties of foreign and domestic crude oil. Recently, Cushing has experienced a shortfall in takeaway pipeline capacity, which has been cited as a principal reason for the decline in the WTI Index price used at Cushing compared to other crude oil price indices. We believe that if and when any of several planned takeaway pipeline expansion projects are completed, this price differential will narrow and Cushing will remain the predominant benchmarking and transportation hub for crude oil in the United States.

The Bakken Shale, the DJ Basin and the Niobrara Shale have emerged as highly attractive areas targeted by upstream companies utilizing horizontal drilling technologies. According to North Dakota state statistics, Bakken Shale oil production has increased steadily from 28 million barrels in 2008 to 86 million barrels in 2010. The Niobrara Shale is in the early stages of exploration, but a United States Geological Survey, or USGS, study estimated mean undiscovered hydrocarbons from the Niobrara Shale in the DJ Basin at 127 million barrels of oil equivalent. Upstream companies have also been applying horizontal drilling technologies to proven plays that have traditionally been drilled with vertical wells, such as the Granite Wash and Mississippian oil trend. According to industry research, the application of horizontal drilling techniques to these established plays is expected to increase production volumes in the coming years.

Business Strategies

Our principal business objective is to increase the quarterly cash distributions that we pay to our unitholders over time while maintaining the ongoing stability of our business. We expect to achieve this objective through the following strategies:

 

   

Capitalizing on organic growth opportunities associated with our existing assets. We seek to identify and evaluate economically attractive organic expansion and asset enhancement opportunities that leverage our existing asset footprint and strategic relationships with our customers. We are currently (i) constructing an additional 1.95 million barrels of crude oil storage capacity at Cushing, (ii) expanding capacity on portions of our Kansas and Oklahoma pipeline system through de-bottlenecking projects, (iii) evaluating additional markets for our Bakken Shale operations and (iv) constructing an additional 100,000 barrels of storage capacity, and planning for the construction of six additional truck unloading lanes and an additional 10,000 barrels of storage capacity, at our Platteville facility.

 

 

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Growing our business through strategic and accretive asset acquisitions from third parties and SemGroup. We plan to pursue accretive acquisitions from SemGroup and third parties of midstream energy assets that are complementary to our existing asset base or that provide attractive potential returns in new operating regions or business lines.

 

   

Focusing on stable, fee-based services and fixed-margin transactions. We focus on opportunities to provide midstream services under fee-based arrangements and fixed-margin transactions, which minimize our direct exposure to commodity price fluctuations.

 

   

Mitigating commodity price exposure. We mitigate the commodity price exposure of substantially all our crude oil marketing operations by entering into “back-to-back” transactions, which are intended to lock in positive margins based on the timing, location or quality of the crude oil purchased and delivered, and through the use of derivative contracts.

 

   

Maintaining financial flexibility and utilizing leverage prudently. We plan to pursue a disciplined financial policy and maintain a conservative capital structure to allow us to execute on our identified growth projects, as well as pursue additional growth projects and acquisitions, even in challenging market environments. We will have minimal debt at the closing of this offering.

Competitive Strengths

We believe that the following competitive strengths position us to successfully execute our principal business objective:

 

   

Strategically located assets that provide a strong platform for growth and operational flexibility to our customers. The majority of our assets are located in or connected to Cushing, and our numerous interconnections to other terminals and pipelines provide our customers with multiple options for the receipt and delivery of crude oil. We believe that we are well positioned to take advantage of both the increased throughput at Cushing that is expected to result from the construction of additional transportation capacity to and from the hub and the growing production in the Bakken Shale, DJ Basin, Niobrara Shale, Granite Wash and Mississippian oil trend.

 

   

Modern crude oil storage and unloading assets. Our Cushing storage tanks and our Platteville facility have all been placed into service since the beginning of 2009. The recent construction of these facilities results in reduced maintenance costs, and we believe that customers prefer the additional reliability and safety that is generally associated with newer assets.

 

   

Stable cash flow. For the year ended December 31, 2010 and the nine months ended September 30, 2011, approximately 85% and 73% of our adjusted gross margin, respectively, was generated from fee-based services and fixed-margin transactions. Our fee-based and fixed-margin activities mitigate our exposure to margin fluctuations caused by commodity price volatility.

 

   

Affiliation with SemGroup. We believe that our relationship with SemGroup strengthens our ability to make strategic acquisitions and to access other business opportunities. In addition, we believe that SemGroup, as the owner of a substantial interest in us, will be motivated to promote and support the successful execution of our business strategies.

 

   

Experienced, knowledgeable management team with a proven track record. Our management team has an average of over 27 years of experience in the energy industry, including in building, acquiring, integrating and operating midstream assets. In addition, our management team has established strong relationships throughout the U.S. upstream and midstream industries, which we believe will be beneficial to us in pursuing acquisition and organic expansion opportunities.

 

 

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Recent Developments

Announcement by Plains All American Pipeline, L.P. On October 24, 2011, Plains All American Pipeline, L.P. (“Plains”) announced that it had made an unsolicited proposal to acquire all of the outstanding shares of SemGroup for $24.00 per share in cash. On October 24, 2011, SemGroup announced that it had rejected the Plains proposal and that its board of directors had previously reviewed the proposal and had determined that it substantially undervalued SemGroup. The announcement also noted that SemGroup’s board of directors is willing to consider any transaction that reflects the full and fair value of SemGroup’s current business and future prospects. On November 16, 2011, Plains reiterated its proposal to acquire all of the outstanding shares of SemGroup for $24.00 in cash. On November 17, 2011, SemGroup announced that its board of directors had reviewed the Plains proposal and found that the Plains proposal substantially undervalues SemGroup and its future prospects. The board of directors reiterated that it is willing to consider any transaction that reflects the full and fair value of SemGroup’s current business and future prospects.

Additional proposals to acquire SemGroup, from Plains or other parties, may be received by SemGroup, and SemGroup may enter into an agreement with respect to such a transaction, at any time. Plains or other third parties may also seek to gain control of SemGroup through other methods, including tender offers, consent solicitations or proxy contests. Please see “Our general partner interest or the control of our general partner or SemGroup may be transferred to a third party without unitholder consent. In addition, SemGroup has received an unsolicited proposal to acquire all of its common stock. A change in control of SemGroup or our general partner could result in a change in our business strategy that does not favor our unitholders or could otherwise have a material adverse effect on our business” on page 37.

Our Relationship with SemGroup

One of our principal strengths is our relationship with SemGroup. SemGroup provides gathering, transportation, processing, storage, distribution, marketing and other midstream services primarily to independent oil and natural gas producers, refiners of petroleum products and other market participants located in the Mid-Continent and Rocky Mountain regions of the United States and in Canada, Mexico and the United Kingdom. Since 2008, SemGroup has taken numerous steps to restructure its business portfolio and to shift away from trading activities and toward a business heavily weighted in fee-based and fixed-margin activities. As of November 15, 2011, excluding the assets being contributed to us in connection with this offering, SemGroup had a midstream asset portfolio that included, among other assets:

 

   

a 51% interest in the White Cliffs Pipeline, which SemGroup operates;

 

   

a 7.5% interest in NGL Energy Holdings LLC, the general partner of NGL Energy Partners LP;

 

   

8.93 million common units of NGL Energy Partners LP;

 

   

more than 1,400 miles of natural gas and natural gas liquid, or NGL, transportation, gathering and distribution pipelines in Arizona, Arkansas, Kansas, Montana, Oklahoma and Texas and Alberta, Canada;

 

   

8.7 million barrels of owned multiproduct storage capacity located in the United Kingdom;

 

   

14 asphalt terminals in Mexico;

 

   

majority interests in four natural gas processing plants located in Alberta, Canada, with a combined operating capacity of 654 million cubic feet per day, or MMcf/d; and

 

   

three natural gas processing plants located in Oklahoma and Texas, with a combined operating capacity of 78 MMcf/d.

SemGroup’s Class A common stock trades on the New York Stock Exchange, or NYSE, under the symbol “SEMG.”

 

 

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Following the completion of this offering, SemGroup will continue to own and operate a substantial portfolio of midstream assets and will retain a significant interest in us through its ownership of a 57.1% limited partner interest and 2.0% general partner interest in us, as well as all of our incentive distribution rights. Given SemGroup’s significant ownership in us following this offering, we believe that SemGroup will be motivated to promote and support the successful execution of our business strategies, including through the potential contribution of additional midstream assets to us over time and the facilitation of accretive acquisitions, although SemGroup is under no obligation to offer any assets or business opportunities to us or accept any offer for its assets that we may choose to make. SemGroup constantly evaluates acquisitions and dispositions and may elect to acquire or dispose of assets in the future without offering us the opportunity to purchase those assets. SemGroup has retained such flexibility because it believes it is in the best interests of its shareholders to do so. We cannot say with any certainty which, if any, opportunities to acquire assets from SemGroup may be made available to us or if we will choose to pursue any such opportunity. Moreover, the consideration to be paid by us for assets offered to us by SemGroup, if any, as well as the consummation and timing of any acquisition by us of these assets, would depend upon, among other things, the timing of SemGroup’s decision to sell, transfer or otherwise dispose of these assets, our ability to successfully negotiate a purchase price and other terms, and our ability to obtain financing.

We will enter into an omnibus agreement with SemGroup and our general partner that will govern our relationship with them regarding certain indemnification matters, among other things. Please read “Certain Relationships and Related Party Transactions—Agreements with Affiliates—Omnibus Agreement” beginning on page 152. While our relationship with SemGroup provides us with a significant advantage, it is also a source of potential conflicts. For example, SemGroup is not restricted from competing with us, and may acquire, construct or dispose of midstream energy assets without any obligation to offer us the opportunity to acquire or construct such assets. Please read “Conflicts of Interest and Fiduciary Duties” beginning on page 155 and “Risk Factors—Risks Inherent in an Investment in Us—SemGroup owns and controls our general partner, which has sole responsibility for conducting our business and managing our operations. SemGroup and our general partner will have conflicts of interest with us and may favor their own interests to your detriment” on page 36.

On July 22, 2008, SemGroup and certain of its subsidiaries, including the entities comprising our predecessor, filed petitions for reorganization under Chapter 11 of the U.S. Bankruptcy Code. Later during 2008, certain other U.S. subsidiaries filed petitions for reorganization. During the reorganization process, SemGroup filed a plan of reorganization with the court, which was confirmed on October 28, 2009. The plan of reorganization determined, among other things, how pre-petition date obligations would be settled, the equity structure of the reorganized company upon emergence and the financing arrangements upon emergence. SemGroup emerged from bankruptcy on November 30, 2009.

Risk Factors

An investment in our common units involves risks associated with our business, regulatory and legal matters, our limited partnership structure and the tax characteristics of our common units. The following list of risk factors is not exhaustive. Please read carefully the risks described under the caption “Risk Factors” immediately following this Summary, beginning on page 21, for a more thorough description of the risks associated with an investment in our common units.

Risks Related to our Business

 

   

We may not have sufficient cash from operations following the establishment of cash reserves and payment of fees and expenses, including cost reimbursements to our general partner, to enable us to pay the minimum quarterly distribution to holders of our common and subordinated units.

 

 

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The amount of cash we have available for distribution to holders of our common and subordinated units depends primarily on our cash flow rather than on our profitability, which may prevent us from making distributions, even during periods in which we record net income.

 

   

The assumptions underlying the forecast of adjusted EBITDA and cash available for distribution that we include in “Our Cash Distribution Policy and Restrictions on Distributions” are inherently uncertain and are subject to significant business, economic, financial, regulatory and competitive risks and uncertainties that could cause actual results to differ materially from those forecasted.

 

   

Our profitability depends on the demand for crude oil in the markets we serve.

 

   

Because of the natural decline in production from existing wells, our success depends on our ability to obtain new sources of crude oil, which is dependent on certain factors beyond our control. Any decrease in the volumes of crude oil that we gather, transport, store and market could adversely affect our business and operating results.

 

   

We face intense competition in our gathering, transportation, storage and marketing activities. Competition from other providers of those services that are able to supply our customers with those services at a lower price or on otherwise better terms could adversely affect our business and operating results.

 

   

We may not be able to renew or replace expiring storage contracts.

Risks Inherent in an Investment in Us

 

   

SemGroup owns and controls our general partner, which has sole responsibility for conducting our business and managing our operations. SemGroup and our general partner will have conflicts of interest with us and may favor their own interests to your detriment.

 

   

Our general partner interest or the control of our general partner or SemGroup may be transferred to a third party without unitholder consent. In addition, SemGroup has received an unsolicited proposal to acquire all of its common stock. A change in control of SemGroup or our general partner could result in a change in our business strategy that does not favor our unitholders or otherwise have a material adverse effect on our business.

 

   

SemGroup is not limited in its ability to compete with us and is not obligated to offer us the opportunity to acquire additional assets or businesses, which could limit our ability to grow and could adversely affect our business, results of operations, financial condition and ability to make cash distributions to our unitholders.

 

   

Our partnership agreement limits our general partner’s fiduciary duties to holders of our common and subordinated units.

 

   

Our partnership agreement limits the liability of and reduces the fiduciary duties owed by our general partner, and also restricts the remedies available to holders of our common and subordinated units for actions taken by our general partner that might otherwise constitute breaches of fiduciary duty. Please see the risk factor set forth under this heading on page 39.

 

   

Our partnership agreement requires that we distribute all of our available cash, which could limit our ability to grow and make acquisitions.

 

   

Holders of our common units will have limited voting rights and will not be entitled to elect our general partner or its directors.

 

   

Even if holders of our common units are dissatisfied, they will not initially be able to remove our general partner without its consent.

 

   

You will experience immediate and substantial dilution in pro forma net tangible book value of $3.50 per common unit.

 

 

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Tax Risks to Common Unitholders

 

   

Our tax treatment depends on our status as a partnership for federal income tax purposes. If the Internal Revenue Service, or IRS, were to treat us as a corporation for federal income tax purposes, which would subject us to entity-level taxation, then our cash available for distribution to our unitholders would be substantially reduced.

 

   

The tax treatment of publicly traded partnerships or an investment in our common units could be subject to potential legislative, judicial or administrative changes and differing interpretations, possibly on a retroactive basis.

 

   

Your share of our income will be taxable to you for U.S. federal income tax purposes even if you do not receive any cash distributions from us.

Formation Transactions and Partnership Structure

Formation Transactions

We are a growth-oriented Delaware limited partnership recently formed by SemGroup to own, operate, develop and acquire a diversified portfolio of midstream energy assets. On November 29, 2011, the following transactions, which we refer to as the formation transactions, occurred:

 

   

SemCrude, L.P., which owns all of our initial assets, distributed to SemGroup certain assets and liabilities not intended to be contributed to us (consisting of (i) certain inactive assets and certain liabilities and (ii) a 100% membership interest in SemCrude Pipeline, L.L.C., which holds a 51% interest in the White Cliffs Pipeline); and

 

   

SemGroup contributed 100% of the limited and general partner interests in SemCrude, L.P. to us.

In connection with the closing of this offering, the following transactions will occur:

 

   

we will distribute to SemGroup all of our cash on hand immediately prior to the closing of this offering;

 

   

we will issue to Rose Rock Midstream GP, LLC, our general partner and a wholly owned subsidiary of SemGroup, 342,437 general partner units, representing a 2.0% general partner interest in us, as well as all of our incentive distribution rights;

 

   

we will issue 1,389,709 common units and 8,389,709 subordinated units, representing an aggregate 57.1% limited partner interest in us, to SemGroup;

 

   

we will issue 7,000,000 common units, representing a 40.9% limited partner interest in us, to the public;

 

   

we will apply the net proceeds from the issuance and sale of such common units to the public as described in “Use of Proceeds”;

 

   

we will close our new $150 million revolving credit facility, under which we expect to borrow approximately $1.8 million at the closing of this offering; and

 

   

we will enter into an omnibus agreement with SemGroup and our general partner which will address, among other things, certain indemnification matters.

The statements regarding the number of common units that we will issue to SemGroup and the public made in the third and fourth bullets of the preceding paragraph assume that the underwriters will not exercise their option to purchase up to an additional 1,050,000 common units. To the extent the underwriters exercise this option, the number of common units issued to the public (as reflected in the fourth bullet) will increase by the aggregate number of common units purchased by the underwriters pursuant to such exercise, and the number of common units issued to SemGroup (as reflected in the third bullet) will decrease by the aggregate number of common units purchased by the underwriters pursuant to such exercise.

 

 

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Ownership of Rose Rock Midstream, L.P.

The diagram below illustrates our organization and ownership after giving effect to the formation transactions and this offering and assumes that the underwriters’ option to purchase additional common units is not exercised.

 

Public Common Units

     40.9

Sponsor Units:

  

Common Units

     8.1

Subordinated Units

     49.0

General Partner Units

     2.0
  

 

 

 

Total

     100.0

LOGO

 

 

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Our Management

We are managed and operated by the board of directors and executive officers of our general partner, Rose Rock Midstream GP, LLC. SemGroup will own all of the ownership interests in our general partner and will be entitled to appoint the entire board of directors of our general partner. Our unitholders will not be entitled to elect our general partner or its directors or otherwise directly participate in our management or operation. All of the officers of our general partner are also officers and/or directors of SemGroup. For information about the executive officers and directors of our general partner, please read “Management” beginning on page 132.

In order to maintain operational flexibility, our operations will be conducted through, and our operating assets will be owned by, Rose Rock Midstream Operating, LLC and its subsidiaries. However, we, Rose Rock Midstream Operating, LLC and its subsidiaries will not have any employees. Although all of the employees that conduct our business will be employed by an affiliate of our general partner, we sometimes refer to these individuals in this prospectus as our employees.

Following the closing of this offering, our general partner and its affiliates will not receive any management fee or other compensation in connection with our general partner’s management of our business, but will be reimbursed for expenses incurred on our behalf. These expenses will include the costs of officer and director and other employee compensation and benefits properly allocable to us, and all other expenses necessary or appropriate for the conduct of our business and allocable to us. Our partnership agreement provides that our general partner will determine in good faith the expenses that are allocable to us.

Our general partner will own 342,437 general partner units representing a 2.0% general partner interest in us, which will entitle it to receive 2.0% of all the distributions we make. Our general partner will also own all of our incentive distribution rights, which will entitle it to increasing percentages, up to a maximum of 48.0%, of the cash we distribute in excess of $0.3625 per unit per quarter after the closing of our initial public offering. In addition, SemGroup will own 1,389,709 common units and 8,389,709 subordinated units. Please read “Certain Relationships and Related Party Transactions” beginning on page 151.

Principal Executive Offices and Internet Address

Our principal executive offices are located at Two Warren Place, 6120 S. Yale Avenue, Suite 700, Tulsa, OK 74136-4216, and our telephone number is (918) 524-7700. Our website is located at www.rrmidstream.com, and will be activated immediately following the closing of this offering. We expect to make available our periodic reports and other information filed with or furnished to the Securities and Exchange Commission, or the SEC, free of charge through our website, as soon as reasonably practicable after those reports and other information are electronically filed with or furnished to the SEC. Information on our website or any other website is not incorporated by reference herein and does not constitute a part of this prospectus.

Summary of Conflicts of Interest and Fiduciary Duties

General

Our general partner has a legal duty to manage us in a manner beneficial to the holders of our common and subordinated units. This legal duty originates in statutes and judicial decisions and is commonly referred to as a “fiduciary duty.” However, the officers and directors of our general partner also have a fiduciary duty to manage the business of our general partner in a manner beneficial to its owner, SemGroup. All of the officers of our general partner are also officers and/or directors of SemGroup. As a result of these relationships, conflicts of interest may arise in the future between us and holders of our common units, on the one hand, and SemGroup and our general partner, on the other hand. For example, our general partner will be entitled to make determinations that affect the amount of cash distributions we make to the holders of common units, which in turn has an effect on whether our general partner receives incentive cash distributions as discussed above.

 

 

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Partnership Agreement Modifications to Fiduciary Duties

Our partnership agreement limits the liability of, and reduces the fiduciary duties owed by, our general partner to holders of our common and subordinated units. Our partnership agreement also restricts the remedies available to holders of our common and subordinated units for actions that might otherwise constitute a breach of our general partner’s fiduciary duties. By purchasing a common unit, the purchaser agrees to be bound by the terms of our partnership agreement and, pursuant to the terms of our partnership agreement, each holder of common units consents to various actions and potential conflicts of interest contemplated in the partnership agreement that might otherwise be considered a breach of fiduciary or other duties under applicable state law.

 

 

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The Offering

 

Common units offered to the public

7,000,000 common units.

 

  8,050,000 common units if the underwriters exercise in full their option to purchase additional common units.

 

Units outstanding after this offering

8,389,709 common units and 8,389,709 subordinated units, each representing a 49.0% limited partner interest in us.

If the underwriters do not exercise their option to purchase additional common units, we will issue 1,050,000 additional common units to SemGroup at the expiration of the option period in consideration of its contribution to us of all of the limited and general partner interests in SemCrude, L.P. at closing. To the extent the underwriters exercise their option to purchase additional common units, the number of common units purchased by the underwriters pursuant to such exercise will be sold to the public, and the remainder of the common units that are subject to the option, if any, will be issued to SemGroup at the expiration of the option period. Accordingly, the exercise of the underwriters’ option will not affect the total number of units outstanding or the amount of cash needed to pay the minimum quarterly distribution on all outstanding units.

 

  Our general partner will own 342,437 general partner units, representing a 2.0% general partner interest in us.

 

Use of proceeds

We expect to receive net proceeds of approximately $127.3 million from this offering, based upon the mid-point of the price range set forth on the cover page of this prospectus and after deducting underwriting discounts and commissions, structuring fees and offering expenses. We intend to use the net proceeds from this offering to make a cash distribution to SemGroup.

 

  The cash distribution to SemGroup made with the net proceeds of this offering will be made in consideration of its contribution to us of all of the partnership interests in SemCrude, L.P., which owns all of our initial assets, and to reimburse SemGroup for certain capital expenditures incurred with respect to those assets.

 

  If the underwriters exercise their option to purchase additional common units in full, the additional net proceeds will be approximately $19.5 million. The net proceeds from any exercise of such option will be used to make an additional cash distribution to SemGroup in consideration of its contribution to us of all of the limited and general partner interests in SemCrude, L.P. at closing and to reimburse SemGroup for certain capital expenditures incurred with respect to our assets.

 

 

SemGroup has informed us that all of the net proceeds distributed to it will be used to repay, on a pro rata basis, a portion of the indebtedness

 

 

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outstanding under its term loans. Affiliates of certain of the underwriters are lenders under one of the term loans and will, in that respect, receive a portion of the net proceeds of this offering.

 

Cash distributions

We intend to pay a minimum quarterly distribution of $0.3625 per unit ($1.45 per unit on an annualized basis) to the extent we have sufficient cash from operations after establishment of cash reserves and payment of fees and expenses, including payments to our general partner and its affiliates. We refer to this cash as “available cash,” and it is defined in our partnership agreement included in this prospectus as Appendix A. Our ability to pay the minimum quarterly distribution is subject to various restrictions and other factors described in more detail under the caption “Our Cash Distribution Policy and Restrictions on Distributions” beginning on page 54. We will adjust the minimum quarterly distribution payable for the period from the closing of this offering through December 31, 2011, based on the length of that period.

 

  Our partnership agreement requires that we distribute all of our available cash each quarter in the following manner:

 

   

first, 98.0% to the holders of common units and 2.0% to our general partner, until each common unit has received the minimum quarterly distribution of $0.3625, plus any arrearages from prior quarters;

 

   

second, 98.0% to the holders of subordinated units and 2.0% to our general partner, until each subordinated unit has received the minimum quarterly distribution of $0.3625; and

 

   

third, 98.0% to all unitholders, pro rata, and 2.0% to our general partner, until each unit has received a distribution of $0.416875.

 

  If cash distributions to our unitholders exceed $0.416875 per unit in any quarter, our general partner will receive, in addition to distributions on its 2.0% general partner interest, increasing percentages, up to 48.0%, of the cash we distribute in excess of that amount. We refer to these distributions as “incentive distributions.” In certain circumstances, our general partner, as the initial holder of our incentive distribution rights, will have the right to reset the target distribution levels to higher levels based on our cash distributions at the time of the exercise of this reset election. Please read “Provisions of Our Partnership Agreement Relating to Cash Distributions” beginning on page 67.

Pro forma cash available for distribution generated during the year ended December 31, 2010 and the twelve months ended September 30, 2011 was approximately $32.3 million and $30.1 million, respectively. The amount of available cash we will need to pay the minimum quarterly distribution for four quarters on our common units and subordinated units to be outstanding immediately after this offering and the corresponding distributions on our general partner’s 2.0% interest will be approximately $24.8 million (or an

 

 

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average of approximately $6.2 million per quarter). As a result, for each of the year ended December 31, 2010 and the twelve months ended September 30, 2011, we would have generated available cash sufficient to pay the full minimum quarterly distribution of $0.3625 per unit per quarter ($1.45 per unit on an annualized basis) on all of our common units and subordinated units for each such period. Please read “Our Cash Distribution Policy and Restrictions on Distributions—Unaudited Pro Forma Available Cash for the Year Ended December 31, 2010 and the Twelve Months Ended September 30, 2011,” beginning on page 57.

 

  We believe, based on our financial forecast and the related assumptions included under “Cash Distribution Policy and Restrictions on Distributions—Estimated Adjusted EBITDA for the Year Ending December 31, 2012,” that we will have sufficient cash available for distribution to pay the minimum quarterly distribution of $0.3625 per unit on all our common and subordinated units and the corresponding distributions on our general partner’s 2.0% interest for the four quarters ending December 31, 2012.

 

Subordinated units

Rose Rock Midstream Holdings, LLC will initially own all of our subordinated units. The principal difference between our common units and subordinated units is that in any quarter during the subordination period, holders of the subordinated units are not entitled to receive any distribution of available cash until the common units have received the minimum quarterly distribution plus any arrearages in the payment of the minimum quarterly distribution from prior quarters. Subordinated units will not accrue arrearages.

 

Conversion of subordinated units

The subordination period will end on the first business day after we have earned and paid at least (i) $1.45 (the minimum quarterly distribution on an annualized basis) on each outstanding common and subordinated unit and the corresponding distributions on our general partner’s 2.0% interest for each of three consecutive, non-overlapping four-quarter periods ending on or after December 31, 2014 or (ii) $2.175 (150% of the annualized minimum quarterly distribution) on each outstanding common and subordinated unit and the corresponding distributions on our general partner’s 2.0% interest and the incentive distribution rights for any four-quarter period ending on or after December 31, 2012, in each case provided that there are no arrearages on our common units at that time.

 

  In addition, the subordination period will end upon the removal of our general partner other than for cause if the units held by our general partner and its affiliates are not voted in favor of such removal.

 

  When the subordination period ends, all subordinated units will convert into common units on a one-for-one basis, and all common units thereafter will no longer be entitled to arrearages. Please read “Provisions of our Partnership Agreement Relating to Cash Distributions—Subordination Period” beginning on page 70.

 

 

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Issuance of additional units

Our partnership agreement authorizes us to issue an unlimited number of additional units without the approval of our unitholders. Please read “Units Eligible for Future Sale” beginning on page 178 and “The Partnership Agreement—Issuance of Additional Securities” on page 168.

 

Limited voting rights

Our general partner will manage and operate us. Unlike the holders of common stock in a corporation, you will have only limited voting rights on matters affecting our business. You will have no right to elect our general partner or its directors on an annual or continuing basis. Our general partner may not be removed except by a vote of the holders of at least 66 2/3% of the outstanding limited partner units voting together as a single class, including any limited partner units owned by our general partner and its affiliates, including SemGroup. Upon the closing of this offering, SemGroup will own an aggregate of 58.3% of our common and subordinated units. This will give SemGroup the ability to prevent the involuntary removal of our general partner. Please read “The Partnership Agreement—Voting Rights” beginning on page 166.

 

Limited call right

If at any time our general partner and its affiliates own more than 80% of the outstanding common units, our general partner will have the right, but not the obligation, to purchase all of the remaining common units at a price that is not less than the then-current market price of the common units.

 

Estimated ratio of taxable income to distributions

We estimate that if you own the common units you purchase in this offering through the record date for distributions for the period ending December 31, 2014, you will be allocated, on a cumulative basis, an amount of federal taxable income for that period that will be 20% or less of the cash distributed to you with respect to that period. For example, if you receive an annual distribution of $1.45 per unit, we estimate that your average allocable federal taxable income per year will be no more than approximately $0.29 per unit. Please read “Material Federal Income Tax Consequences—Tax Consequences of Unit Ownership—Ratio of Taxable Income to Distributions” on page 182.

 

Material federal income tax consequences

For a discussion of other material federal income tax consequences that may be relevant to prospective unitholders who are individual citizens or residents of the United States, please read “Material Federal Income Tax Consequences” beginning on page 179.

 

Exchange listing

We have been approved to list our common units on the NYSE under the symbol “RRMS” subject to official notice of issuance.

 

 

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Summary Historical and Pro Forma Financial and Operating Data

The following table shows summary historical combined financial and operating data of our predecessor for accounting purposes, and summary pro forma combined financial and operating data of Rose Rock Midstream, L.P., for the periods and as of the dates indicated. The summary historical combined financial data of our predecessor as of December 31, 2009 and 2010 and for the year ended December 31, 2008, the eleven months ended November 30, 2009, the one month ended December 31, 2009 and the year ended December 31, 2010 are derived from the audited combined financial statements of our predecessor included elsewhere in this prospectus. The summary historical combined balance sheet data of our predecessor as of November 30, 2009 are derived from the audited combined financial statements of our predecessor not included in this prospectus. The summary historical combined balance sheet data of our predecessor as of December 31, 2008 are derived from unaudited combined financial statements of our predecessor not included in this prospectus. The summary historical combined financial data of our predecessor as of September 30, 2010 and 2011 and for the nine months ended September 30, 2010 and 2011 are derived from the unaudited combined interim financial statements of our predecessor included elsewhere in this prospectus. The following table should be read together with, and is qualified in its entirety by reference to, the audited and unaudited historical and unaudited pro forma combined financial statements and the accompanying notes included elsewhere in this prospectus. The table should also be read together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” beginning on page 87. For ease of reference, we refer to the historical financial data of our predecessor as being “our” historical financial data.

The summary pro forma combined financial data presented in the following table for the year ended December 31, 2010 and as of and for the nine months ended September 30, 2011 are derived from the unaudited pro forma combined financial statements of Rose Rock Midstream, L.P. included elsewhere in this prospectus. The pro forma balance sheet data were prepared assuming that the offering and the related transactions occurred as of September 30, 2011, and the pro forma statement of operations data were prepared assuming that the offering and the related transactions occurred as of January 1, 2010. These transactions include, and the pro forma financial data give effect to, the following:

 

   

the elimination of Eaglwing, L.P., which is included in the historical combined financial statements of our predecessor, but which will not be contributed to us;

 

   

SemGroup’s contribution to us of 100% of the limited and general partner interests in SemCrude, L.P., which owns all of our initial assets;

 

   

our issuance to SemGroup of 1,389,709 common units, 8,389,709 subordinated units and a 2% general partner interest and our issuance to the public of 7,000,000 common units;

 

   

the application of the net proceeds of this offering as described under “Use of Proceeds”;

 

   

the closing of our new $150 million revolving credit facility, under which we expect to borrow approximately $1.8 million at the closing of this offering; and

 

   

the allocation by SemGroup to us of certain corporate overhead expenses that were not allocated to our predecessor.

The pro forma combined financial data do not give effect to the estimated $1.9 million in incremental annual general and administrative expenses that we expect to incur as a result of being a separate publicly traded partnership.

Our predecessor includes SemCrude, L.P., exclusive of its wholly-owned subsidiary SemCrude Pipeline, L.L.C., which holds a 51% interest in the White Cliffs Pipeline. SemCrude, L.P. transferred its ownership interests in SemCrude Pipeline, L.L.C. to an affiliate prior to this offering, and as a result, SemCrude Pipeline, L.L.C. was not contributed to us. Therefore, SemCrude, L.P.’s ownership of SemCrude Pipeline, L.L.C. is not

 

 

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reflected in the financial statements of our predecessor. Our predecessor also includes Eaglwing, L.P., a wholly-owned subsidiary of SemGroup. Eaglwing, L.P. is not currently conducting any revenue-generating operations, and it will not be contributed to us, but it is included in the financial statements of our predecessor because it previously conducted business operations that were similar to those of SemCrude, L.P.

On July 22, 2008, SemGroup and certain of its subsidiaries, including the entities comprising our predecessor, filed petitions for reorganization under Chapter 11 of the U.S. Bankruptcy Code. Later during 2008, certain other U.S. subsidiaries filed petitions for reorganization. During the reorganization process, SemGroup filed a plan of reorganization with the court, which was confirmed on October 28, 2009. The plan of reorganization determined, among other things, how pre-petition date obligations would be settled, the equity structure of the reorganized company upon emergence and the financing arrangements upon emergence. SemGroup emerged from bankruptcy on November 30, 2009. As described in the notes to the financial statements included in this prospectus, on November 30, 2009, SemGroup applied fresh-start reporting, whereby its assets, liabilities and new capital structure were adjusted to reflect their estimated fair value as of November 30, 2009. As a result, the financial data of our predecessor prior to November 30, 2009 are not comparable to the financial data of our predecessor on and after November 30, 2009.

The following table presents the non-GAAP financial measures of adjusted gross margin and adjusted EBITDA, which we use in our business and view as important supplemental measures of our performance and, in the case of adjusted EBITDA, our liquidity. Adjusted gross margin and adjusted EBITDA are not calculated or presented in accordance with GAAP. For definitions of adjusted gross margin and adjusted EBITDA and a reconciliation of adjusted gross margin to operating income (loss) and of adjusted EBITDA to net income (loss) and net cash provided by (used in) operating activities, their most directly comparable financial measures calculated and presented in accordance with GAAP, please see “—Non-GAAP Financial Measures” on page 19.

 

    Predecessor
Historical
(Prior to Emergence)
         Predecessor Historical
(Subsequent to Emergence)
    Rose Rock
Midstream, L.P.

Pro Forma
 
    Year
Ended
December 31,
2008
    Eleven
Months
Ended
November 30,

2009
         Month
Ended
December  31,

2009
    Year
Ended
December 31,
2010
    Nine
Months
Ended
September  30,
2010
    Nine
Months
Ended
September  30,
2011
    Year
Ended
December  31,
2010
    Nine
Months
Ended

September 30,
2011
 
                                 (Unaudited)     (Unaudited)  
    (In thousands, except per unit and operating data)  

Statement of operations data:

                   

Revenues(1):

                   

Product

  $ 3,010,645      $ 197,203          $ 6,724      $ 158,308      $ 96,265      $ 271,824      $ 158,308      $ 271,824   

Service

    19,129        40,281            3,891        49,408        36,833        27,077        49,408        27,077   

Other

    10        3                   365        348        220        365        220   
 

 

 

   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

    3,029,784        237,487            10,615        208,081        133,446        299,121        208,081        299,121   

Expenses(1):

                   

Costs of products sold, exclusive of depreciation and amortization shown below

    3,685,594        180,154            5,969        146,614        90,358        252,804        146,614        252,804   

Operating

    298,874        15,614            1,536        20,398        16,026        13,695        20,398        13,695   

General and administrative

    33,841        5,813            1,270        7,660        5,922        6,507        9,160        7,642   

Depreciation and amortization

    2,995        3,193            818        10,435        7,785        8,505        10,435        8,505   
 

 

 

   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total expenses

    4,021,304        204,774            9,593        185,107        120,091        281,511        186,607        282,646   
 

 

 

   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income (loss)

    (991,520     32,713            1,022        22,974        13,355        17,610        21,474        16,475   

Other expenses (income):

                   

Interest expense

    2,907        1,699            43        482        226        1,405        1,003        1,796   

Other expense (income), net

    (806     (1,602         (306     (985     (64     (202     (951     (199
 

 

 

   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other expenses (income)

    2,101        97            (263     (503     162        1,203        52        1,597   
 

 

 

   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

 

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Table of Contents
    Predecessor
Historical
(Prior to Emergence)
         Predecessor Historical
(Subsequent to Emergence)
    Rose Rock
Midstream, L.P.

Pro Forma
 
    Year
Ended
December 31,
2008
    Eleven
Months
Ended
November 30,

2009
         Month
Ended
December  31,

2009
    Year
Ended
December 31,
2010
    Nine
Months
Ended
September  30,
2010
    Nine
Months
Ended
September  30,
2011
    Year
Ended
December  31,
2010
    Nine
Months
Ended
September  30,
2011
 
                                 (Unaudited)     (Unaudited)  
    (In thousands, except per unit and operating data)  

Income (loss) before reorganization items

    (993,621     32,616            1,285        23,477        13,193        16,407        21,422        14,878   

Reorganization items gain (loss)(1)

    (94,424     99,936                                                 
 

 

 

   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

  $ (1,088,045   $ 132,552          $ 1,285      $ 23,477      $ 13,193      $ 16,407      $ 21,422      $ 14,878   
 

 

 

   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) per common unit (basic and diluted)

                  $ 1.25      $ 0.87   
                 

 

 

   

 

 

 

Net income (loss) per subordinated unit (basic and diluted)

                  $ 1.25      $ 0.87   
                 

 

 

   

 

 

 

Statement of cash flows data:

                   

Net cash provided by (used in):

                   

Operating activities

  $ (56,164   $ 58,931          $ 2,088      $ 31,492      $ 34,863      $ 47,637       

Investing activities

    58,836        (34,490         (2,047     (16,723     (9,709     (25,542    

Financing activities

    (27,931     (23,426         (1,056     (14,466     (25,154     (22,398    

Other financial data:

                   

Adjusted gross margin

  $ (1,661,071   $ 57,079          $ 4,364      $ 62,230      $ 42,593      $ 45,983      $ 62,230      $ 45,983   

Adjusted EBITDA

    (2,020,618     (40,412         1,864        38,564        24,395        25,095        37,030        23,957   

Capital expenditures

    76,192        34,530            2,047        16,732        9,712        25,545       

Balance sheet data (at period end):

                   

Property, plant and equipment, net

  $ 82,346      $ 252,477          $ 253,706      $ 260,048      $ 255,636      $ 274,827        $ 273,540   

Total assets

    771,797        298,799            297,949        357,131        312,138        386,803          387,316   

Total long-term debt

                                                    1,800   

Net parent equity (deficit)

    (1,136,417     280,370            280,214        289,988        278,466        283,719          282,581   

Operating data:

                   

Cushing storage capacity (MMBbls as of period end)

            3.9        4.7        4.2        5.0       

Percent of Cushing capacity contracted (as of period end)

            100     95     94     95    

Transportation volumes (Average Bpd)(2)

            31,800        26,600        25,600        37,900       

Marketing volumes (Average Bpd)

            2,100        15,800        15,200        12,000       

Unloading/Platteville volumes (Average Bpd)

            21,700        25,800        25,200        31,700       

 

(1) For a discussion of transactions between our predecessor and SemGroup, please see Note 12 to our audited combined financial statements for the year ended December 31, 2010 and Note 5 to our unaudited interim combined financial statements for the nine months ended September 30, 2011.
(2) Includes fee-based services and fixed-margin transactions.

 

 

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Table of Contents

Non-GAAP Financial Measures

We define adjusted gross margin as total revenues minus costs of products sold and unrealized gain (loss) on derivatives. We define adjusted EBITDA as net income (loss) before interest expense, income tax expense (benefit), depreciation and amortization and any non-cash adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities. Because our predecessor is a pass-through entity for federal and state income tax purposes, no provision for income taxes is reported in our historical statements of operations. Adjusted gross margin and adjusted EBITDA are used as supplemental financial measures by our management and external users of our financial statements, such as investors, lenders and industry analysts, to assess our operating performance as compared to that of other companies in our industry, without regard to financing methods, historical cost basis, capital structure or the impact of fluctuating commodity prices.

In addition, adjusted EBITDA is used as a liquidity measure to assess:

 

   

the ability of our assets to generate sufficient cash flow to make distributions to our partners;

 

   

our ability to incur and service debt and fund capital expenditures; and

 

   

the viability of acquisitions and other capital expenditure projects and the returns on investment of various investment opportunities.

We believe that the presentation of adjusted gross margin and adjusted EBITDA in this prospectus provides information useful to investors in assessing our financial condition and results of operations. The GAAP measure most directly comparable to adjusted gross margin is operating income (loss), and the GAAP measures most directly comparable to adjusted EBITDA are net income (loss) and net cash provided by (used in) operating activities. Adjusted gross margin and adjusted EBITDA should not be considered alternatives to operating income (loss), net income (loss), net cash provided by (used in) operating activities or any other measure of financial performance or liquidity presented in accordance with GAAP. Adjusted gross margin and adjusted EBITDA have important limitations as analytical tools because they exclude some, but not all, items that affect net income and net cash provided by operating activities. Because adjusted gross margin and adjusted EBITDA are defined differently by other companies in our industry, our definitions of adjusted gross margin and adjusted EBITDA may not be comparable to similarly titled measures of other companies, thereby diminishing their utility.

Management compensates for the limitations of adjusted gross margin and adjusted EBITDA as analytical tools by reviewing the comparable GAAP measures, understanding the differences between adjusted gross margin and adjusted EBITDA, on the one hand, and operating income (loss), net income (loss) and net cash provided by (used in) operating activities, on the other hand, and incorporating this knowledge into its decision-making processes. We believe that investors benefit from having access to the same financial measures that our management uses in evaluating our operating results.

 

 

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Table of Contents

The following table presents a reconciliation of (i) adjusted gross margin to operating income (loss) and (ii) adjusted EBITDA to net income (loss) and net cash provided by (used in) operating activities, the most directly comparable GAAP financial measures, on a historical basis and pro forma basis, as applicable, for each of the periods indicated.

 

    Predecessor
Historical
(Prior to Emergence)
         Predecessor
Historical
(Subsequent to Emergence)
    Rose Rock
Midstream, L.P.

Pro Forma
 
    Year
Ended
December 31,
2008
    Eleven
Months
Ended
November 30,

2009
         Month
Ended
December  31,

2009
    Year
Ended
December  31,

2010
    Nine
Months
Ended
September  30,
2010
    Nine
Months
Ended
September  30,
2011
    Year
Ended
December  31,
2010
    Nine
Months
Ended
September  30,
2011
 
    (Unaudited; in thousands)  

Reconciliation of adjusted gross margin to operating income (loss):

                   

Operating income (loss)

  $ (991,520   $ 32,713          $ 1,022      $ 22,974      $ 13,355      $ 17,610      $ 21,474      $ 16,475   

Add:

                   

Unrealized (gain) loss on derivatives

    (1,005,261     (254         (282     763        (495     (334     763        (334

Operating expense

    298,874        15,614            1,536        20,398        16,026        13,695        20,398        13,695   

General and administrative expense

    33,841        5,813            1,270        7,660        5,922        6,507        9,160        7,642   

Depreciation and amortization expense

    2,995        3,193            818        10,435        7,785        8,505        10,435        8,505   
 

 

 

   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted gross margin

  $ (1,661,071   $ 57,079          $ 4,364      $ 62,230      $ 42,593      $ 45,983      $ 62,230      $ 45,983   
 

 

 

   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Reconciliation of adjusted EBITDA to net income (loss):

                   

Net income (loss)

  $ (1,088,045   $ 132,552          $ 1,285      $ 23,477      $ 13,193      $ 16,407      $ 21,422      $ 14,878   

Add:

                   

Interest expense

    2,907        1,699            43        482        226        1,405        1,003        1,796   

Income tax expense (benefit)

                                                           

Depreciation and amortization

    2,995        3,193            818        10,435        7,785        8,505        10,435        8,505   

Unrealized (gain) loss on derivatives

    (1,005,261     (254         (282     763        (495     (334     763        (334

(Gain) loss on impairment or sale of assets

    2,901        (40                67        46        12        67        12   

Non-cash reorganization items

    63,896        (24,682                                              

Provision for uncollectible accounts receivable

    (11                       3,340        3,640        (900     3,340        (900

Adjustments for plan effects and fresh start accounting

           (152,880                                              
 

 

 

   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA

  $ (2,020,618   $ (40,412       $ 1,864      $ 38,564      $ 24,395      $ 25,095      $ 37,030      $ 23,957   
 

 

 

   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Reconciliation of adjusted EBITDA to net cash provided by (used in) operating activities:

                   

Net cash provided by (used in) operating activities

  $ (56,164   $ 58,931          $ 2,088      $ 31,492      $ 34,863      $ 47,637       

Less:

                   

Changes in assets and liabilities, net of acquisitions and deconsolidated subsidiaries

    1,967,361        101,042            267        (6,590     10,694        23,947       

Add:

                   

Interest expense

    2,907        1,699            43        482        226        1,405       
 

 

 

   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

     

Adjusted EBITDA

  $ (2,020,618   $ (40,412       $ 1,864      $ 38,564      $ 24,395      $ 25,095       
 

 

 

   

 

 

       

 

 

   

 

 

   

 

 

   

 

 

     

 

 

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Table of Contents

RISK FACTORS

Limited partner units are inherently different from capital stock of a corporation, although many of the business risks to which we are subject are similar to those that would be faced by a corporation engaged in similar businesses. We urge you to carefully consider the following risk factors together with all of the other information included in this prospectus in evaluating an investment in our common units.

If any of the events described in the following risk factors were to occur, our business, results of operations, financial condition or ability to make cash distributions to our unitholders could be materially adversely affected. In that case, we might not be able to pay the minimum quarterly distribution on our common units, the trading price of our common units could decline and you could lose all or part of your investment in us.

Risks Related to Our Business

We may not have sufficient cash from operations following the establishment of cash reserves and payment of fees and expenses, including cost reimbursements to our general partner, to enable us to pay the minimum quarterly distribution to holders of our common and subordinated units.

In order to pay the minimum quarterly distribution of $0.3625 per unit per quarter, or $1.45 per unit per year, we will require available cash of approximately $6.2 million per quarter, or approximately $24.8 million per year, based on the number of common and subordinated units to be outstanding immediately after completion of this offering. We may not have sufficient available cash from operating surplus each quarter to enable us to pay the minimum quarterly distribution. The amount of cash we can distribute on our units principally depends upon the amount of cash we generate from our operations, which will fluctuate from quarter to quarter based on, among other things:

 

   

the price of crude oil and the level of production of, and demand for, crude oil in the markets we serve;

 

   

the volume of crude oil that we gather, transport, store and market;

 

   

the fees with respect to volumes that we handle;

 

   

the profitability of our marketing operations;

 

   

damage to pipelines, facilities, related equipment and surrounding properties caused by earthquakes, floods, fires, severe weather, explosions and other natural disasters and acts of terrorism or inadvertent damage to pipelines from construction, farm and utility equipment;

 

   

leaks or accidental releases of crude oil or other materials into the environment, whether as a result of human error or otherwise;

 

   

demand charges and volumetric fees associated with our transportation services;

 

   

the level of competition from other midstream energy companies;

 

   

the level of our operating, maintenance and general and administrative costs;

 

   

regulatory action affecting the supply of or demand for crude oil, the rates we can charge, how we contract for services, our existing contracts, our operating costs or our operating flexibility;

 

   

changes in tax laws; and

 

   

prevailing economic conditions.

In addition, the actual amount of cash we will have available for distribution will depend on other factors, some of which are beyond our control, including:

 

   

the level of capital expenditures we make;

 

   

the cost of acquisitions;

 

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Table of Contents
   

our debt service requirements and other liabilities;

 

   

fluctuations in our working capital needs;

 

   

our ability to borrow funds and access capital markets;

 

   

restrictions contained in debt agreements to which we are a party; and

 

   

the amount of cash reserves established by our general partner.

For a description of additional restrictions and factors that may affect our ability to make cash distributions, please read “Our Cash Distribution Policy and Restrictions on Distributions” beginning on page 54.

The amount of cash we have available for distribution to holders of our common and subordinated units depends primarily on our cash flow rather than on our profitability, which may prevent us from making distributions, even during periods in which we record net income.

The amount of cash we will have available for distribution will depend primarily upon our cash flow and not solely on profitability, which will be affected by non-cash items. As a result, we may make cash distributions during periods when we record losses for financial accounting purposes and may not make cash distributions during periods when we record net earnings for financial accounting purposes.

The assumptions underlying the forecast of adjusted EBITDA and cash available for distribution that we include in “Our Cash Distribution Policy and Restrictions on Distributions” are inherently uncertain and are subject to significant business, economic, financial, regulatory and competitive risks and uncertainties that could cause actual results to differ materially from those forecasted.

The forecast of adjusted EBITDA and cash available for distribution set forth in “Our Cash Distribution Policy and Restrictions on Distributions” includes our forecasted results of operations, adjusted EBITDA and cash available for distribution for the year ending December 31, 2012. The financial forecast has been prepared by management, and we have not received an opinion or report on it from our or any other independent auditor. The assumptions underlying the forecast are inherently uncertain and are subject to significant business, economic, financial, regulatory and competitive risks and uncertainties that could cause actual results to differ materially from those forecasted. If we do not achieve the forecasted results, we may not be able to pay the full minimum quarterly distribution or any amount on our common or subordinated units, in which event the market price of our common units may decline materially.

Our profitability depends on the demand for crude oil in the markets we serve.

Any sustained reduction in demand for crude oil in markets served by our midstream assets could result in a significant reduction in the volume of crude oil that we handle, thereby adversely affecting our business, results of operations, financial condition and ability to make cash distributions to our unitholders. A reduction in demand could result from a number of factors including:

 

   

an increase in the price of products derived from crude oil;

 

   

higher taxes, including federal excise taxes, severance taxes or sales taxes or other governmental or regulatory actions that increase, directly or indirectly, the cost of crude oil based products;

 

   

adverse economic conditions which result in lower spending by consumers and businesses on products derived from crude oil;

 

   

the effects of weather, natural phenomena, terrorism, war, or other similar acts;

 

   

an increase in fuel economy, whether as a result of a shift by consumers to more fuel efficient vehicles, technological advances by manufacturers or federal or state regulations;

 

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Table of Contents
   

decisions by our customers or suppliers to use alternate service providers for a portion of all of their needs, operate in different markets not served by us, reduce operations or cease operations entirely; and

 

   

an increase in the use of alternative fuel sources, such as ethanol, biodiesel, fuel cells, solar and wind power, or of other fossil fuels, including natural gas.

Most of our operating costs are fixed and do not vary with our throughput. These costs may not decline ratably or at all should we experience a reduction in throughput, which would result in a decline in our margins and profitability.

Because of the natural decline in production from existing wells, our success depends on our ability to obtain new sources of crude oil, which is dependent on certain factors beyond our control. Any decrease in the volumes of crude oil that we gather, transport, store and market could adversely affect our business and operating results.

The volumes that support our business are dependent on the level of production from crude oil wells in our areas of operation, the production of which will naturally decline over time. As a result, in order to maintain or increase the amount of crude oil that we handle, we must obtain new sources of crude oil. The primary factors affecting our ability to obtain new sources of crude oil include the level of successful drilling activity near our systems or operations and our ability to compete for volumes.

We have no control over the level of drilling activity or the amount of reserves in our areas of operation, or the rate at which production in any of our areas of operation will decline. In addition, we have no control over producers or their drilling or production decisions, which are affected by, among other things, the availability and cost of capital, prevailing and projected energy prices, demand for hydrocarbons, levels of reserves, geological considerations, governmental regulations, the availability of drilling rigs and other production and development costs. Fluctuations in energy prices can also greatly affect investments in the development of new crude oil reserves. Because of these factors, even if new crude oil reserves are known to exist in our areas of operation, producers may choose not to develop those reserves. Declines in crude oil prices could have a negative impact on exploration, development and production activity, and if sustained, could lead to a material decrease in such activity. Sustained reductions in exploration or production activity in our areas of operation would lead to reduced utilization of our assets and a reduced need for our marketing operations.

If competition or reductions in drilling activity result in our inability to maintain the current levels of crude oil that we gather, transport, store and market, it could have an adverse effect on our business, results of operations, financial condition and ability to make cash distributions to our unitholders.

A prolonged decline in index prices at Cushing relative to other index prices could reduce the demand for our transportation to, and storage in, Cushing.

Shifts in the overall supply of and demand for crude oil in regional, national and global markets, over which we have no control, can have an adverse impact on crude oil index prices in the markets we serve relative to other index prices. For example, Cushing has experienced a shortfall in takeaway pipeline capacity, which has in turn led to an oversupply of crude oil at Cushing. This has been cited as a principal reason for the decline in the WTI Index price used at Cushing relative to other crude oil price indexes, including the Brent Crude index. A prolonged decline in the WTI Index price relative to other index prices may cause reduced demand for our transportation to, and storage in, Cushing, which could have a material adverse effect on our business, results of operations, financial condition and ability to make cash distributions to our unitholders.

 

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We face intense competition in our gathering, transportation, storage and marketing activities. Competition from other providers of those services that are able to supply our customers with those services at a lower price or on otherwise better terms could adversely affect our business and operating results.

We are subject to competition from other crude oil gathering, transportation, storage and marketing operations that may be able to supply our customers with the same or comparable services at a lower price or otherwise on better terms. We compete with national, regional and local gathering, transportation and storage companies of widely varying sizes, financial resources and experience, including the major integrated oil companies. With respect to our gathering and transportation services, these competitors include Enterprise Products Partners L.P., Plains All American Pipeline, L.P., ConocoPhillips Company, Sunoco Logistics Partners L.P. and National Cooperative Refinery Association, among others. With respect to our storage services, these competitors include Magellan Midstream Partners, L.P., Enbridge Energy Partners, L.P. and Plains All American Pipeline, L.P. Several of our competitors conduct portions of their operations through publicly traded partnerships with structures similar to ours, including Plains All American Pipeline, L.P., Enterprise Products Partners L.P., Sunoco Logistics Partners L.P., Enbridge Energy Partners, L.P. and Magellan Midstream Partners, L.P. Our ability to compete could be harmed by numerous factors, including:

 

   

price competition;

 

   

the perception that another company can provide better service;

 

   

a reluctance to contract with us due to SemGroup’s bankruptcy filing; and

 

   

the availability of alternative supply points, or supply points located closer to the operations of our customers.

Some of our competitors have greater financial, managerial and other resources than we do, and control substantially more storage or transportation capacity than we do. Our competitors may expand their assets or operations, creating additional competition for the services we provide to our customers. In addition, our customers may develop their own gathering, transportation and storage systems or marketing operations in lieu of using ours. Our ability to renew or replace existing contracts with our customers at rates sufficient to maintain current revenues and cash flow could be adversely affected by the activities of our competitors and our customers.

In addition, SemGroup owns midstream assets and is not limited in its ability to compete with us. If we are unable to compete with services offered by other midstream enterprises, including SemGroup, it could have a material adverse effect on our business, results of operations, financial condition and ability to make cash distributions to our unitholders. See “—Risks Inherent in an Investment in Us—SemGroup is not limited in its ability to compete with us and may not be obligated to offer us the opportunity to acquire additional assets or businesses, which could limit our ability to grow and could adversely affect our results of operations and cash available for distribution to our unitholders.”

Restrictions in our revolving credit facility could adversely affect our business, results of operations, financial condition and ability to make cash distributions to our unitholders.

We have entered into a revolving credit facility which limits our ability to, among other things:

 

   

incur additional debt;

 

   

make cash distributions on, or redeem or repurchase, units;

 

   

make certain investments and acquisitions;

 

   

incur certain liens or permit them to exist;

 

   

enter into certain transactions with affiliates;

 

   

merge or consolidate with another company or otherwise engage in a change of control; and

 

   

transfer or otherwise dispose of assets.

 

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Our revolving credit facility also contains covenants requiring us to maintain certain financial ratios.

The provisions of our revolving credit facility may affect our ability to obtain future financing and pursue attractive business opportunities and our flexibility in planning for, and reacting to, changes in business conditions. In addition, a failure to comply with the provisions of this facility could result in a default or an event of default that could enable our lenders to declare the outstanding principal of that debt, together with accrued and unpaid interest, to be immediately due and payable. If the payment of our debt is accelerated, our assets may be insufficient to repay such debt in full, and our unitholders could experience a partial or total loss of their investment.

Our future debt may limit our flexibility to obtain financing and pursue business opportunities.

Upon the closing of this offering, we expect to have $148.2 million of borrowing capacity under our revolving credit facility. Our future debt could have important consequences to us, including the following:

 

   

our ability to obtain additional financing, if necessary, for working capital, capital expenditures, acquisitions or other purposes may be impaired or such financing may not be available on favorable terms;

 

   

our funds available for operations, future business opportunities and distributions to unitholders will be reduced by that portion of our cash flow required to make interest payments on our debt;

 

   

we may be more vulnerable to competitive pressures or a downturn in our business or the economy generally; and

 

   

our flexibility in responding to changing business and economic conditions may be limited.

Our ability to service our debt will depend upon, among other things, our future financial and operating performance, which will be affected by prevailing economic conditions and financial, business, regulatory and other factors, some of which are beyond our control. If our operating results are not sufficient to service any future indebtedness, we will be forced to take actions such as reducing distributions, reducing or delaying our business activities, acquisitions, investments or capital expenditures, selling assets or seeking additional equity capital. We may not be able to effect any of these actions on satisfactory terms or at all.

Our access to credit markets may be limited, which may adversely impact our liquidity.

We may require additional capital from outside sources from time to time. Our ability to arrange financing or renew existing facilities, along with the cost of such capital, is dependent upon a number of variables, including:

 

   

general economic, financial and business conditions;

 

   

industry specific conditions;

 

   

credit availability from banks and other financial institutions;

 

   

investor confidence in us;

 

   

our cash flow and adjusted EBITDA levels;

 

   

competitive, legislative and regulatory matters; and

 

   

provisions of tax and securities laws that may impact raising capital.

In addition, volatility in the capital markets may adversely affect our ability to access any available borrowing capacity under our new revolving credit facility. Our access to these funds is dependent on the ability of the lenders to meet their funding obligations under this revolving credit facility. Lenders may not be able to meet their funding commitments if they experience shortages of capital and liquidity, resulting in a reduction of our available borrowing capacity.

 

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The credit profile of SemGroup could adversely affect our credit rating, which could increase our borrowing costs or hinder our ability to raise capital.

The credit profile of SemGroup may be a factor considered in credit evaluations of us. This is because SemGroup, through our general partner, controls our business activities, including our cash distribution policy, acquisition strategy and business risk profile. If we seek a credit rating in the future, our credit rating may be adversely affected by the credit profile of SemGroup and its 2008 bankruptcy filing, because the ratings agencies may consider SemGroup’s ownership interest in and control of us and the strong operational links between SemGroup and us. If SemGroup’s credit profile adversely affects our credit rating, it would increase our cost of borrowing or hinder our ability to access financing in the capital markets, which could impair our ability to grow our business or make cash distributions to our unitholders.

Our general partner is an obligor under, and subject to a pledge related to, SemGroup’s credit agreement. In the event SemGroup is unable to meet its obligations under that agreement, or is declared bankrupt, SemGroup’s lenders may gain control of our general partner or, in the case of bankruptcy, our partnership may be dissolved.

Our general partner is an obligor under, and all of its assets and SemGroup’s ownership interest in it are subject to a lien related to, SemGroup’s credit agreement. In the event SemGroup is unable to satisfy its obligations under the credit agreement and the lenders foreclose on their collateral, the lenders will own our general partner and all of its assets, which include the general partner interest in us and our incentive distribution rights. In such event, the lenders would control our management and operations. Moreover, in the event SemGroup becomes insolvent or is declared bankrupt, our general partner may be deemed insolvent or declared bankrupt as well. Under the terms of our partnership agreement, the bankruptcy or insolvency of our general partner will cause a dissolution of our partnership.

We may not be able to renew or replace expiring storage contracts.

We have significant exposure to market risk at the time our existing storage contracts expire and are subject to renegotiation and renewal. As of September 30, 2011, the weighted average remaining tenor of our existing portfolio of firm storage contracts was approximately 4.3 years. The extension or replacement of existing contracts depends on a number of factors beyond our control, including:

 

   

the level of existing and new competition to provide storage services to our markets;

 

   

the macroeconomic factors affecting crude oil storage economics for our current and potential customers;

 

   

the balance of supply and demand, on a short-term, seasonal and long-term basis, in our markets;

 

   

the extent to which the customers in our markets are willing to contract on a long-term basis; and

 

   

the effects of federal, state or local regulations on the contracting practices of our customers.

Any failure to extend or replace a significant portion of our existing contracts, or extend or replace them at comparable rates, could have a material adverse effect on our business, results of operations, financial condition and ability to make cash distributions to our unitholders.

We depend on a limited number of customers for a substantial portion of our revenues. The loss of or a material nonpayment or nonperformance by any of these key customers could adversely affect our business, results of operations, financial condition and ability to make cash distributions to our unitholders.

We rely on a limited number of customers for a substantial portion of our revenues. Sunoco Partners Marketing & Terminals LP, Gavilon LLC and Parnon Gathering, Inc. each accounted for more than 10% of our total revenue for the nine months ended September 30, 2011, at approximately 23%, 17% and 11%, respectively. SemCanada Crude Company, Sunoco Partners Marketing & Terminals LP and Gavilon LLC each

 

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accounted for more than 10% of our total revenue for the year ended December 31, 2010, at approximately 27%, 24% and 18%, respectively. We may be unable to negotiate extensions or replacements of contracts with our key customers on favorable terms. In addition, some of these key customers may experience financial problems that could have a significant effect on their creditworthiness. Severe financial problems encountered by our customers could limit our ability to collect amounts owed to us, or to enforce performance of obligations under contractual arrangements. Furthermore, some of our customers may be highly leveraged and subject to their own operating and regulatory risks, which increases the risk that they may default on their obligations to us. The loss of all or even a portion of the contracted volumes of these key customers, as a result of competition, creditworthiness or otherwise, could have a material adverse effect on our business, results of operations, financial condition and ability to make cash distributions to our unitholders.

We are exposed to the creditworthiness and performance of our customers, suppliers and contract counterparties, including our hedge counterparties, and any material nonpayment or nonperformance by one or more of these parties could adversely affect our financial and operating results.

Although we attempt to assess the creditworthiness of our customers, suppliers and contract counterparties, including the counterparties to our hedging arrangements, there can be no assurance that our assessments will be accurate or that there will not be a rapid or unanticipated deterioration in their creditworthiness, which may have an adverse impact on our business, results of operations, financial condition and ability to make cash distributions to our unitholders. In addition, there can be no assurance that our counterparties will perform or adhere to existing or future contractual arrangements.

The procedures and policies we use to manage our exposure to credit risk, such as credit analysis, credit monitoring and, in some cases, requiring credit support, cannot fully eliminate counterparty credit risks. To the extent our procedures and policies prove to be inadequate, our financial and operational results may be negatively impacted.

Some of our counterparties may be highly leveraged or have limited financial resources and will be subject to their own operating and regulatory risks. Even if our credit review and analysis mechanisms work properly, we may experience financial losses in our dealings with such parties. For example, we have certain hedging arrangements with MF Global Inc. with a balance of approximately $0.7 million as of September 30, 2011. An affiliate of MF Global Inc. has recently filed for bankruptcy. In addition, volatility in commodity prices might have an impact on many of our counterparties, which, in turn, could have a negative impact on their ability to meet their obligations to us and may also increase the magnitude of these obligations.

Any material nonpayment or nonperformance by our counterparties could require us to pursue substitute counterparties for the affected operations, reduce operations or provide alternative services. There can be no assurance that any such efforts would be successful or would provide similar financial and operational results.

Our storage operations are influenced by the overall forward market for crude oil, and certain market conditions may adversely affect our financial and operating results and, in turn, our ability to make cash distributions to our unitholders.

Our storage operations are influenced by the overall forward market for crude oil. A contango market (meaning that the price of crude oil for future delivery is higher than the current price) is associated with greater demand for crude oil storage capacity, because a party can simultaneously purchase crude oil at current prices for storage and sell at higher prices for future delivery. A backwardated market (meaning that the price of crude oil for future delivery is lower than the current price) is associated with lower demand for crude oil storage capacity, because a party can capture a premium for prompt delivery of crude oil rather than storing it for future sale. A prolonged backwardated market or other adverse market conditions could have an adverse impact on our ability to negotiate favorable prices under new or renewing storage contracts, which could have an adverse impact on our storage revenues. Finally, higher absolute levels of crude oil prices increase the costs of financing and insuring crude oil in storage, which negatively affects storage economics. As a result, the overall forward market for crude oil may have an adverse effect on our business, results of operations, financial condition and ability to make cash distributions to our unitholders.

 

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Our risk management policy governing our marketing activities cannot eliminate all risks associated with the marketing of crude oil, and we cannot ensure that employees of our general partner will fully comply with the policy at all times, both of which could impact our financial and operational results and, in turn, our ability to make cash distributions to our unitholders.

We have in place a risk management policy that seeks to establish limits for marketing exposure by requiring that we restrict net open positions (i.e., positions that are not fully hedged as to commodity price risk) to specified levels. Our risk management policy has restrictive terms with respect to acquiring and holding physical inventory, futures contracts and derivative products. These policies and practices, however, cannot eliminate all risks. Derivatives contracts and contracts for the future delivery of crude oil expose us to the risk of non-delivery under product purchase contracts or the failure of gathering and transportation systems to supply us with crude oil. Any event that disrupts our anticipated physical supply of crude oil could create a net open position that would expose us to risk of loss resulting from price changes.

Moreover, we are exposed to price movements on products that are not hedged, including certain of our inventory, such as linefill, which must be maintained to operate our pipelines and gathering system. We are also exposed to certain price risks that cannot be readily hedged, such as price risks for “basis differentials.” Basis differentials can be created to the extent that we hold or sell crude oil of a grade or quality, at a location or at a time that differs from the specific delivery terms with respect to grade or quality, time or location of the applicable offsetting agreement or derivative instrument. If this occurs, we may not be able to use the physical or derivative commodity markets to fully hedge our price risk. Our exposure to price risks could impact our operational and financial results and our ability to make cash distributions to our unitholders.

We are also subject to the risk that employees of our general partner involved in our marketing operations may not comply at all times with our risk management policy. We cannot ensure that all violations of the risk management policy, particularly if deception or other intentional misconduct is involved, will be detected prior to our businesses being materially affected.

Our hedging arrangements could reduce our quarterly or annual profits or increase our cash obligations, which could negatively impact our financial position or our ability to make cash distributions to our unitholders.

We hedge our exposure to price fluctuations for our crude oil marketing activities by utilizing physical purchase and sale agreements, futures contracts traded on the NYMEX, options contracts or over-the-counter transactions. We could experience material fluctuations in our quarterly or annual results of operations as a result of marking our hedging positions to market. In addition, to the extent these hedges are entered into on a public exchange or in the over-the-counter market, we may be required to post margin or provide collateral, which could result in material cash obligations.

Laws regulating derivatives established under the Dodd-Frank Act and the regulations being promulgated thereunder could adversely affect our ability to manage business and financial risks by reducing the availability of, and increasing our cost of using, derivative instruments as hedges against fluctuating commodity prices and interest rates.

The Dodd-Frank Wall Street Reform and Consumer Protection Act, or the Dodd-Frank Act, establishes a new regulatory framework for derivative instruments, including a requirement that certain transactions be cleared on a derivatives clearing organization and traded on an exchange or a swap execution facility, and a requirement to post cash collateral (commonly referred to as “margin”) for such transactions. The Dodd-Frank Act requires the Commodity Futures Trading Commission, or CFTC, federal regulators of banks and other financial institutions, or the prudential regulators, and the SEC to promulgate the rules implementing the new law, which must be finally adopted by December 31, 2011. Until these regulations are adopted, effective and implemented in practice, we cannot determine what impact the new regulatory framework will have on our business.

 

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At present, we are contractually required to post collateral with clearing brokers with respect to substantially all of our commitments and potential obligations under our hedging instruments. Depending on the final regulations adopted by the CFTC, the prudential regulators and the SEC, we may be subject to a margin requirement that will cause us to post collateral in excess of present levels. Such a requirement may increase our costs and decrease our profitability. Moreover, our counterparties may also be required to post margin on our transactions and comply with minimum capital requirements, which could result in additional costs being passed on to us, thereby decreasing our profitability.

The Dodd-Frank Act permits the CFTC to set position limits in derivative instruments. Our counterparties may be subject to these position limits, which may reduce our ability to enter into hedging transactions with these counterparties. In addition, the Dodd-Frank Act may also require the counterparties to our derivative instruments to spin off some of their derivative activities to a separate entity, which may not be as creditworthy as the current counterparty. These changes might not only increase costs, but could also reduce the availability of some derivatives to protect against risks we encounter, reduce our ability to monetize or restructure our existing derivative contracts and potentially increase our exposure to less creditworthy counterparties. If our use of derivatives is reduced, our results of operations may become more volatile and our cash flows may be less predicable, which could adversely affect our ability to plan for and fund capital expenditures and to make cash distributions to our unitholders. Increased volatility may make us less attractive to certain types of investors.

An increase in interest rates could impact demand for our storage capacity and cause the market price of our common units to decline.

There is a financing cost for a storage capacity user to own crude oil while it is stored. That financing cost is impacted by the cost of capital or interest rate incurred by the storage user in addition to the commodity cost of the crude oil in inventory. Absent other factors, a higher financing cost adversely impacts the economics of storing crude oil for future sale. As a result, a significant increase in interest rates could adversely affect the demand for our storage capacity independent of other market factors.

In addition, as interest rates rise, the ability of investors to obtain higher risk-adjusted rates of return by purchasing government-backed debt securities may cause a corresponding decline in demand for riskier investments generally, including yield-based equity investments such as publicly traded limited partner interests. Reduced demand for our common units resulting from investors seeking other, more favorable investment opportunities may cause the trading price of our common units to decline.

From time to time, we are involved in litigation, claims and other proceedings which could have a material adverse effect on our business, results of operations, financial condition and ability to make cash distributions to our unitholders.

From time to time, we are involved in litigation, claims and other proceedings relating to the conduct of our business, including but not limited to claims related to the operation of our assets, the services we provide to our customers and our marketing activities, as well as claims relating to environmental and regulatory matters. For example, SemGroup is involved in several proceedings relating to its bankruptcy and plan of reorganization. An adverse ruling in these proceedings could have a material adverse effect on us. The uncertainties of litigation and the uncertainties related to the collection of insurance and indemnification coverage make it difficult to accurately predict the ultimate financial effect of these claims. If we are unsuccessful in defending a claim or elect to settle a claim, we could incur material costs that could have a material adverse effect on our business, results of operations, financial condition and ability to make cash distributions to our unitholders. Additionally, our insurance coverage may be insufficient to cover adverse judgments against us. Please see “Business—Legal Proceedings” beginning on page 129.

 

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Our business involves many hazards and operational risks, some of which may not be covered by insurance.

Leaks and other releases of crude oil are possible in our operations. Other possible operating risks include the breakdown or failure of equipment, information systems or processes; the performance of equipment at levels below those originally intended (whether due to misuse, unexpected degradation or design, or construction or manufacturing defects); operator error; labor disputes; disputes with interconnected facilities and carriers; and catastrophic events such as natural disasters, fires, explosions, acts of terrorism and other similar events, many of which are beyond our control.

These risks could result in substantial losses due to personal injury or loss of life, severe damage to, and destruction of, property and equipment and pollution or other environmental damage, and may result in curtailment or suspension of our related operations. We are not fully insured against all risks incident to our business. In addition, as a result of market conditions, premiums for our insurance could increase significantly. In some instances, insurance could become unavailable or available only for reduced amounts of coverage. If a significant accident or event occurs that is not fully insured, it could adversely affect our business, results of operations, financial condition and ability to make cash distributions to our unitholders. Even if a significant accident or event is covered by insurance, we may still have responsibility for applicable deductibles, and in addition, the proceeds of any such insurance may not be paid in a timely manner. With a few limited exceptions, our customers have not agreed to indemnify us for losses arising from a release of crude oil, and we may instead be required to indemnify our customers in the event of a release or other incident.

Adverse developments in our existing areas of operation could adversely impact our business, results of operations, financial condition and ability to make cash distributions to our unitholders.

Our operations are focused on gathering, transporting, storing and marketing crude oil and are principally located in the Mid-Continent and Rocky Mountain regions of the United States. As a result, our business, results of operations, financial condition and ability to make cash distributions to our unitholders depend upon the demand for our services in these regions. Due to our current lack of diversification in industry type and geographic location, adverse developments in our current segment of the midstream industry, or our existing areas of operation, could have a significantly greater impact on our business, results of operations, financial condition and ability to make cash distributions to our unitholders than they would if our operations were more diversified.

Our operations could be adversely affected if third-party pipelines or other facilities interconnected to our facilities become partially or fully unavailable.

Our facilities connect to other pipelines or facilities, some of which are owned by third parties. The continuing operation of such third-party pipelines or facilities is not within our control. These pipelines and other facilities may become unavailable, or available only at a reduced capacity. If any of these third-party pipelines or facilities becomes unable to transport the crude oil transported or stored by us, our business, results of operations, financial condition and ability to make cash distributions to our unitholders could be adversely affected.

We intend to grow our business in part by constructing new assets, which may not result in the anticipated revenue increases.

One of the ways we intend to grow our business is through the construction of new assets. The construction of additions or modifications to our existing systems and of new assets involves numerous regulatory, environmental, political and legal uncertainties beyond our control. Any such construction projects, including our planned expansions of our storage terminal in Cushing and our Platteville facility, may not be completed on schedule, at their budgeted cost or at all. Revenues may not increase immediately upon the completion of a particular project, or we may construct facilities to capture anticipated future growth that does not materialize. In addition, the construction of additions to our existing assets may require us to obtain new rights-of-way. We may be unable to obtain such rights-of-way to capitalize on attractive expansion opportunities, or the cost of obtaining new rights-of-way may exceed our expectations.

 

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A key component of our growth strategy is to make acquisitions. We may not be able to make acquisitions on economically acceptable terms, which may limit our ability to grow. In addition, any acquisition that we pursue will involve risks that may adversely affect our business.

Our ability to grow in the future will depend, in part, on our ability to make acquisitions that result in an increase in the cash generated from our operations. We may be unable to make accretive acquisitions, including acquisitions from SemGroup or third parties, because we are unable to identify attractive acquisition candidates, negotiate acceptable purchase terms, or obtain financing for these acquisitions on economically acceptable terms or because we are outbid by competitors. If we are unable to successfully acquire new businesses or assets, our future growth and ability to increase distributions will be limited. Furthermore, even if we do make acquisitions that we believe will be accretive, these acquisitions may nevertheless result in a decrease in the cash generated from operations per unit.

Any acquisition that we pursue will involve potential risks, including

 

   

performance from the acquired businesses or assets that is below the forecasts we used in evaluating the acquisition;

 

   

a significant increase in our indebtedness and working capital requirements;

 

   

the inability to timely and effectively integrate the operations of recently acquired businesses or assets;

 

   

the incurrence of substantial unforeseen environmental and other liabilities arising out of the acquired businesses or assets, including liabilities arising from the operation of the acquired businesses or assets prior to our acquisition;

 

   

risks associated with operating in lines of business that are distinct and separate from our historical operations;

 

   

loss of customers or key employees from the acquired businesses; and

 

   

the diversion of management’s attention from other business concerns.

Any of these factors could adversely affect our ability to achieve anticipated levels of cash flows from our acquisitions, realize other anticipated benefits or meet the debt service requirements of any debt incurred in connection with such acquisitions.

We do not own all the land on which our pipelines and other facilities are located, which could result in disruptions to our operations.

We do not own all of the land on which our pipelines and other facilities have been constructed, and we are, therefore, subject to the possibility of more onerous terms and/or increased costs to retain necessary land use if we do not have valid rights-of-way or if such rights-of-way lapse or terminate. We obtain the rights to construct and operate our pipelines on land owned by third parties and governmental agencies for a specific period of time. Our loss of these rights, through our inability to renew right-of-way contracts or otherwise, could have a material adverse effect on our business, results of operations, financial condition and ability to make cash distributions to our unitholders.

We are subject to regulation by multiple governmental agencies, which could adversely impact our business, results of operations and financial condition.

Our business activities are subject to regulation by multiple federal, state and local governmental agencies. Our historical and projected operating costs reflect the recurring costs resulting from compliance with these regulations, and we do not anticipate material expenditures in excess of these amounts in the absence of future acquisitions, or changes in regulation, or discovery of existing but unknown compliance issues. Additional proposals and proceedings that affect the midstream industry are regularly considered by Congress, as well as by state legislatures and federal and state regulatory commissions, agencies and courts. We cannot predict when or

 

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whether any such proposals may become effective or the magnitude of the impact changes in laws and regulations may have on our business. However, additions to the regulatory burden on our industry generally increase our cost of doing business and affect our profitability.

A change in the jurisdictional characterization of some of our assets by federal, state or local regulatory agencies or a change in policy by those agencies could result in increased regulation of our assets, which could affect existing costs and rates.

Intrastate transportation and gathering pipelines that do not provide interstate services are not subject to regulation by FERC. However, the distinction between FERC-regulated interstate pipeline transportation on the one hand, and intrastate pipeline transportation, on the other hand, is a fact-based determination. The classification and regulation of our crude oil pipelines are subject to change based on future determinations by FERC, federal courts, Congress or regulatory commissions, courts or legislatures in the states in which we operate.

Our Kansas and Oklahoma gathering pipeline system carries crude oil owned by us and by third parties. We own all of the crude oil shipped on our pipeline system across state lines. We believe that the pipeline segments on which we provide service to third parties and the services we provide to third parties on the gathering pipeline system meet the traditional tests that FERC has used to determine that the pipeline services provided are not in interstate commerce. We believe that the pipeline segments on which we transport only crude oil owned by us should not be subject to regulation by FERC under the Interstate Commerce Act, or ICA, or that these pipeline segments would qualify for waiver from FERC’s regulatory requirements, if applicable. However, we cannot provide assurance that FERC will not in the future, either at the request of other entities or on its own initiative, determine that some or all of our Kansas and Oklahoma gathering pipeline system and the services we provide on that system are within its jurisdiction, or that such a determination would not adversely affect our results of operations. If some or all of the gathering system were subject to FERC jurisdiction, and not otherwise exempt from any applicable regulatory requirements, for that portion of the gathering pipeline system we would be required to file a tariff with FERC, and if our tariff rates were subject to protest, provide a cost justification for the transportation rate subject to protest and provide service to all potential shippers without undue discrimination. In addition, if the services we provide on any segment(s) of our gathering system become regulated by FERC under the ICA, our services could be subject to a protest and/or complaint before FERC. If FERC were to determine, in response to a complaint, that our rates are unjust and unreasonable, we could be required to pay reparations and refunds dating to two years before the filing of the complaint. Furthermore, if in the future our services become subject to state regulation, they could be subject to a protest and/or complaint before a state commission with jurisdiction.

We may incur significant costs and liabilities resulting from pipeline integrity programs and related repairs.

Our pipeline facilities are subject to regulation by the U.S. Department of Transportation, or DOT, through the Pipeline and Hazardous Materials Safety Administration, or the PHMSA, pursuant to the Hazardous Liquids Pipeline Safety Act of 1979, as amended by the Pipeline Safety Improvement Act of 2002, and reauthorized and amended by the Pipeline Inspection, Protection, Enforcement and Safety Act of 2006. The PHMSA has adopted regulations requiring hazardous liquid pipeline operators to develop and implement integrity management programs for pipeline segments that, in the event of a leak or rupture, could affect “high consequence areas,” such as high population areas, areas that are sources of drinking water, ecological resource areas that are unusually sensitive to environmental damage from a pipeline release and commercially navigable waterways, unless the operator effectively demonstrates by risk assessment that the pipeline could not affect the area. The Pipeline Inspection, Protection, Enforcement and Safety Act of 2006 expired on September 30, 2010 but operated under a continuing resolution that expired on March 4, 2011. The reauthorization of the Pipeline Safety Act being considered by Congress could result in new and more costly compliance requirements. Current regulations require operators of covered pipelines to:

 

   

perform on-going assessments of pipeline integrity on a recurring frequency schedule;

 

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identify and characterize applicable potential threats to pipeline segments that could impact a high consequence area;

 

   

improve data collection, integration and analysis;

 

   

repair and remediate the pipeline as necessary; and

 

   

implement preventive and mitigating actions.

In addition, states have adopted regulations similar to existing DOT regulations for intrastate hazardous liquid pipelines. We currently estimate that we will incur an aggregate cost of approximately $2.8 million during 2011 and 2012 to implement necessary pipeline integrity management program testing along certain segments of our pipelines required by existing DOT and state regulations. This estimate may not include all costs of any repair, remediation, preventative or mitigating actions that may be determined to be necessary as a result of the testing program, which costs could be substantial. At this time, we cannot predict the ultimate cost of compliance with these regulations, as the cost will vary significantly depending on the number and extent of any repairs found to be necessary as a result of the pipeline integrity testing. Following the initial round of testing and repairs, we will continue our pipeline integrity testing programs on an on-going basis to assess and maintain the integrity of our pipelines. The results of these tests could cause us to incur significant and unanticipated capital and operating expenditures for repairs or upgrades deemed necessary to ensure the continued safe and reliable operations of our pipelines and, consequently, result in a reduction in our revenue and cash flows from shutting down our pipelines during the pendency of such repairs or upgrades.

The PHMSA adopted regulations requiring hazardous liquid pipelines that use supervisory control and data acquisition systems and have at least one controller and control room to develop written control room management procedures by August 1, 2011 and implement those procedures no later than February 1, 2013, although the PHMSA has proposed to accelerate the deadline by which the procedures must be implemented. Implementing these procedures could cause us to incur unanticipated operating expenditures.

The PHMSA has amended its pipeline safety regulations so that the pipeline safety requirements will apply, effective October 1, 2011, to all rural low-stress hazardous liquids pipelines, regardless of diameter, except for certain gathering lines.

We may incur significant costs and liabilities in the future resulting from a failure to comply with new or existing environmental laws or regulations or an accidental release of hazardous substances, crude oil or wastes into the environment.

Our operations are subject to federal, state and local environmental laws and regulations governing the discharge of materials into the environment or otherwise relating to environmental protection. These laws include, for example:

 

   

federal and comparable state laws that impose obligations related to air emissions;

 

   

federal and comparable state laws that impose requirements for the handling, storage, treatment or disposal of solid and hazardous waste from our facilities;

 

   

federal and comparable state laws that regulate the cleanup of hazardous substances that may have been released at properties currently or previously owned or operated by us or at locations to which our hazardous substances have been transported for disposal; and

 

   

federal and comparable state laws that regulate discharges of wastewater from our facilities, require spill protection planning and preparation and set requirements for other actions for protection of waters.

Failure to comply with these laws and regulations, or newly adopted laws or regulations, may trigger a variety of administrative, civil and criminal enforcement measures, including the assessment of monetary penalties, the imposition of remedial requirements and the issuance of orders enjoining future operations or

 

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imposing additional compliance requirements on such operations. Claims pursued under certain environmental laws impose strict, joint and several liability for costs required to clean up and restore sites where hazardous substances or petroleum products have been disposed or otherwise released. Provisions also exist that may require remediation or other compensation to pay for damages to natural resources. Moreover, it is not uncommon for individuals to file claims for personal injury and property damage allegedly caused by the release of hazardous substances, crude oil or waste products in the environment.

There is an inherent risk of incurring environmental costs and liabilities in connection with our operations due to our handling of crude oil, air emissions and water discharges related to our operations and historical industry operations and waste disposal practices. For example, an accidental release from one of our facilities could subject us to substantial liabilities for environmental cleanup and restoration costs, claims made by individuals for personal injury, natural resource and property damages and fines or penalties for related violations of environmental laws or regulations. Moreover, the possibility exists that stricter laws, regulations or enforcement policies could significantly increase our operational or compliance costs and the cost of any remediation that may become necessary. We may not be able to recover all or any of these costs from insurance and fines or penalties paid for compliance violations, whether alleged or proven, will not be covered by insurance.

Climate change legislation and related regulatory initiatives could result in increased operating costs and reduced demand for our services.

In December 2009, the U.S. Environmental Protection Agency, or EPA, published its findings that emissions of carbon dioxide, methane and other “greenhouse gases,” or GHGs, present an endangerment to public health and the environment because emissions of such gases are contributing to warming of the earth’s atmosphere and other climatic changes. These findings by the EPA allow the agency to proceed with the adoption and implementation of regulations that would restrict emissions of GHGs under existing provisions of the federal Clean Air Act. Accordingly, the EPA has adopted regulations that require a reduction in emissions of GHGs from motor vehicles and trigger permit review for GHG emissions from certain large stationary sources. In addition, the EPA issued a final rule, effective in December 2009, requiring the reporting of GHG emissions from specified large GHG emission sources in the U.S., beginning in 2011 for emissions occurring in 2010. Further, in March 2010, the EPA finalized new GHG reporting requirements for upstream petroleum and natural gas systems, which will be added to EPA’s GHG Reporting Rule. Facilities containing petroleum and natural gas systems that emit 25,000 metric tons or more of CO2 equivalent per year will be required to report annual GHG emissions to EPA, with the first report due on March 31, 2012. The adoption and implementation of any regulations imposing reporting obligations on, or limiting emissions of GHGs from, our equipment and operations could require us to incur additional costs to reduce emissions of GHGs associated with our operations or could adversely affect demand for the crude oil we gather, transport, store or otherwise handle in connection with our services.

The United States Congress has been considering legislation to reduce such emissions and almost one half of the states, either individually or through multi-state regional initiatives, have already begun implementing legal measures to reduce emissions of GHGs, primarily through the planned development of GHG emission inventories and/or GHG cap and trade programs. Depending on the particular program and scope thereof, we could be required to purchase and surrender allowances for GHG emissions resulting from our operations or could face additional taxes and a higher cost of doing business. Although we would not be impacted to a greater degree than other similarly situated midstream energy service providers, a stringent GHG control program could have an adverse effect on our cost of doing business and could reduce demand for crude oil.

The potential increase in the costs of our operations resulting from any legislation or regulation to restrict emissions of GHGs could include new or increased costs to operate and maintain our facilities, install new emission controls on our facilities, acquire allowances to authorize our GHG emissions, pay any taxes related to our GHG emissions and administer and manage a GHG emissions program. While we may be able to include

 

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some or all of such increased costs in the rates charged by our pipelines or other facilities, such recovery of costs is uncertain. Moreover, incentives to conserve energy or use alternative energy sources could reduce demand for crude oil, resulting in a decrease in the demand for our services.

Increased regulation of hydraulic fracturing could result in reductions or delays in crude oil production in our areas of operation, which could adversely impact our business and results of operations.

An increasing percentage of crude oil production is being developed from unconventional sources such as shales. These reservoirs require hydraulic fracturing completion processes to release the crude oil from the rock so it can flow through casing to the surface. Hydraulic fracturing involves the injection of water, sand and chemicals under pressure into the formation to stimulate crude oil production. The EPA has commenced a study of the potential environmental impacts of hydraulic fracturing activities, including on water quality and public health, with results of the study anticipated to be available by late 2012. At the same time, certain environmental groups have suggested that additional laws may be needed to more closely and uniformly regulate the hydraulic fracturing process, and legislation has been proposed by some members of Congress to provide for such regulation. For instance, the U.S. Congress is currently considering legislation to amend the federal Safe Drinking Water Act to subject hydraulic fracturing operations to regulation under that act. Sponsors of bills currently pending before the U.S. Senate and House of Representatives have asserted that chemicals used in the fracturing process could adversely affect drinking water supplies. Proposed legislation would require, among other things, the reporting and public disclosure of chemicals used in the fracturing process, which could make it easier for third parties opposing the hydraulic fracturing process to initiate legal proceedings against producers and service providers. In addition, these bills, if adopted, could establish an additional level of regulation and permitting of hydraulic fracturing operations at the federal level, which could lead to operational delays, increased operating and compliance costs and additional regulatory burdens that could make it more difficult or commercially impracticable to perform hydraulic fracturing, delaying the development of unconventional resources from shale formations which are not commercial without the use of hydraulic fracturing. The Department of Energy, at the direction of the President, is also studying hydraulic fracturing in order to provide recommendations and identify best practices and other steps to enhance companies’ safety and environmental performance in their hydraulic fracturing operations. In addition, several states have already passed, or are considering, legislation that is intended to regulate hydraulic fracturing. We cannot predict what effect such legislation will have on the production of crude oil in our areas of operation. The imposition of additional regulations and permit requirements could lead to delays or increased operating costs for crude oil producers. A reduction in the production of crude oil in our areas of operation could have an adverse effect on our business, results of operations, financial condition and ability to make cash distributions to our unitholders.

The loss of skilled operational employees could significantly reduce our ability to execute our growth and other strategies.

Much of our future success depends on the continued availability and service of skilled operational personnel. Experienced personnel in the midstream industry are in high demand. There can be no assurance that we will continue to attract and retain key operational personnel. If a significant number of our skilled employees resign and are not adequately replaced, or if we are unable to fill currently vacant positions, our business, results of operations, financial condition and ability to make cash distributions to our unitholders could be materially adversely affected.

Because SemGroup’s and our predecessor’s financial statements reflect fresh-start reporting adjustments made upon SemGroup’s emergence from bankruptcy, and because of the effects of the transactions that became effective pursuant to SemGroup’s plan of reorganization, financial information in our current and future financial statements will not be comparable to financial information from prior periods.

In connection with SemGroup’s bankruptcy reorganization, it adopted fresh-start reporting effective as of the close of business on November 30, 2009, in accordance with the Financial Accounting Standards Board

 

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Accounting Standards Codification (ASC) 852, “Reorganizations.” Its adoption of fresh-start reporting resulted in it becoming a new entity for financial reporting purposes. As required by fresh-start reporting, SemGroup’s assets and liabilities, including those contributed to us, were adjusted to reflect fair value at November 30, 2009. In addition to fresh-start reporting, SemGroup’s and our predecessor’s financial statements reflect the effects of all of the transactions implemented through SemGroup’s plan of reorganization. Accordingly, our predecessor’s financial statements for periods ending on or prior to November 30, 2009 are not comparable with our predecessor’s financial statements for periods ending subsequent to November 30, 2009. Furthermore, the estimates and assumptions used to implement fresh-start reporting are inherently subject to significant uncertainties and contingencies beyond our control. Accordingly, we cannot provide assurance that the estimates, assumptions, and values reflected in our valuations will be realized, and our actual results could vary materially.

Risks Inherent in an Investment in Us

SemGroup owns and controls our general partner, which has sole responsibility for conducting our business and managing our operations. SemGroup and our general partner will have conflicts of interest with us and may favor their own interests to your detriment.

Following this offering, SemGroup will own and control our general partner, as well as appoint all of the officers and directors of our general partner, some of whom will also be officers and/or directors of SemGroup. Although our general partner has a fiduciary duty to manage us in a manner that is beneficial to us and our unitholders, the directors and officers of our general partner have a fiduciary duty to manage our general partner in a manner that is beneficial to its owner, SemGroup. Therefore, conflicts of interest may arise between SemGroup and our general partner, on the one hand, and us and our unitholders, on the other hand. In resolving these conflicts of interest, our general partner may favor its own interests and the interests of SemGroup over our interests and the interests of our unitholders. These conflicts include the following situations, among others:

 

   

Neither our partnership agreement nor any other agreement requires SemGroup to pursue a business strategy that favors us.

 

   

SemGroup is not limited in its ability to compete with us and may offer business opportunities or sell midstream assets to parties other than us.

 

   

Our general partner is allowed to take into account the interests of parties other than us, such as SemGroup, in resolving conflicts of interest.

 

   

All of the officers and certain of the directors of our general partner are also officers and/or directors of SemGroup and will owe fiduciary duties to SemGroup. The officers of our general partner will also devote significant time to the business of SemGroup and will be compensated by SemGroup accordingly.

 

   

The limited partner interests that SemGroup will initially own will permit it to effectively control any vote of our limited partners. SemGroup will be entitled to vote its units in accordance with its own interests, which may be contrary to your interests.

 

   

Our partnership agreement limits the liability of, and reduces the fiduciary duties owed by, our general partner, and also restricts the remedies available to our unitholders for actions that, without the limitations, might constitute breaches of fiduciary duty.

 

   

Except in limited circumstances, our general partner has the power and authority to conduct our business without unitholder approval.

 

   

Our general partner determines the amount and timing of asset purchases and sales, borrowings, issuance of additional partnership securities and the creation, reduction or increase of reserves, each of which can affect the amount of cash that is distributed to our unitholders.

 

   

Our general partner determines the amount and timing of any capital expenditures and whether a capital expenditure is classified as a maintenance capital expenditure, which reduces operating surplus, or an expansion capital expenditure, which does not reduce operating surplus. This determination can affect

 

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the amount of cash that is distributed to our unitholders and to our general partner and the ability of the subordinated units to convert to common units.

 

   

Our general partner determines which costs incurred by it are reimbursable by us.

 

   

Our general partner may cause us to borrow funds in order to permit the payment of cash distributions, even if the purpose or effect of the borrowing is to make a distribution on the subordinated units, to make incentive distributions or to accelerate the expiration of the subordination period.

 

   

Our partnership agreement permits us to classify up to $25 million as operating surplus, even if it is generated from asset sales, non-working capital borrowings or other sources that would otherwise constitute capital surplus. This cash may be used to fund distributions on our subordinated units or to our general partner in respect of the general partner interest or the incentive distribution rights.

 

   

Our partnership agreement does not restrict our general partner from causing us to pay it or its affiliates for any services rendered to us or entering into additional contractual arrangements with any of these entities on our behalf.

 

   

Our general partner intends to limit its liability regarding our contractual and other obligations.

 

   

Our general partner may exercise its right to call and purchase all of the common units not owned by it and its affiliates if they own more than 80% of the common units.

 

   

Our general partner controls the enforcement of the obligations that it and its affiliates owe to us.

 

   

Our general partner decides whether to retain separate counsel, accountants or others to perform services for us.

 

   

Our general partner may elect to cause us to issue common units to it in connection with a resetting of the target distribution levels related to our general partner’s incentive distribution rights without the approval of the Conflicts Committee of the board of directors of our general partner or our unitholders. This election may result in lower distributions to our common unitholders in certain situations.

Please read “Conflicts of Interest and Fiduciary Duties” beginning on page 155.

Our general partner interest or the control of our general partner or SemGroup may be transferred to a third party without unitholder consent. In addition, SemGroup has received an unsolicited proposal to acquire all of its common stock. A change in control of SemGroup or our general partner could result in a change in our business strategy that does not favor our unitholders or could otherwise have a material adverse effect on our business.

Our general partner may transfer its general partner interest to a third party in a merger or in a sale of all or substantially all of its assets without the consent of the unitholders. Furthermore, our partnership agreement does not restrict the ability of SemGroup to transfer all or a portion of its ownership interest in our general partner to a third party, directly or indirectly. In addition, SemGroup may be acquired by a third party, or a third party may otherwise obtain control of SemGroup, which would result in such third party gaining control of our general partner. On October 24, 2011, Plains All American Pipeline, L.P. (“Plains”) announced that it had made an unsolicited proposal to acquire all of the outstanding shares of SemGroup for $24.00 per share in cash. On November 16, 2011, Plains reiterated its proposal. Additional proposals to acquire SemGroup, from Plains or other parties, may be received by SemGroup, and SemGroup may enter into an agreement with respect to such a transaction, at any time. Plains or other third parties may also seek to gain control of SemGroup through other methods, including tender offers, consent solicitations or proxy contests.

Any new owner of SemGroup, our general partner or our general partner interest would be in a position to replace our management and the board of directors of our general partner with its own designees, in each case without the consent of unitholders, and may change our business strategy from the one described in this prospectus. For example, any new owner may choose not to pursue our strategy to grow our business through

 

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acquisitions from SemGroup and may choose not to pursue business opportunities that our unitholders may consider beneficial to us. In addition, a new owner may sell our assets or the assets of SemGroup to third parties. Further, any such change in ownership may result in a change in our capitalization and may expose us to increased or unanticipated liabilities and costs, some of which may be material. The failure of SemGroup to own our general partner would be an event of default under our credit facility. Any of these changes, and any other changes as a result of a change in ownership of SemGroup, our general partner or our general partner interest, may lower the trading price of our common units and may have an adverse impact on our business, results of operations, financial condition and ability to make cash distributions to our unitholders.

Pursuant to the SemGroup credit facility, our general partner and Rose Rock Midstream Holdings, LLC, the sole member of our general partner, will pledge the general partner interest in us and the membership interests in our general partner, respectively. In the event that SemGroup is unable to meet its obligations under its credit facility, the lenders may foreclose on the pledged collateral and thereby acquire control of our general partner and its 2.0% general partner interest in us.

Pursuant to the SemGroup credit facility, our general partner and Rose Rock Midstream Holdings, LLC, the sole member of our general partner, will enter into a pledge agreement with the lenders thereunder. Pursuant to the pledge agreement, the assets of Rose Rock Midstream Holdings, LLC and our general partner, including Rose Rock Midstream Holdings, LLC’s membership interest in our general partner our general partner’s general partner interest in us, will be subject to a security interest in favor of such lenders. In the event that SemGroup is unable to meet its obligations under its credit facility and the lenders foreclose on the pledged collateral, the lenders will own our general partner and all of its assets, including its 2.0% general partner interest in us and all of our incentive distribution rights. In such event, the lenders would control our management and operations.

SemGroup is not limited in its ability to compete with us and is not obligated to offer us the opportunity to acquire additional assets or businesses, which could limit our ability to grow and could adversely affect our business, results of operations, financial condition and ability to make cash distributions to our unitholders.

SemGroup is not prohibited from owning assets or engaging in businesses that compete directly or indirectly with us. In addition, in the future, SemGroup may acquire, construct or dispose of additional midstream or other assets and may be presented with new business opportunities, without any obligation to offer us the opportunity to purchase or construct such assets or to engage in such business opportunities. Moreover, while SemGroup may offer us the opportunity to buy additional assets from it, it will be under no contractual obligation to do so and we are unable to predict whether or when such acquisitions might be completed.

Our partnership agreement limits our general partner’s fiduciary duties to holders of our common and subordinated units.

Our partnership agreement contains provisions that modify and reduce the fiduciary standards to which our general partner would otherwise be held by state fiduciary duty law. For example, our partnership agreement permits our general partner to make a number of decisions in its individual capacity, as opposed to in its capacity as our general partner, or otherwise free of fiduciary duties to us and our unitholders. This entitles our general partner to consider only the interests and factors that it desires and relieves it of any duty or obligation to give any consideration to any interest of, or factors affecting, us, our affiliates or our limited partners. Examples of decisions that our general partner may make in its individual capacity include:

 

   

how to allocate corporate opportunities among us and its affiliates;

 

   

whether to exercise its limited call right;

 

   

how to exercise its voting rights with respect to the units it owns;

 

   

whether to exercise its registration rights;

 

   

whether to elect to reset target distribution levels; and

 

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whether to consent to any merger or consolidation of the partnership or amendment to the partnership agreement.

By purchasing a common unit, a common unitholder agrees to become bound by the provisions in the partnership agreement, including the provisions discussed above. Please read “Conflicts of Interest and Fiduciary Duties—Fiduciary Duties” beginning on page 160.

Our partnership agreement limits the liability of and reduces the fiduciary duties owed by our general partner, and also restricts the remedies available to holders of our common and subordinated units for actions taken by our general partner that might otherwise constitute breaches of fiduciary duty.

Our partnership agreement contains provisions that reduce the fiduciary duties of our general partner and restrict the remedies available to unitholders for actions taken by our general partner that might otherwise constitute breaches of fiduciary duty under state fiduciary duty law. For example, our partnership agreement:

 

   

provides that whenever our general partner makes a determination or takes, or declines to take, any other action in its capacity as our general partner, our general partner is required to make such determination, or take or decline to take such other action, in good faith, meaning that it subjectively believed that the decision was in, or not opposed to, the interests of our partnership, and will not be subject to any other or different standard imposed by our partnership agreement, Delaware law, or any other law, rule or regulation, or at equity;

 

   

provides that our general partner will not have any liability to us or our unitholders for decisions made in its capacity as a general partner so long as such decisions are made in good faith;

 

   

provides that our general partner and its officers and directors will not be liable for monetary damages to us or our limited partners resulting from any act or omission unless there has been a final and non-appealable judgment entered by a court of competent jurisdiction determining that our general partner or its officers and directors, as the case may be, acted in bad faith or, in the case of a criminal matter, acted with knowledge that the conduct was criminal; and

 

   

provides that our general partner will not be in breach of its obligations under the partnership agreement or its fiduciary duties to us or our unitholders if a transaction with an affiliate or the resolution of a conflict of interest is:

 

  (a) approved by the Conflicts Committee of the board of directors of our general partner, although our general partner is not obligated to seek such approval;

 

  (b) approved by the vote of a majority of the outstanding common units, excluding any common units owned by our general partner and its affiliates;

 

  (c) on terms no less favorable to us than those generally being provided to or available from unrelated third parties; or

 

  (d) fair and reasonable to us, taking into account the totality of the relationships among the parties involved, including other transactions that may be particularly favorable or advantageous to us.

In connection with a situation involving a transaction with an affiliate or a conflict of interest, any determination by our general partner must be made in good faith. If an affiliate transaction or the resolution of a conflict of interest is not approved by our common unitholders or the Conflicts Committee and the board of directors of our general partner determines that the resolution or course of action taken with respect to the affiliate transaction or conflict of interest satisfies either of the standards set forth in subclauses (c) and (d) above, then it will be presumed that, in making its decision, the board of directors acted in good faith, and in any proceeding brought by or on behalf of any limited partner or the partnership, the person bringing or prosecuting such proceeding will have the burden of overcoming such presumption.

 

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Cost reimbursements due to SemGroup and our general partner for services provided to us or on our behalf will be substantial and will reduce our cash available for distribution to you. The amount and timing of such reimbursements will be determined by our general partner.

We intend to use all of the proceeds from this offering to make a cash distribution to SemGroup. Furthermore, prior to making distributions on our common units going forward, we will reimburse our general partner and its affiliates for all expenses they incur on our behalf. These expenses will include all costs incurred by SemGroup and our general partner in managing and operating us. Our partnership agreement provides that our general partner will determine in good faith the expenses that are allocable to us. The reimbursements to SemGroup and our general partner will reduce the amount of cash otherwise available for distribution to our unitholders.

If you are not an Eligible Holder, your common units may be subject to redemption.

We have adopted certain requirements regarding those investors who may own our common and subordinated units. Eligible Holders are limited partners whose (a) federal income tax status is not reasonably likely to have a material adverse effect on the rates that can be charged by us on assets that are subject to regulation by FERC or an analogous regulatory body and (b) nationality, citizenship or other related status would not create a substantial risk of cancellation or forfeiture of any property in which we have an interest, in each case as determined by our general partner with the advice of counsel. If you are not an Eligible Holder, in certain circumstances as set forth in our partnership agreement, your units may be redeemed by us at the then-current market price. The redemption price will be paid in cash or by delivery of a promissory note, as determined by our general partner. Please read “The Partnership Agreement—Ineligible Holders; Redemption.”

Our partnership agreement requires that we distribute all of our available cash, which could limit our ability to grow and make acquisitions.

Our partnership agreement requires that we distribute all of our available cash to our unitholders, and we will rely primarily upon external financing sources, including borrowings under our revolving credit facility and the issuance of debt and equity securities, to fund our acquisitions and expansion capital expenditures. As a result, to the extent we are unable to finance growth externally, our cash distribution policy will significantly impair our ability to grow. Furthermore, we anticipate using substantially all of the net proceeds of this offering to make a distribution to SemGroup, and therefore, the net proceeds of this offering will not be directly used to grow our business.

In addition, because we distribute all of our available cash, our growth may not be as fast as that of businesses that reinvest their available cash to expand ongoing operations. To the extent we issue additional units in connection with any acquisitions or expansion capital expenditures, the payment of distributions on those additional units may increase the risk that we will be unable to maintain or increase our per unit distribution level. There are no limitations in our partnership agreement or in our new revolving credit facility on our ability to issue additional units, including units ranking senior to the common units. The incurrence of additional bank borrowings (under our revolving credit facility or otherwise) or other debt to finance our growth strategy will result in increased interest expense, which, in turn, may impact the available cash that we have to distribute to our unitholders.

Holders of our common units will have limited voting rights and will not be entitled to elect our general partner or its directors.

Unlike the holders of common stock in a corporation, unitholders will have only limited voting rights on matters affecting our business and, therefore, limited ability to influence management’s decisions regarding our business. Unitholders will have no right on an annual or ongoing basis to elect our general partner or its board of directors. The board of directors of our general partner, including the independent directors, will be chosen by SemGroup. Furthermore, if our unitholders become dissatisfied with the performance of our general partner, they

 

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will have little ability to remove our general partner. As a result of these limitations, the price at which the common units will trade could be diminished because of the absence or reduction of a takeover premium in the trading price. Our partnership agreement also contains provisions limiting the ability of unitholders to call meetings or to acquire information about our operations, as well as other provisions limiting the unitholders’ ability to influence the manner or direction of management.

Even if holders of our common units are dissatisfied, they will not initially be able to remove our general partner without its consent.

The unitholders will initially be unable to remove our general partner without its consent because our general partner and its affiliates will own sufficient units upon completion of this offering to be able to prevent its removal. The vote of the holders of at least 66 2/3% of all outstanding limited partner units voting together as a single class is required to remove our general partner. Following the closing of this offering, SemGroup will own 58.3% of our outstanding common and subordinated units. Also, if our general partner is removed without cause during the subordination period and units held by our general partner and its affiliates are not voted in favor of that removal, all remaining subordinated units will automatically convert into common units and any existing arrearages on our common units will be extinguished. A removal of our general partner under these circumstances would adversely affect our common units by prematurely eliminating their distribution and liquidation preference over our subordinated units, which would otherwise have continued until we had met certain distribution and performance tests. Cause is narrowly defined to mean that a court of competent jurisdiction has entered a final, non-appealable judgment finding our general partner liable for actual fraud, gross negligence or willful or wanton misconduct in its capacity as our general partner. Cause does not include most cases of charges of poor management of the business, so the removal of our general partner because of the unitholder’s dissatisfaction with our general partner’s performance in managing our partnership will most likely result in the termination of the subordination period and conversion of all subordinated units to common units.

Our partnership agreement restricts the voting rights of unitholders owning 20% or more of our common units.

Unitholders’ voting rights are further restricted by a provision of our partnership agreement providing that any units held by a person that owns 20% or more of any class of units then outstanding, other than our general partner, its affiliates, their transferees and persons who acquired such units with the prior approval of the board of directors of our general partner, cannot vote on any matter. Because SemGroup is an affiliate of, and appoints all the members of the board of directors of, our general partner, this provision ensures that SemGroup will maintain voting control with respect to decisions affecting the partnership.

Our general partner’s incentive distribution rights may be transferred to a third party without unitholder consent.

Our general partner may transfer all or a portion of its incentive distribution rights to a third party at any time without the consent of our unitholders. If our general partner transfers its incentive distribution rights to a third party but retains its general partner interest, our general partner will not have the same incentive to grow our partnership and increase our quarterly distributions to unitholders over time as it would have had if it had retained ownership of its incentive distribution rights.

Our general partner intends to limit its liability regarding our obligations.

Our general partner intends to limit its liability under contractual arrangements so that the counterparties to such arrangements have recourse only against our assets, and not against our general partner or its assets. Our general partner may therefore cause us to incur indebtedness or other obligations that are nonrecourse to our general partner. Our partnership agreement provides that any action taken by our general partner to limit its liability is not a breach of our general partner’s fiduciary duties, even if we could have obtained more favorable terms without the limitation on liability. In addition, we are obligated to reimburse or indemnify our general

 

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partner to the extent that it incurs obligations on our behalf. Any such reimbursement or indemnification payments would reduce the amount of cash otherwise available for distribution to our unitholders.

Our general partner may elect to cause us to issue to it additional common and general partner units in connection with a resetting of the target distribution levels related to its incentive distribution rights without the approval of the Conflicts Committee of its board of directors or the holders of our common units. This could result in lower distributions to holders of our common units.

Our general partner has the right, at any time when there are no subordinated units outstanding and it has received incentive distributions at the highest level to which it is entitled (48%) for each of the four most recently completed fiscal quarters (and the amount of each such distribution did not exceed adjusted operating surplus for each such quarter), to reset the initial target distribution levels at higher levels based on our cash distributions at the time of the exercise of the reset election. Following a reset election by our general partner, the minimum quarterly distribution will be adjusted to equal the reset minimum quarterly distribution and the target distribution levels will be reset to correspondingly higher levels based on percentage increases above the reset minimum quarterly distribution.

If our general partner elects to reset the target distribution levels, it will be entitled to receive the number of common units equal to that number of common units which would have entitled their holder to an average aggregate quarterly cash distribution in the prior two quarters equal to the average of the distributions to our general partner on the incentive distribution rights in the prior two quarters. Our general partner will also be issued the number of general partner units necessary to maintain its general partner interest in us that existed immediately prior to the reset election. We anticipate that our general partner would exercise this reset right in order to facilitate acquisitions or internal growth projects that would not otherwise be sufficiently accretive to cash distributions per common unit. It is possible, however, that our general partner could exercise this reset election at a time when it is experiencing, or expects to experience, declines in the cash distributions it receives related to its incentive distribution rights and may, therefore, desire to be issued common units rather than retain the right to receive incentive distributions based on the initial target distribution levels. As a result, a reset election may cause our common unitholders to experience a reduction in the amount of cash distributions that they would have otherwise received had we not issued new common units and general partner units to our general partner in connection with resetting the target distribution levels. Please read “Provisions of Our Partnership Agreement Relating to Cash Distributions—General Partner’s Right to Reset Incentive Distribution Levels” beginning on page 74.

Our general partner has a limited call right that may require you to sell your units at an undesirable time or price.

If at any time our general partner and its affiliates own more than 80% of the common units, our general partner will have the right, which it may assign to any of its affiliates or to us, but not the obligation, to acquire all, but not less than all, of the common units held by unaffiliated persons at a price that is not less than their then-current market price. As a result, you may be required to sell your common units at an undesirable time or price and may not receive any return on your investment. You may also incur a tax liability upon a sale of your units. At the completion of this offering, and assuming no exercise of the underwriters’ option to purchase additional common units, SemGroup will own approximately 16.6% of our outstanding common units. At the end of the subordination period, assuming no additional issuances of common units (other than upon the conversion of the subordinated units), SemGroup will own approximately 58.3% of our outstanding common units. For additional information about this right, please read “The Partnership Agreement—Limited Call Right” on page 174.

You will experience immediate and substantial dilution in pro forma net tangible book value of $3.50 per common unit.

The estimated initial public offering price of $20.00 per common unit exceeds our pro forma net tangible book value of $16.50 per unit. Based on the estimated initial public offering price of $20.00 per common unit,

 

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you will incur immediate and substantial dilution of $3.50 per common unit. This dilution results primarily because the assets contributed by our general partner and its affiliates are recorded in accordance with GAAP at their historical cost, and not their fair value. Please read “Dilution” on page 53.

We may issue additional units without your approval, which would dilute your existing ownership interests.

Our partnership agreement does not limit the number of additional limited partner interests that we may issue at any time without the approval of our unitholders. The issuance by us of additional common units or other equity securities of equal or senior rank will have the following effects:

 

   

our existing unitholders’ proportionate ownership interest in us will decrease;

 

   

the amount of cash available for distribution on each unit may decrease;

 

   

because a lower percentage of total outstanding units will be subordinated units, the risk that a shortfall in the payment of the minimum quarterly distribution will be borne by our common unitholders will increase;

 

   

the ratio of taxable income to distributions may increase;

 

   

the relative voting strength of each previously outstanding unit may be diminished; and

 

   

the market price of the common units may decline.

SemGroup may sell units in the public or private markets, and such sales could have an adverse impact on the trading price of the common units.

After the sale of the common units offered by this prospectus, assuming that the underwriters do not exercise their option to purchase additional common units, SemGroup will hold an aggregate of 1,389,709 common units and 8,389,709 subordinated units. All of the subordinated units will convert into common units at the end of the subordination period and may convert earlier under certain circumstances. In addition, we have agreed to provide SemGroup with certain registration rights which may facilitate the sale by SemGroup of its common and subordinated units into the public markets. Please see “The Partnership Agreement—Registration Rights” on page 177 and “Units Eligible for Future Sale” on page 178. The sale of these units in the public or private markets could have an adverse impact on the price of the common units or on any trading market that may develop.

There is no existing market for our common units, and a trading market that will provide you with adequate liquidity may not develop. The price of our common units may fluctuate significantly, and you could lose all or part of your investment.

Prior to this offering, there has been no public market for our common units. After this offering, there will be only 7,000,000 publicly traded common units, assuming no exercise of the underwriters’ option to purchase additional common units. We do not know the extent to which investor interest will lead to the development of a trading market or how liquid that market might be. You may not be able to resell your common units at or above the initial public offering price. Additionally, the lack of liquidity may result in wide bid-ask spreads, contribute to significant fluctuations in the market price of the common units and limit the number of investors who are able to buy the common units.

The initial public offering price for the common units will be determined by negotiations between us and the representative of the underwriters and may not be indicative of the market price of the common units that will prevail in the trading market. The market price of our common units may decline below the initial public offering price. The market price of our common units may also be influenced by many factors, some of which are beyond our control, including:

 

   

our quarterly distributions;

 

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our quarterly or annual earnings or those of other companies in our industry;

 

   

the loss of a large customer;

 

   

announcements by us or our competitors of significant contracts or acquisitions;

 

   

changes in accounting standards, policies, guidance, interpretations or principles;

 

   

general economic conditions;

 

   

the failure of securities analysts to cover our common units after this offering or changes in financial estimates by analysts;

 

   

future sales of our common units; and

 

   

other factors described in these “Risk Factors.”

Your liability may not be limited if a court finds that unitholder action constitutes control of our business.

A general partner of a partnership generally has unlimited liability for the obligations of the partnership, except for those contractual obligations of the partnership that are expressly made without recourse to the general partner. Our partnership is organized under Delaware law, and we conduct business in a number of other states. The limitations on the liability of holders of limited partner interests for the obligations of a limited partnership have not been clearly established in some of the other states in which we do business. You could be liable for any and all of our obligations as if you were a general partner if a court or government agency were to determine that:

 

   

we were conducting business in a state but had not complied with that particular state’s partnership statute; or

 

   

your right to act with other unitholders to remove or replace our general partner, to approve some amendments to our partnership agreement or to take other actions under our partnership agreement constitute “control” of our business.

For a discussion of the implications of the limitations of liability on a unitholder, please read “The Partnership Agreement—Limited Liability” beginning on page 167.

Unitholders may have liability to repay distributions that were wrongfully distributed to them.

Under certain circumstances, unitholders may have to repay amounts wrongfully returned or distributed to them. Under Section 17-607 of the Delaware Revised Uniform Limited Partnership Act, we may not make a distribution to you if the distribution would cause our liabilities to exceed the fair value of our assets. Delaware law provides that for a period of three years from the date of an impermissible distribution, limited partners who received the distribution and who knew at the time of the distribution that it violated Delaware law will be liable to the limited partnership for the distribution amount. Substituted limited partners are liable both for the obligations of the assignor to make contributions to the partnership that were known to the substituted limited partner at the time it became a limited partner and for those obligations that were unknown if the liabilities could have been determined from the partnership agreement. Neither liabilities to partners on account of their partnership interest nor liabilities that are non-recourse to the partnership are counted for purposes of determining whether a distribution is permitted.

An increase in interest rates may cause the market price of our common units to decline.

Like all equity investments, an investment in our common units is subject to certain risks. In exchange for accepting these risks, investors may expect to receive a higher rate of return than would otherwise be obtainable from lower-risk investments. Accordingly, as interest rates rise, the ability of investors to obtain higher risk-adjusted rates of return by purchasing government-backed debt securities may cause a corresponding decline in demand for riskier investments generally, including yield-based equity investments such as publicly traded

 

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limited partnership interests. Reduced demand for our common units resulting from investors seeking other more favorable investment opportunities may cause the trading price of our common units to decline.

We will incur increased costs as a result of being a publicly traded partnership.

We have no history operating as a publicly traded partnership. As a publicly traded partnership, we will incur significant legal, accounting and other expenses. Public companies are required to comply with the rules and regulations of the SEC and the securities exchanges, as well as laws enacted by Congress such as the Sarbanes-Oxley Act of 2002. We expect these rules and regulations to increase our legal and financial compliance costs and to make activities more time-consuming and costly. For example, as a result of becoming a publicly traded partnership, we are required to have at least three independent directors, create an audit committee and adopt policies regarding internal controls and disclosure controls and procedures, including the preparation of reports on internal controls over financial reporting. In addition, we will incur additional costs associated with our publicly traded partnership reporting requirements. We also expect these new rules and regulations to make it more difficult and more expensive for our general partner to obtain director and officer liability insurance and to possibly result in our general partner having to accept reduced policy limits and coverage. As a result, it may be more difficult for our general partner to attract and retain qualified persons to serve on its board of directors or as executive officers. We have included $1.9 million of estimated incremental costs per year associated with being a publicly traded partnership in our financial forecast included elsewhere in this prospectus. However, it is possible that our actual incremental costs of being a publicly traded partnership will be higher than we currently estimate.

The NYSE does not require a publicly traded limited partnership like us to comply with certain of its corporate governance requirements.

We have been approved to list our common units on the NYSE subject to official notice of issuance. As a limited partnership, we will not be required to, and do not intend to, have a majority of independent directors on our general partner’s board of directors or establish a compensation committee or a nominating and corporate governance committee, as is required for other NYSE-listed entities. Accordingly, unitholders will not have the same protections afforded to investors in other entities, including most corporations, that are subject to all of the NYSE corporate governance requirements. Please see “Management” beginning on page 132.

If we fail to develop or maintain an effective system of internal controls, we may not be able to report our financial results accurately or prevent fraud, which would likely have a negative impact on the market price of our common units.

Prior to this offering, we have not been required to file reports with the SEC. Upon the completion of this offering, we will become subject to the public reporting requirements of the Securities Exchange Act of 1934, as amended, or the Exchange Act. We prepare our combined financial statements in accordance with GAAP, but our internal accounting controls may not currently meet all standards applicable to companies with publicly traded securities. Effective internal controls are necessary for us to provide reliable financial reports, prevent fraud and to operate successfully as a publicly traded partnership. Our efforts to develop and maintain our internal controls may not be successful, and we may be unable to maintain effective controls over our financial processes and reporting in the future or to comply with our obligations under Section 404 of the Sarbanes-Oxley Act of 2002, which we refer to as Section 404. For example, Section 404 will require us, among other things, to annually review and report on, and our independent registered public accounting firm to attest to, the effectiveness of our internal controls over financial reporting. We must comply with Section 404 for our fiscal year ending December 31, 2012. Any failure to develop, implement or maintain effective internal controls or to improve our internal controls could harm our operating results or cause us to fail to meet our reporting obligations. Given the difficulties inherent in the design and operation of internal controls over financial reporting, we can provide no assurance as to our, or our independent registered public accounting firm’s, conclusions about the effectiveness of our internal controls, and we may incur significant costs in our efforts to

 

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comply with Section 404. Ineffective internal controls will subject us to regulatory scrutiny and a loss of confidence in our reported financial information, which could have an adverse effect on our business and would likely have a negative effect on the trading price of our common units.

If we are deemed to be an “investment company” under the Investment Company Act of 1940, it would adversely affect the price of our common units and could have a material adverse effect on our business.

Our initial assets will consist of our ownership interests in our operating subsidiaries. If our assets are deemed to be “investment securities” within the meaning of the Investment Company Act of 1940, or the Investment Company Act, we would either have to register as an investment company under the Investment Company Act, obtain exemptive relief from the SEC or modify our organizational structure or contract rights so as to fall outside of the definition of investment company. Registering as an investment company could, among other things, materially limit our ability to engage in transactions with affiliates, including the purchase and sale of certain securities or other property from or to our affiliates, restrict our ability to borrow funds or engage in other transactions involving leverage and require us to add additional directors who are independent of us or our affiliates. The occurrence of some or all of these events would adversely affect the price of our common units and could have a material adverse effect on our business.

Moreover, treatment of us as an investment company would prevent our qualification as a partnership for federal income tax purposes, in which case we would be treated as a corporation for federal income tax purposes. As a result, we would pay federal income tax on our taxable income at the corporate tax rate, distributions to you would generally be taxed again as corporate distributions and none of our income, gains, losses or deductions would flow through to you. If we were taxed as a corporation, our cash available for distribution to you would be substantially reduced. Therefore, treatment of us as an investment company would result in a material reduction in the anticipated cash flow and after-tax return to the unitholders, likely causing a substantial reduction in the value of our common units. For a discussion of the federal income tax implications that would result from our treatment as a corporation in any taxable year, please read “Material Federal Income Tax Consequences—Partnership Status” beginning on page 179.

Tax Risks to Common Unitholders

In addition to reading the following risk factors, you should read “Material Federal Income Tax Consequences” for a more complete discussion of the expected material federal income tax consequences of owning and disposing of our common units.

Our tax treatment depends on our status as a partnership for federal income tax purposes, as well as our not being subject to a material amount of entity-level taxation by individual states. If the Internal Revenue Service, or IRS, were to treat us as a corporation for federal income tax purposes or we were to become subject to material additional amounts of entity-level taxation for state purposes, then our cash available for distribution to our unitholders would be substantially reduced.

The anticipated after-tax economic benefit of an investment in the common units depends largely on our being treated as a partnership for federal income tax purposes. We have not requested, and do not plan to request, a ruling from the IRS on this or any other tax matter affecting us.

Despite the fact that we are a limited partnership under Delaware law, it is possible in certain circumstances for a partnership such as ours to be treated as a corporation for federal income tax purposes. A change in our business or a change in current law could cause us to be treated as a corporation for federal income tax purposes or otherwise subject us to taxation as an entity.

If we were to be treated as a corporation for federal income tax purposes, we would pay federal income tax on our taxable income at the corporate tax rate, which is currently a maximum of 35.0%, and would likely pay

 

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state and local income tax at varying rates. Distributions would generally be taxed again as corporate dividends (to the extent of our current and accumulated earnings and profits), and no income, gains, losses, deductions, or credits would flow through to you. Because a tax would be imposed upon us as a corporation, our cash available for distribution to you would be substantially reduced. Therefore, if we were to be treated as a corporation for federal income tax purposes, there would be a material reduction in the anticipated cash flow and after-tax return to our unitholders, likely causing a substantial reduction in the value of our common units.

In Texas, we will be subject to an entity-level tax on any portion of our income that is generated in Texas in the prior year. Imposition of any such additional taxes on us or an increase in the existing tax rates would reduce the cash available for distribution to our unitholders.

Our partnership agreement provides that if a law is enacted or existing law is modified or interpreted in a manner that subjects us to taxation as a corporation or otherwise subjects us to entity-level taxation, the minimum quarterly distribution amount and the target distribution amounts may be adjusted to reflect the impact of that law on us.

If we were to be subjected to a material amount of additional entity-level taxation by individual states, it would reduce our cash available for distribution to our unitholders.

Changes in current state law may subject us to additional entity-level taxation by individual states. Because of widespread state budget deficits and other reasons, several states are evaluating ways to subject partnerships to entity-level taxation through the imposition of state income, franchise and other forms of taxation. Imposition of any such taxes would reduce the cash available for distribution to you. Our partnership agreement provides that if a law is enacted or existing law is modified or interpreted in a manner that subjects us to entity-level taxation, the minimum quarterly distribution amount and the target distribution amounts may be adjusted to reflect the impact of that law on us.

The tax treatment of publicly traded partnerships or an investment in our common units could be subject to potential legislative, judicial or administrative changes and differing interpretations, possibly on a retroactive basis.

The present federal income tax treatment of publicly traded partnerships, including us, or an investment in our common units may be modified by administrative, legislative or judicial interpretation at any time. Recently, the Obama administration and members of the U.S. Congress have considered substantive changes to the existing federal income tax laws that affect certain publicly traded partnerships which, if enacted, may or may not be applied retroactively. Although we are unable to predict whether any of these changes or any other proposals will ultimately be enacted, any such changes could negatively impact the value of an investment in our common units.

Your share of our income will be taxable to you for U.S. federal income tax purposes even if you do not receive any cash distributions from us.

Because you will be treated as a partner to whom we will allocate taxable income, which could be different in amount than the cash we distribute, your allocable share of our taxable income will be taxable to you, which may require the payment of federal income taxes and, in some cases, state and local income taxes on your share of our taxable income even if you receive no cash distributions from us. You may not receive cash distributions from us equal to your share of our taxable income or even equal to the actual tax liability that results from that income.

 

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If the IRS contests the federal income tax positions we take, the market for our common units may be adversely impacted and the cost of any IRS contest will reduce our cash available for distribution to our unitholders.

We have not requested a ruling from the IRS with respect to our treatment as a partnership for federal income tax purposes or any other matter affecting us. The IRS may adopt positions that differ from the conclusions of our counsel expressed in this prospectus or from the positions we take, and the IRS’s positions may ultimately be sustained. It may be necessary to resort to administrative or court proceedings to sustain some or all of our counsel’s conclusions or the positions we take and such positions may not ultimately be sustained. A court may not agree with some or all of our counsel’s conclusions or the positions we take. Any contest with the IRS, and the outcome of any IRS contest, may have a materially adverse impact on the market for our common units and the price at which they trade. In addition, the costs of any contest with the IRS will be borne indirectly by our unitholders and our general partner because the costs will reduce our cash available for distribution.

Tax gain or loss on the disposition of your common units could be more or less than expected.

If you sell your common units, you will recognize a gain or loss for federal income tax purposes equal to the difference between the amount realized and your tax basis in those common units. Because distributions in excess of your allocable share of our net taxable income decrease your tax basis in your common units, the amount, if any, of such prior excess distributions with respect to the common units you sell will, in effect, become taxable income to you if you sell such common units at a price greater than your tax basis in those common units, even if the price you receive is less than your original cost. Furthermore, a substantial portion of the amount realized on any sale of your common units, whether or not representing gain, may be taxed as ordinary income due to potential recapture items, including depreciation recapture. In addition, because the amount you realize will include your share of our nonrecourse liabilities, if you sell your common units, you may incur a tax liability in excess of the amount of cash you receive from the sale. Please read “Material Federal Income Tax Consequences—Disposition of Common Units—Recognition of Gain or Loss” beginning on page 188 for a further discussion of the foregoing.

Tax-exempt entities and non-U.S. persons face unique tax issues from owning our common units that may result in adverse tax consequences to them.

Investment in common units by tax-exempt entities, such as employee benefit plans and individual retirement accounts (known as IRAs), and non-U.S. persons raises issues unique to them. For example, virtually all of our income allocated to organizations that are exempt from federal income tax, including IRAs and other retirement plans, will be unrelated business taxable income and will be taxable to them. Distributions to non-U.S. persons will be reduced by withholding taxes at the highest applicable effective tax rate, and non-U.S. persons will be required to file U.S. federal income tax returns and pay tax on their share of our taxable income. If you are a tax-exempt entity or a non-U.S. person, you should consult a tax advisor before investing in our common units.

We will treat each purchaser of common units as having the same tax benefits without regard to the actual common units purchased. The IRS may challenge this treatment, which could adversely affect the value of the common units.

Because we cannot match transferors and transferees of common units and because of other reasons, we will adopt depreciation and amortization positions that may not conform to all aspects of existing Treasury Regulations. A successful IRS challenge to those positions could adversely affect the amount of tax benefits available to you. Our counsel is unable to opine as to the validity of such filing positions. It also could affect the timing of these tax benefits or the amount of gain from your sale of common units and could have a negative impact on the value of our common units or result in audit adjustments to your tax returns. Please read “Material Federal Income Tax Consequences—Tax Consequences of Unit Ownership—Section 754 Election” beginning on page 185 for a further discussion of the effect of the depreciation and amortization positions we will adopt.

 

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We prorate our items of income, gain, loss and deduction for U.S. federal income tax purposes between transferors and transferees of our units each month based upon the ownership of our units on the first day of each month, instead of on the basis of the date a particular unit is transferred. The IRS may challenge this treatment, which could change the allocation of items of income, gain, loss and deduction among our unitholders.

We will prorate our items of income, gain, loss and deduction for U.S. federal income tax purposes between transferors and transferees of our units each month based upon the ownership of our units on the first day of each month, instead of on the basis of the date a particular unit is transferred. The use of this proration method may not be permitted under existing Treasury Regulations. If the IRS were to challenge this method or new Treasury regulations were to be issued, we could be required to change the allocation of items of income, gain, loss and deduction among our unitholders. Andrews Kurth LLP has not rendered an opinion with respect to whether our monthly convention for allocating taxable income and losses is permitted by existing Treasury Regulations. Please read “Material Federal Income Tax Consequences—Disposition of Common Units—Allocations Between Transferors and Transferees” on page 189.

A unitholder whose common units are loaned to a “short seller” to cover a short sale of common units may be considered as having disposed of those common units. If so, he would no longer be treated for federal income tax purposes as a partner with respect to those common units during the period of the loan and may recognize gain or loss from the disposition.

Because a unitholder whose common units are loaned to a “short seller” to cover a short sale of common units may be considered as having disposed of the loaned common units, he may no longer be treated for federal income tax purposes as a partner with respect to those common units during the period of the loan to the short seller and the unitholder may recognize gain or loss from such disposition. Moreover, during the period of the loan to the short seller, any of our income, gain, loss or deduction with respect to those common units may not be reportable by the unitholder and any cash distributions received by the unitholder as to those common units could be fully taxable as ordinary income. Our counsel has not rendered an opinion regarding the treatment of a unitholder whose common units are loaned to a short seller to cover a short sale of common units. As a result, unitholders desiring to assure their status as partners and avoid the risk of gain recognition from a loan to a short seller are urged to consult a tax advisor to discuss whether it is advisable to modify any applicable brokerage account agreements to prohibit their brokers from loaning their common units.

We will adopt certain valuation methodologies and monthly conventions for U.S. federal income tax purposes that may result in a shift of income, gain, loss and deduction between our general partner and our unitholders. The IRS may challenge this treatment, which could adversely affect the value of the common units.

When we issue additional units or engage in certain other transactions, we will determine the fair market value of our assets and allocate any unrealized gain or loss attributable to our assets to the capital accounts of our unitholders and our general partner. Our methodology may be viewed as understating the value of our assets. In that case, there may be a shift of income, gain, loss and deduction between certain unitholders and our general partner, which may be unfavorable to such unitholders. Moreover, under our valuation methods, subsequent purchasers of common units may have a greater portion of their Internal Revenue Code Section 743(b) adjustment allocated to our tangible assets and a lesser portion allocated to our intangible assets. The IRS may challenge our valuation methods, our allocation of the Section 743(b) adjustment attributable to our tangible and intangible assets, and our allocations of taxable income, gain, loss and deduction between our general partner and certain of our unitholders.

A successful IRS challenge to these methods or allocations could adversely affect the amount of taxable income or loss allocated to our unitholders. It also could affect the amount of taxable gain from our unitholders’ sale of common units and could have a negative impact on the value of the common units or result in audit adjustments to our unitholders’ tax returns without the benefit of additional deductions.

 

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The sale or exchange of 50% or more of our capital and profits interests during any twelve-month period will result in the termination of our partnership for federal income tax purposes.

We will be considered to have technically terminated our partnership for federal income tax purposes if there is a sale or exchange of 50% or more of the total interests in our capital and profits within a twelve-month period. For purposes of determining whether the 50% threshold has been met, multiple sales of the same interest will be counted only once. Our technical termination would, among other things, result in the closing of our taxable year for all unitholders, which would result in us filing two tax returns (and our unitholders could receive two Schedules K-1 if special relief from the IRS was not available) for one fiscal year and could result in a deferral of depreciation deductions allowable in computing our taxable income. In the case of a unitholder reporting on a taxable year other than a fiscal year ending December 31, the closing of our taxable year may also result in more than twelve months of our taxable income or loss being includable in his taxable income for the year of termination. Our termination currently would not affect our classification as a partnership for federal income tax purposes, but instead we would be treated as a new partnership for tax purposes. If treated as a new partnership, we must make new tax elections and could be subject to penalties if we are unable to determine that a termination occurred. Please read “Material Federal Income Tax Consequences—Disposition of Common Units—Constructive Termination” beginning on page 189 for a discussion of the consequences of our termination for federal income tax purposes.

As a result of investing in our common units, you may become subject to state and local taxes and return filing requirements in jurisdictions where we operate or own or acquire properties.

In addition to federal income taxes, our unitholders will likely be subject to other taxes, including state and local taxes, unincorporated business taxes and estate, inheritance or intangible taxes that are imposed by the various jurisdictions in which we conduct business or own property now or in the future, even if they do not live in any of those jurisdictions. Our unitholders will likely be required to file state and local income tax returns and pay state and local income taxes in some or all of these various jurisdictions. Further, our unitholders may be subject to penalties for failure to comply with those requirements. We will initially own property or conduct business in a number of states, most of which currently impose a personal income tax on individuals. Most of these states also impose an income tax on corporations and other entities. As we make acquisitions or expand our business, we may own property or conduct business in additional states that impose a personal income tax. It is your responsibility to file all U.S. federal, state and local tax returns. Our counsel has not rendered an opinion on the state or local tax consequences of an investment in our common units.

Compliance with and changes in tax laws could adversely affect our performance.

We are subject to extensive tax laws and regulations, including federal, state and foreign income taxes and transactional taxes such as excise, sales/use, payroll, franchise and ad valorem taxes. New tax laws and regulations and changes in existing tax laws and regulations are continuously being enacted that could result in increased tax expenditures in the future. Many of these tax liabilities are subject to audits by the respective taxing authority. These audits may result in additional taxes as well as interest and penalties.

 

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USE OF PROCEEDS

We expect to receive net proceeds of approximately $127.3 million from the issuance and sale of the common units offered by this prospectus, based upon the mid-point of the price range set forth on the cover page of this prospectus and after deducting underwriting discounts and commissions, structuring fees and offering expenses. We intend to use the net proceeds from this offering to make a cash distribution to SemGroup.

The table below sets forth our anticipated use of the expected net proceeds of this offering, after deducting underwriting discounts and commissions, structuring fees and offering expenses:

 

     Amount of
Proceeds
(in millions)
     Percentage of
Net Proceeds

Distribution to SemGroup

   $ 127.3       100%

The cash distribution to SemGroup made with the net proceeds of this offering will be made in consideration of its contribution to us of all of the partnership interests in SemCrude, L.P., which owns all of our initial assets, and to reimburse SemGroup for certain capital expenditures incurred with respect to those assets.

If and to the extent the underwriters exercise their option to purchase additional common units, the number of common units purchased by the underwriters pursuant to such exercise will be issued to the public. If the underwriters exercise their option to purchase additional common units in full, the additional net proceeds will be approximately $19.5 million. The net proceeds from any exercise of such option will be used to make an additional cash distribution to SemGroup in consideration of its contribution to us of all of the limited and general partner interests in SemCrude, L.P. at closing and to reimburse SemGroup for certain capital expenditures incurred with respect to our assets. If the underwriters do not exercise their option to purchase additional common units in full, we will issue the common units not purchased to SemGroup upon the expiration of the option (1,050,000 common units if the option is not exercised at all) in consideration of its contribution to us of all of the limited and general partner interests in SemCrude, L.P. at closing. We will not receive any additional consideration from SemGroup in connection with such issuance. The exercise of the underwriters’ option will not affect the total number of common units outstanding or the amount of cash needed to pay the minimum quarterly distribution on all units.

An increase or decrease in the initial public offering price of $1.00 per common unit would cause the net proceeds from the offering, after deducting underwriting discounts and commissions and structuring fees, to increase or decrease by approximately $6.5 million, and we will adjust the amount of the cash distribution to SemGroup accordingly.

SemGroup has informed us that all of the net proceeds distributed to it will be used to repay, on a pro rata basis, a portion of the aggregate $181 million of indebtedness outstanding under its term loan A and term loan B. The interest rates in effect at September 30, 2011 on the term loan A and the term loan B were 3.74% and 5.75%, respectively. Term loan A matures on June 20, 2016, and term loan B matures on June 20, 2018. SemGroup entered into the term loans in June 2011 and used the proceeds from the term loans, together with proceeds from a new revolving credit facility, to retire its previous revolving credit facility and term loan.

Affiliates of certain of the underwriters are lenders under SemGroup’s term loan A and will, in that respect, receive a portion of the net proceeds of this offering. Please read “Underwriting” beginning on page 197.

 

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CAPITALIZATION

The following table shows:

 

   

the historical cash and cash equivalents and capitalization of our predecessor as of September 30, 2011; and

 

   

our pro forma cash and cash equivalents and capitalization as of September 30, 2011, after giving effect to the pro forma adjustments described in our unaudited pro forma combined financial statements, including:

 

   

the transactions described in “Summary—Formation Transactions and Partnership Structure”; and

 

   

our receipt of net proceeds of $127.3 million from the issuance and sale of 7,000,000 common units to the public at an assumed initial offering price of $20.00 (based upon the mid-point of the price range set forth on the cover page of this prospectus) and the use of such proceeds as described in “Use of Proceeds.”

We derived this table from, and it should be read in conjunction with and is qualified in its entirety by reference to, the unaudited historical and unaudited pro forma combined financial statements and the accompanying notes included elsewhere in this prospectus. You should also read this table in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

     As of September 30, 2011  
     Historical      Pro Forma  
     (in thousands)  

Cash and cash equivalents

   $       $   
  

 

 

    

 

 

 

Long-term debt

   $       $ 1,800   

Owners’ equity:

     

SemGroup Corporation (net parent equity)

     283,719           

Limited partners:

     

Common unitholders—public

             127,300   

Common unitholder—SemGroup

             21,263   

Subordinated unitholder—SemGroup

             128,366   

General partner

             5,652   
  

 

 

    

 

 

 

Total owners’ equity

     283,719         282,581   
  

 

 

    

 

 

 

Total capitalization

   $ 283,719       $ 284,381   
  

 

 

    

 

 

 

 

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DILUTION

Dilution is the amount by which the offering price paid by the purchasers of common units sold in this offering will exceed the pro forma net tangible book value per unit after the offering. On a pro forma basis as of September 30, 2011, after giving effect to the offering of common units and the application of the related net proceeds, and assuming the underwriters’ option to purchase additional common units is not exercised, our net tangible book value would have been $282.6 million, or $16.50 per unit. Purchasers of common units in this offering will experience substantial and immediate dilution in net tangible book value per common unit for financial accounting purposes, as illustrated in the following table:

 

Initial public offering price per common unit

     $ 20.00   

Net tangible book value per unit before the offering(1)

   $ 27.92     

Decrease in net tangible book value per unit attributable to purchasers in the offering

     (11.42  
  

 

 

   

Less: Pro forma net tangible book value per unit after the offering(2)

       16.50   
    

 

 

 

Immediate dilution in tangible net book value per common unit to purchasers in the offering(3)(4)

     $ 3.50   
    

 

 

 

 

(1) Determined by dividing the number of units (1,389,709 common units, 8,389,709 subordinated units and 342,437 general partner units) to be issued to our general partner and its affiliates for the contribution of assets and liabilities to us into the net tangible book value of the contributed assets and liabilities.
(2) Determined by dividing the total number of units to be outstanding after the offering (8,389,709 common units, 8,389,709 subordinated units and 342,437 general partner units) into our pro forma net tangible book value.
(3) If the initial public offering price were to increase or decrease by $1.00 per common unit, then dilution in net tangible book value per common unit would equal $4.50 and $2.50, respectively.
(4) Because the total number of units outstanding following the consummation of this offering will not be impacted by any exercise of the underwriters’ option to purchase additional common units and any net proceeds from such exercise will not be retained by us, there will be no change to the dilution in net tangible book value per common unit to purchasers in the offering due to any such exercise of the underwriters’ option to purchase additional common units.

The following table sets forth the number of units that we will issue and the total consideration contributed to us by our general partner and its affiliates and by the purchasers of common units in this offering upon the closing of the transactions contemplated by this prospectus:

 

     Units Acquired     Total Consideration  
     Number      Percent     Amount
(in thousands)
     Percent  

General partner and affiliates(1)(2)(3)

     10,121,855         59.1   $ 155,281         55.0

Purchasers in the offering

     7,000,000         40.9     127,300         45.0
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

     17,121,855         100.0   $ 282,581        100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

 

(1) The units acquired by our general partner and its affiliates consist of 1,389,709 common units, 8,389,709 subordinated units and 342,437 general partner units.
(2) The assets contributed by our general partner and its affiliates were recorded at historical cost in accordance with GAAP. Book value of the consideration provided by our general partner and its affiliates, as of September 30, 2011, after giving effect to the application of the net proceeds of the offering, would have equaled $155.3 million, reduced by the distributions made to our general partner and its affiliates in connection with this offering of $127.3 million.
(3) Assumes the underwriters’ option to purchase additional common units is not exercised.

 

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OUR CASH DISTRIBUTION POLICY AND RESTRICTIONS ON DISTRIBUTIONS

You should read the following discussion of our cash distribution policy in conjunction with the factors and assumptions upon which our cash distribution policy is based, which are included under the heading “—Assumptions and Considerations” beginning on page 62. In addition, please read “Forward-Looking Statements” on page 206 and “Risk Factors” beginning on page 21 for information regarding statements that do not relate strictly to historical or current facts and certain risks inherent in our business. For additional information regarding our historical and pro forma operating results, you should refer to our historical and pro forma combined financial statements and related notes included elsewhere in this prospectus.

General

Rationale for Our Cash Distribution Policy

Our partnership agreement requires us to distribute all of our available cash quarterly. Our cash distribution policy reflects our belief that our unitholders will be better served if we distribute rather than retain our available cash. Generally, our available cash is the sum of our (i) cash on hand at the end of a quarter after the payment of our expenses and the establishment of cash reserves and (ii) cash on hand resulting from working capital borrowings made after the end of the quarter. Because we are not subject to an entity-level federal income tax, we expect to have more cash to distribute to our unitholders than would be the case if we were subject to federal income tax.

Limitations on Cash Distributions and Our Ability to Change Our Cash Distribution Policy

There is no guarantee that our unitholders will receive quarterly distributions from us. We do not have a legal obligation to pay the minimum quarterly distribution or any other distribution except as provided in our partnership agreement. Our cash distribution policy may be changed at any time and is subject to certain restrictions, including the following:

 

   

Our cash distribution policy will be subject to a condition under our new revolving credit facility that we may not make a cash distribution if an event of default then exists or would result therefrom. If we were to be unable to satisfy this condition, we would be prohibited from making cash distributions notwithstanding our cash distribution policy. Please read “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Revolving Credit Facility” on page 103.

 

   

Our general partner will have the authority to establish reserves for the proper conduct of our business and for future cash distributions to our unitholders, and the establishment or increase of those reserves could result in a reduction in cash distributions to our unitholders from the levels we currently anticipate pursuant to our stated cash distribution policy. Any determination to establish cash reserves made by our general partner in good faith will be binding on our unitholders. Our partnership agreement provides that in order for a determination by our general partner to be considered to have been made in good faith, our general partner must believe that the determination is in, or not opposed to, our interests.

 

   

While our partnership agreement requires us to distribute all of our available cash, our partnership agreement, including the provisions requiring us to make cash distributions contained therein, may be amended. Our partnership agreement generally may not be amended during the subordination period without the approval of our public common unitholders other than in certain limited circumstances where no unitholder approval is required. However, our partnership agreement can be amended with the consent of our general partner and the approval of a majority of the outstanding common units (including common units held by SemGroup) after the subordination period has ended. At the closing of this offering, assuming no exercise of the underwriters’ option to purchase additional common units, SemGroup will own our general partner and approximately 16.6% of our outstanding common units and all of our outstanding subordinated units, or 58.3% of our limited partner interests.

 

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Even if our cash distribution policy is not modified or revoked, the amount of cash that we distribute and the decision to make any distribution is determined by our general partner, taking into consideration the terms of our partnership agreement.

 

   

Under Section 17-607 of the Delaware Revised Uniform Limited Partnership Act, we may not make a distribution if the distribution would cause our liabilities to exceed the fair value of our assets.

 

   

We may lack sufficient cash to pay distributions to our unitholders for a number of reasons, including as a result of increases in our operating or general and administrative expenses, principal and interest payments on our debt, tax expenses, working capital requirements and anticipated cash needs.

 

   

If and to the extent our distributable cash flow materially declines, we may elect to reduce our quarterly cash distributions in order to service or repay our debt or fund expansion capital expenditures.

Our Ability to Grow is Dependent on Our Ability to Access External Expansion Capital

Because we will distribute all of our available cash to our unitholders, we expect that we will rely primarily upon external financing sources, including borrowings under our new revolving credit facility and the issuance of debt and equity securities, to fund our acquisitions and expansion capital expenditures. As a result, to the extent we are unable to finance growth externally, our cash distribution policy will significantly impair our ability to grow. In addition, because we intend to distribute all of our available cash, our growth may not be as fast as that of businesses which reinvest their available cash to expand ongoing operations. To the extent we issue additional units in connection with any acquisitions or expansion capital expenditures, the payment of distributions on those additional units may increase the risk that we will be unable to maintain or increase our per unit distribution level. There are no limitations in our partnership agreement or in the new revolving credit facility on our ability to issue additional units, including units ranking senior to the common units. The incurrence of additional bank borrowings (under our revolving credit facility or otherwise) or other debt to finance our growth strategy will increase our interest expense, which in turn may impact the available cash that we have to distribute to our unitholders.

Our Minimum Quarterly Distribution

Upon completion of this offering, our partnership agreement will provide for a minimum quarterly distribution of $0.3625 per unit per quarter, or $1.45 per unit on an annualized basis, to be paid no later than 45 days after the end of each fiscal quarter beginning with the quarter ending December 31, 2011. This equates to an aggregate cash distribution of approximately $6.2 million per quarter, or approximately $24.8 million on an annualized basis, based on the number of common, subordinated and general partner units expected to be outstanding immediately after the closing of this offering. We will adjust our first distribution for the period from the closing of this offering through December 31, 2011 based on the length of that period.

To the extent the underwriters exercise their option to purchase additional common units in connection with this offering, the number of common units purchased by the underwriters pursuant to such exercise will be sold to the public, and the remaining common units subject to the option, if any, will be issued to SemGroup at the expiration of the option period. Accordingly, the exercise of the underwriters’ option will not affect the total number of common units or subordinated units outstanding or the amount of cash needed to pay the minimum quarterly distribution on all units. Please read “Use of Proceeds” beginning on page 51.

Initially, our general partner will be entitled to 2.0% of all distributions that we make prior to our liquidation. In the future, our general partner’s initial 2.0% interest in these distributions may be reduced if we issue additional units and our general partner does not contribute a proportionate amount of capital to us to maintain its initial 2.0% general partner interest (other than the issuance of common units upon exercise by the underwriters of their option to purchase additional common units, the issuance of common units to SemGroup upon expiration of the underwriters’ option to purchase additional common units or the issuance of common units in connection with a reset of the incentive distribution target levels).

 

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The table below sets forth the number of common, subordinated and general partner units expected to be outstanding immediately following the closing of this offering, assuming that the underwriters do not exercise their option to purchase additional common units, and the aggregate distribution amounts payable on those units during the year following the closing of this offering at our minimum quarterly distribution rate of $0.3625 per unit per quarter ($1.45 per unit on an annualized basis).

 

     Number of
Units
     Minimum Quarterly
Distributions
 
      One Quarter      Annualized  

Publicly held common units (1)

     7,000,000       $ 2,537,500       $ 10,150,000   

Common units held by SemGroup (1)

     1,389,709         503,770         2,015,079   

Subordinated units held by SemGroup

     8,389,709         3,041,270         12,165,079   

2.0% general partner interest held by SemGroup

     342,437         124,133         496,534   
  

 

 

    

 

 

    

 

 

 

Total

     17,121,855       $ 6,206,673      $ 24,826,692   
  

 

 

    

 

 

    

 

 

 

 

(1) Assumes the underwriters do not exercise their option to purchase additional common units. If the underwriters do not exercise their option to purchase additional common units in full, we will issue the common units not purchased to SemGroup upon the expiration of the option period. To the extent the underwriters exercise their option to purchase additional common units, the number of common units purchased by the underwriters pursuant to such exercise will be sold to the public, and the remainder, if any, will be issued to SemGroup. Accordingly, the exercise of the underwriters’ option will not affect the total number of units outstanding or the amount of cash needed to pay the minimum quarterly distribution on all units.

During the subordination period, before we make any quarterly distributions to the holders of our subordinated units, our common unitholders will be entitled to receive the full minimum quarterly distribution plus any arrearages in the payment of the minimum quarterly distribution from prior quarters. The subordination period generally will end, and all of the subordinated units will convert into an equal number of common units, once we have earned and paid at least (i) $1.45 on each outstanding common and subordinated unit and the corresponding distributions on our general partner’s 2.0% interest for each of three consecutive, non-overlapping four-quarter periods ending on or after December 31, 2014, or (ii) $2.175 (150% of the annualized minimum quarterly distribution) on each outstanding common and subordinated unit and the corresponding distributions on our general partner’s 2.0% interest and the incentive distribution rights for any four-quarter period ending on or after December 31, 2012. Please read “Provisions of Our Partnership Agreement Relating to Cash Distributions—Subordination Period” beginning on page 70.

If we do not pay the minimum quarterly distribution on our common units, our common unitholders will not be entitled to receive such payments in the future except during the subordination period. To the extent we have available cash in any future quarter during the subordination period in excess of the amount necessary to pay the minimum quarterly distribution to holders of our common units and the corresponding distributions on our general partner’s 2.0% interest, we will use this excess available cash to pay any distribution arrearages on the common units related to prior quarters before any cash distribution is made to holders of the subordinated units. Please read “Provisions of Our Partnership Agreement Relating to Cash Distributions—Subordination Period” beginning on page 70.

Our cash distribution policy, as expressed in our partnership agreement, may not be modified or repealed without amending our partnership agreement. The actual amount of our cash distributions for any quarter is subject to fluctuations based on the amount of cash we generate from our business and the amount of reserves our general partner establishes in accordance with our partnership agreement as described above. We will pay our distributions on or about the 15th of each of February, May, August and November to holders of record on or about the 1st of each such month. If the distribution date does not fall on a business day, we will make the distribution on the business day immediately preceding the indicated distribution date.

 

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In the sections that follow, we present in detail the basis for our belief that we will be able to fully fund our annualized minimum quarterly distribution of $1.45 per unit for the year ending December 31, 2012. In those sections, we present two tables, consisting of:

 

   

“Partnership Unaudited Pro Forma Available Cash,” in which we present the amount of cash we would have had available for distribution on a pro forma basis for the year ended December 31, 2010 and the twelve months ended September 30, 2011; and

 

   

“Partnership Statement of Estimated Adjusted EBITDA,” which supports our belief that we will be able to generate sufficient estimated adjusted EBITDA to pay the minimum quarterly distribution on all units for the year ending December  31, 2012.

Unaudited Pro Forma Available Cash for the Year Ended December 31, 2010 and the Twelve Months Ended September 30, 2011

If we had completed the transactions contemplated in this prospectus on January 1, 2010, our pro forma available cash generated for the year ended December 31, 2010 would have been approximately $32.3 million. If we had completed the transactions contemplated in this prospectus on October 1, 2010, our pro forma available cash generated for the twelve months ended September 30, 2011 would have been approximately $30.1 million. These amounts would have been sufficient to pay the full minimum quarterly distribution of $0.3625 per unit per quarter ($1.45 per unit on an annualized basis) on all of our common units and subordinated units for such periods.

We estimate that we will incur $1.5 million of incremental general and administrative expenses resulting from SemGroup’s allocation of additional overhead to us upon completion of this offering, primarily relating to financial reporting and legal expenses and corporate services. These incremental general and administrative expenses are reflected in our unaudited pro forma financial statements. Additional incremental general and administrative expenses consist of approximately $1.9 million of expenses that we expect to incur as a result of operating as a publicly traded partnership that are not reflected in our unaudited pro forma financial statements, such as expenses associated with annual and quarterly reporting; tax return and Schedule K-1 preparation and distribution expenses; Sarbanes-Oxley compliance expenses; expenses associated with listing on the NYSE; independent auditor fees; legal fees; investor relations expenses; registrar and transfer agent fees; and director and officer insurance expenses.

We based the adjustments made to our historical financial results upon currently available information and specific estimates and assumptions. The pro forma amounts below do not purport to present our results of operations had the transactions contemplated in this prospectus actually been completed as of the date indicated. In addition, cash available to pay distributions is primarily a cash accounting concept, while our historical combined financial statements were prepared on an accrual basis. As a result, you should view the amount of pro forma available cash only as a general indication of the amount of cash available to pay distributions that we might have generated had we completed the transactions contemplated in this prospectus at the beginning of the periods presented. The pro forma amounts below are presented on a twelve-month basis, and there is no guarantee that we would have had available cash sufficient to pay the full minimum quarterly distribution on all of our outstanding common units and subordinated units for each quarter within the twelve-month periods presented.

 

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The following table illustrates, on a pro forma basis for the year ended December 31, 2010 and the twelve months ended September 30, 2011, the amount of cash that would have been available for distribution to our unitholders, assuming that the transactions contemplated in this prospectus had been consummated at the beginning of such periods. Each of the adjustments reflected or presented below is explained in the footnotes to such adjustments.

Partnership Unaudited Pro Forma Available Cash

 

     Year Ended
December 31, 2010
    Twelve Months
Ended September 30, 2011
 
     (In thousands, except per unit data)  

Pro forma net income

   $ 21,422      $ 24,651   

Add:

    

Depreciation expense

     10,435        11,155   

Unrealized (gain) loss related to derivatives

     763        924   

Provision for uncollectable accounts receivable, net of recoveries(1)

     3,340        (1,200

Loss (gain) on disposal of long-lived assets, net

     67        33   

Interest expense (income), net

     1,003        2,182   

Income tax expense (income), net

              
  

 

 

   

 

 

 

Adjusted EBITDA(2)

   $ 37,030      $ 37,745   

Less:

    

Incremental general and administrative expense of being a publicly traded partnership(3)

     1,900        1,900   

Cash interest expense

     1,003        2,182   

Maintenance capital expenditures(4)

     1,820        3,517   

Expansion capital expenditures(4)

     14,912        29,172   

Add:

    

Capital contribution to fund expansion capital expenditures(5)

     14,912        29,172   
  

 

 

   

 

 

 

Pro forma available cash

   $ 32,307      $ 30,146   
  

 

 

   

 

 

 

Pro forma cash distributions:

    

Distributions per unit

   $ 1.45      $ 1.45   
  

 

 

   

 

 

 

Distributions to public common unitholders(6)

   $ 10,150      $ 10,150   

Distributions to SemGroup—common units(6)

     2,015        2,015   

Distributions to SemGroup—subordinated units(6)

     12,165        12,165   

Distributions to our general partner(6)

     497        497   
  

 

 

   

 

 

 

Total cash distributions

     24,827        24,827   
  

 

 

   

 

 

 

Excess (shortfall)

   $ 7,480      $ 5,319   
  

 

 

   

 

 

 

Percent of minimum quarterly distributions payable to common unitholders

     100     100

Percent of minimum quarterly distributions payable to subordinated unitholders

     100     100

 

(1) Provision for uncollectable accounts receivable for the year ended December 31, 2010 of $3.3 million reflects a charge taken due to the bankruptcy of a customer, net of $0.3 million of recoveries in the last three months of 2010. An additional $0.9 million of recoveries were received in the first nine months of 2011.
(2) For a definition of adjusted EBITDA, please read “Selected Historical Financial and Operating Data—Non-GAAP Financial Measures” beginning on page 85.

 

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(3) Reflects an adjustment to our pro forma adjusted EBITDA for estimated cash expenses associated with being a publicly traded partnership, such as expenses associated with annual and quarterly reporting; tax return and Schedule K-1 preparation and distribution expenses; Sarbanes-Oxley compliance expenses; expenses associated with listing on the NYSE; independent auditor fees; legal fees; investor relations expenses; registrar and transfer agent fees; and director and officer insurance expenses.
(4) Historically, we have not made a distinction between maintenance capital expenditures and expansion capital expenditures. Under our partnership agreement, maintenance capital expenditures are capital expenditures made to maintain our long-term operating income or operating capacity, while expansion capital expenditures are capital expenditures that we expect will increase our operating income or operating capacity over the long term. Examples of maintenance capital expenditures are those made to replace partially or fully depreciated assets, to maintain the existing operating capacity of our assets and to extend their useful lives, or other capital expenditures that are incurred in maintaining existing system volumes and related cash flows. In contrast, expansion capital expenditures are those made to acquire additional assets to grow our business, to expand and upgrade our systems and facilities and to construct or acquire similar systems or facilities.

 

     For the year ended December 31, 2010, our capital expenditures totaled $17 million. We estimate that 11% of our capital expenditures, or $2 million, were maintenance capital expenditures and that 89% of our capital expenditures, or $15 million, were expansion capital expenditures. Expansion capital expenditures for the year ended December 31, 2010 primarily consisted of expenses associated with the construction of 850,000 barrels of additional crude oil storage capacity in Cushing.

 

     For the twelve months ended September 30, 2011, our capital expenditures totaled $32.7 million. We estimate that 11% of our capital expenditures, or $3.5 million, were maintenance capital expenditures and that 89% of our capital expenditures, or $29.2 million, were expansion capital expenditures. Expansion capital expenditures for the twelve months ended September 30, 2011 primarily consisted of expenses associated with the construction of 850,000 barrels of additional crude oil storage capacity in Cushing.
(5) We funded our expansion capital expenditures during the year ended December 31, 2010 and the twelve months ended September 30, 2011 through capital contributions made to us by SemGroup. We expect that in the future, our expansion capital expenditures will primarily be funded through borrowings or the sale of debt or equity securities.
(6) Based on the number of common units, subordinated units and general partner units expected to be outstanding upon the completion of this offering, assuming that the underwriters’ option to purchase additional common units is not exercised.

Estimated Adjusted EBITDA for the Year Ending December 31, 2012

Set forth below is a Partnership Statement of Estimated Adjusted EBITDA that supports our belief that we will be able to generate sufficient cash available for distribution to pay the aggregate annualized minimum quarterly distribution on all of our outstanding units for the year ending December 31, 2012. The financial forecast presents, to the best of our knowledge and belief, our expected results of operations, adjusted EBITDA and cash available for distribution for the forecast period. We define adjusted EBITDA as net income (loss) before interest expense, income tax expense (benefit), depreciation and amortization and any non-cash adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities.

For a reconciliation of adjusted EBITDA to its most directly comparable financial measures calculated and presented in accordance with GAAP, please read “Selected Historical Financial and Operating Data—Non-GAAP Financial Measures” beginning on page 85.

Our Partnership Statement of Estimated Adjusted EBITDA reflects our judgment, as of the date of this prospectus, of conditions we expect to exist and the course of action we expect to take in order to be able to pay the annualized minimum quarterly distribution on all of our outstanding common, subordinated and general partner units for the year ending December 31, 2012. The assumptions discussed below under “—Assumptions and Considerations” beginning on page 62 are those that we believe are significant to our ability to generate our

 

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estimated adjusted EBITDA. We believe our actual results of operations and cash flows will be sufficient to generate the minimum estimated adjusted EBITDA necessary to pay the aggregate annualized minimum quarterly distribution to all our unitholders for the year ending December 31, 2012. We can, however, give you no assurance that we will generate this amount. There will likely be differences between our estimated adjusted EBITDA and our actual results, and those differences could be material. If we fail to generate the minimum estimated adjusted EBITDA set forth below, we may not be able to pay the aggregate annualized minimum quarterly distribution to all of our unitholders. In order to fund distributions on all of our outstanding common, subordinated and general partner units at our initial rate of $1.45 per unit on an annualized basis for the year ending December 31, 2012, our adjusted EBITDA for the year ending December 31, 2012 must be at least $30.9 million.

We do not, as a matter of course, make public projections as to future operations, earnings or other results. However, management has prepared the Partnership Statement of Estimated Adjusted EBITDA and related assumptions and considerations set forth below to substantiate our belief that we will have sufficient available cash to pay the aggregate annualized minimum quarterly distribution to all our unitholders for the year ending December 31, 2012. This forecast is a forward-looking statement and should be read together with our historical combined financial statements and the accompanying notes included elsewhere in this prospectus, as well as “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The accompanying prospective financial information was not prepared with a view toward complying with the guidelines established by the American Institute of Certified Public Accountants with respect to prospective financial information, but, in the view of our management, is substantially consistent with those guidelines and was prepared on a reasonable basis, reflects the best currently available estimates and judgments, and presents, to the best of management’s knowledge and belief, the assumptions on which we base our belief that we can generate the minimum adjusted EBITDA necessary for us to have sufficient cash available for distribution to pay the aggregate annualized minimum quarterly distribution on all of our outstanding common, subordinated and general partner units for the year ending December 31, 2012. However, this information is not fact and should not be relied upon as being necessarily indicative of future results, and readers of this prospectus are cautioned not to place undue reliance on the prospective financial information.

The prospective financial information included in this prospectus has been prepared by, and is the responsibility of, our management. BDO USA, LLP, our independent registered public accounting firm, has not examined, compiled or performed any procedures with respect to the accompanying prospective financial information and, accordingly, BDO USA, LLP does not express an opinion or any other form of assurance with respect thereto. The report of BDO USA, LLP included in this prospectus relates to our historical financial information. It does not extend to the prospective financial information and should not be read to do so.

When considering our financial forecast, you should keep in mind the risk factors and other cautionary statements under “Risk Factors.” Any of the risks discussed in this prospectus, to the extent they are realized, could cause our actual results of operations to vary significantly from those that would enable us to generate the minimum adjusted EBITDA necessary to pay the aggregate annualized minimum quarterly distribution on all of our outstanding common, subordinated and general partner units for the year ending December 31, 2012.

We are providing the Partnership Statement of Estimated Adjusted EBITDA to supplement our historical combined financial statements and in support of our belief that we will have sufficient available cash to pay the aggregate annualized minimum quarterly distribution on all of our outstanding common, subordinated and general partner units for the year ending December 31, 2012. Please read below under “—Assumptions and Considerations” beginning on page 62 for further information about the assumptions we have made for the financial forecast.

We do not undertake any obligation to release publicly the results of any future revisions we may make to the financial forecast or to update this financial forecast to reflect events or circumstances after the date of this prospectus. Therefore, you are cautioned not to place undue reliance on this information.

 

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Partnership Statement of Estimated Adjusted EBITDA

 

    Quarter Ending     Year Ending
December 31,
2012
 
    March 31,
2012
    June 30,
2012
    September 30,
2012
    December 31,
2012
   
    (In thousands, except per unit amounts)  

Revenues

  $ 104,477      $ 105,648      $ 108,314      $ 108,773      $ 427,212   

Cost of products sold, exclusive of depreciation

    89,518        89,786        91,048        91,470        361,822   

Unrealized gain (loss) on derivatives(1)

    —          —          —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted gross margin(2)

    14,959        15,862        17,266        17,303        65,390   

Operating expenses:

         

Operating

    5,382        5,382        5,382        5,383        21,529   

General and administrative(3)

    3,013        2,455        2,445        2,540        10,453   

Depreciation

    2,952        3,047        3,217        3,234        12,450   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

  $ 11,347      $ 10,884      $ 11,044      $ 11,157      $ 44,432   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

  $ 3,612      $ 4,978      $ 6,222      $ 6,146      $ 20,958   

Interest expense, net(4)

    567        653        763        835        2,818   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

  $ 3,045      $ 4,325      $ 5,459      $ 5,311      $ 18,140   

Add:

         

Depreciation and amortization

    2,952        3,047        3,217        3,234        12,450   

Interest expense, net

    567        653        763        835        2,818   

Income tax expense (benefit)(5)

    —          —          —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Estimated adjusted EBITDA(6)

  $ 6,564      $ 8,025      $ 9,439      $ 9,380      $ 33,408   

Less:

         

Cash interest expense

    460        544        651        723        2,378   

Maintenance capital expenditures

    866        1,405        1,169        280        3,720   

Expansion capital expenditures

    8,743        8,705        10,877        5,383        33,708   

Add:

         

Borrowings to fund expansion capital expenditures

    8,743        8,705        10,877        5,383        33,708   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Estimated distributable cash flow

  $ 5,238      $ 6,076      $ 7,619      $ 8,377      $ 27,310   

Less:

         

Cash reserves

    (969     (131     1,412        2,170        2,483   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Minimum estimated available cash from distributable cash flow

  $ 6,207      $ 6,207      $ 6,207      $ 6,207      $ 24,827   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Per unit minimum distribution

  $ 0.3625      $ 0.3625      $ 0.3625      $ 0.3625      $ 1.45   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash distributions:

         

Publicly held common units

  $ 2,538      $ 2,538      $ 2,538      $ 2,538      $ 10,150   

Common units held by SemGroup

    504        504        504        504        2,015   

Subordinated units held by SemGroup

    3,041        3,041        3,041        3,041        12,165   

2% general partner interest

    124        124        124        124        497   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total minimum cash distributions

  $ 6,207      $ 6,207      $ 6,207      $ 6,207      $ 24,827   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Because we believe it is not reasonably possible to forecast unrealized gains or losses on derivatives for future periods, we have assumed none for purposes of this forecast.
(2) For a definition of adjusted gross margin, please read “Selected Historical Financial and Operating Data—Non-GAAP Financial Measures” beginning on page 85.
(3) Includes incremental general and administrative expenses of $1.5 million resulting from SemGroup’s allocation of additional overhead expenses to us upon completion of this offering, which are reflected in our unaudited pro forma financial statements, and an estimated $1.9 million of incremental general and administrative expenses that we anticipate incurring as a result of becoming a publicly traded partnership, which are not reflected in our unaudited pro forma financial statements.
(4) Reflects (i) pro forma interest expense, at an assumed interest rate of 4.50%, on $20.8 million of average borrowings that we estimate will be outstanding during the forecast period under our new revolving credit facility to fund the $33.7 million of estimated expansion capital expenditures, $1.7 million in credit facility arrangement fees and a $0.1 million administrative agent fee, (ii) the pro forma amortization during the forecast period of the $1.7 million in credit facility arrangement fees, which will be amortized over a five-year period, and an annual $0.1 million administrative agent fee and (iii) letters of credit and commitment fees.
(5) As a limited partnership, we expect that we will pay no income tax during the forecast period.
(6) For a definition of adjusted EBITDA, please read “Selected Historical Financial and Operating Data—Non-GAAP Financial Measures” beginning on page 85.

 

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Assumptions and Considerations

We believe our minimum estimated available cash from distributable cash flow for the year ending December 31, 2012 will be not less than $24.8 million. Our estimates do not assume any incremental revenue, expenses or other costs associated with potential acquisitions. While the assumptions discussed below are not all-inclusive, the assumptions discussed below are those that we believe are significant to our forecasted results of operations, and any assumptions not discussed below were not deemed significant. We believe that the estimates, assumptions and considerations incorporated into our calculation of minimum estimated available cash from distributable cash flow are reasonable, and include the following:

 

    Pro Forma
Year  Ended
December 31,

2010
    Pro Forma
Twelve  Months
Ended

September 30,
2011
    Forecast for
Year Ending
December 31,
2012
 
    (in thousands)  

Gross product revenue

  $ 556,518      $ 915,935      $ 1,041,874   

Nonmonetary transaction adjustment (1)

    (397,447     (581,144     (656,392

Net unrealized gain (loss) on derivatives

    (763     (924     —     
 

 

 

   

 

 

   

 

 

 

Product revenue

    158,308        333,867        385,482   

Service revenue

    49,408        39,652        41,730   

Other

    365        237        —     
 

 

 

   

 

 

   

 

 

 

Total revenue

    208,081        373,756        427,212   
 

 

 

   

 

 

   

 

 

 

Costs of products sold, exclusive of depreciation

    146,614        309,060        361,822   

Operating expenses

    20,398        18,067        21,529   

General and administrative expenses

    9,160        9,759        10,453   

Depreciation

    10,435        11,155        12,450   
 

 

 

   

 

 

   

 

 

 

Operating income

  $ 21,474      $ 25,715      $ 20,958   
 

 

 

   

 

 

   

 

 

 

Calculation of adjusted gross margin:

     

Total revenue

  $ 208,081      $ 373,756      $ 427,212   

Less: Costs of products sold, exclusive of depreciation

    (146,614     (309,060     (361,822

Less: Unrealized (gain) loss on derivatives

    763        924          
 

 

 

   

 

 

   

 

 

 

Adjusted gross margin

  $ 62,230      $ 65,620      $ 65,390   
 

 

 

   

 

 

   

 

 

 

 

 

(1) Accounting Standards Codification (ASC) 845-10-15, “Nonmonetary Transactions,” requires transactions in which inventory is purchased from a customer and then resold to the same customer to be presented in the income statement on a net basis. This results in an equal reduction of product revenue and costs of products sold, but has no effect on operating income (loss). Based on our experience during the twelve months ended September 30, 2011, we estimate that our product revenue during the forecast period, after reduction pursuant to ASC 845-10-15, will be approximately 37% of our gross product revenue.

 

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The table below compares our forecasted contracted storage capacity and forecasted transportation, marketing and unloading volumes for the year ending December 31, 2012 to our historical contracted storage capacity and transportation, marketing and unloading volumes for the year ended December 31, 2010 and the twelve months ended September 30, 2011. The table below also compares our forecasted sales and purchase price per barrel of crude oil for the year ending December 31, 2012 to the historical prices for the year ended December 31, 2010 and the twelve months ended September 30, 2011:

 

     Year Ended
December  31,
2010
    Twelve Months Ended
September 30, 2011
    Forecast for
Year Ending
December 31,
2012
 

Cushing storage capacity (MMBbls as of period end)

     4.7        5.0        7.0   

Percent of Cushing capacity contracted (as of period end)

     95     95     96

Transportation volumes (Average Bpd)

     26,600        35,800        36,400   

Marketing volumes (Average Bpd)

     15,800        13,400        16,200   

Unloading/Platteville volumes (Average Bpd)

     25,800        30,600        36,000   

Average sales price per barrel

   $ 78.64      $ 90.06      $ 86.83   

Average purchase cost per barrel

   $ 76.48      $ 87.51      $ 84.86   

 

Revenues

Product Revenues. Our product revenues consist of revenues generated by the purchase and sale of crude oil pursuant to fixed-margin transactions or in our marketing business. We estimate that our product revenues for the year ending December 31, 2012 will be $385.5 million, as compared to $158.3 million and $333.9 million for the year ended December 31, 2010 and the twelve months ended September 30, 2011, respectively. We expect gross product revenues to increase primarily due to a shift in our Kansas and Oklahoma operations from fee-based transportation agreements, which are not included in gross product revenues, to fixed-margin transactions, which are included in gross product revenues. The ASC 845-10-15 adjustment will eliminate the cost component of these fixed-margin transactions, resulting in a net increase in product revenue equal to the realized margin on such transactions. The expected increase in product revenue over the year ended December 31, 2010 is also due to an assumed increase in the average sales price per barrel of crude oil sold during the forecast period to $86.83, based on NYMEX forward price data as of November 4, 2011, compared to an average sales price of $78.64 per barrel for crude oil sold during the year ended December 31, 2010. The expected increase in product revenue over the twelve months ended September 30, 2011 is also due to expected additional volumes attributable to our Bakken Shale operations, partially offset by a reduction in the average sales price per barrel from the $90.06 sales price realized during the twelve months ended September 30, 2011.

Service Revenues. Our service revenues consist of revenues generated by fees charged for the unloading, transportation and storage of crude oil and related ancillary fees. We estimate that our total service revenues for the year ending December 31, 2012 will be $41.7 million, as compared to $49.4 million and $39.7 million for the year ended December 31, 2010 and the twelve months ended September 30, 2011, respectively. Service revenues are expected to decrease from 2010 due to a shift in our Kansas and Oklahoma operations to fixed-margin transactions, which are not included in service revenues, from fee-based agreements, which are included in service revenues. We anticipate that the decrease in service revenues from 2010 will be partially offset by additional revenues arising from additional barrels of storage capacity at our Cushing terminal that we expect to be placed into service at various points during the forecast period. Service revenues are expected to increase from the twelve months ended September 30, 2011 due to the additional storage revenues described above, partially offset by the effects of the shift in our Kansas and Oklahoma operations described above.

Costs of Products Sold

We estimate that our costs of products sold will be $361.8 million for the year ending December 31, 2012, as compared to $146.6 million and $309.1 million for the year ended December 31, 2010 and the twelve months ended September 30, 2011, respectively. The increase in costs of products sold over the year ended December 31,

 

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2010 is due to an assumed increase in the average cost per barrel of crude oil purchased during the forecast period to $84.86, based on NYMEX forward price data as of November 4, 2011 (less an estimated margin), compared to an average cost of $76.48 per barrel for crude oil purchased during the year ended December 31, 2010. The expected increase in costs of products sold over the twelve months ended September 30, 2011 is also due to expected additional volumes attributable to our Bakken Shale operations, partially offset by a reduction in the average cost per barrel from the $87.51 cost per barrel of crude oil purchased during the twelve months ended September 30, 2011.

Adjusted Gross Margin

We define adjusted gross margin as total revenues minus costs of products sold and unrealized gain (loss) on derivatives. Because we believe it is not reasonably possible to forecast unrealized gains or losses on derivatives for future periods, we have assumed none for the year ending December 31, 2012. We estimate that our adjusted gross margin will be $65.4 million for the year ending December 31, 2012, as compared to $62.2 million and $65.6 million for the year ended December 31, 2010 and the twelve months ended September 30, 2011, respectively, primarily due to:

 

   

an expected increase in adjusted gross margin from our Cushing storage operations due to an expected increase in contracted storage capacity to approximately 6.8 million barrels as of December 31, 2012 from approximately 4.5 million barrels and 4.8 million barrels as of December 31, 2010 and September 30, 2011, respectively, partially offset by a decrease in our average storage rate for the year ending December 31, 2012 by $0.08 per barrel and $0.02 per barrel compared to the year ended December 31, 2010 and the twelve months ended September 30, 2011, respectively, and the expiration of the recognition of deferred storage revenues attributable to a prepaid contract;

 

   

an expected decrease in adjusted gross margin attributable to our fee-based and fixed-margin gathering and transportation operations due to an increase in short-haul volumes, partially offset by an expected increase in transportation volumes to an average of approximately 36,400 barrels per day for the year ending December 31, 2012, from an average of approximately 26,600 barrels per day for the year ended December 31, 2010 and 35,800 barrels per day for the twelve months ended September 30, 2011, due to new transportation and fixed-margin contracts;

 

   

an expected increase in adjusted gross margin from our marketing operations due to a higher anticipated spread between the purchase and sale price for volumes sold, combined with an expected increase in marketing volumes to an average of approximately 16,200 barrels per day for the year ending December 31, 2012, from an average of approximately 15,800 barrels per day for the year ended December 31, 2010 and 13,400 barrels per day for the twelve months ended September 30, 2011, due to new crude oil marketing contracts; and

 

   

an expected increase in adjusted gross margin from our Platteville operations due to an expected increase in unloading volumes to an average of approximately 36,000 barrels per day for the year ending December 31, 2012, from an average of approximately 25,800 barrels per day for the year ended December 31, 2010 and 30,600 barrels per day for the twelve months ended September 30, 2011, due to a capacity expansion on the White Cliffs Pipeline. We expect that the per-barrel unloading fee we receive will remain relatively constant.

Operating Expenses

Our operating expenses include salary and wage expense, utility costs, insurance premiums, taxes and other operating costs. We estimate that we will incur operating expenses of $21.5 million for the year ending December 31, 2012, as compared to $20.4 million and $18.1 million for the year ended December 31, 2010 and the twelve months ended September 30, 2011, respectively. Operating expenses for the year ended December 31, 2010 increased by $3.3 million due to a provision for uncollectable accounts receivable, related to the bankruptcy of a customer. Operating expenses for the twelve months ended September 30, 2011 decreased by $1.2 million due to a partial recovery of these accounts receivable. We do not assume any recoveries will be made in the forecast period. Our forecasted operating expenditures are otherwise higher due to incremental operating expenses associated with growth projects and additional business activities.

 

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We do not expect our operating expenses to increase proportionately when we make capacity additions adjacent to our existing facilities in the future, as we believe we will be able to capitalize on our current scale and existing infrastructure to improve operating margins with incremental growth and because these additions do not require significant additions of operating employees.

General and Administrative Expenses

We estimate that our general and administrative expenses will be $10.5 million for the year ending December 31, 2012, as compared to $9.2 million and $9.8 million for the year ended December 31, 2010 and the twelve months ended September 30, 2011, respectively, on a pro forma basis. General and administrative expenses for the year ended December 31, 2010 included bankruptcy-related expenses that we will not incur during the forecast period. We estimate that we will incur $1.5 million of incremental general and administrative expenses resulting from SemGroup’s allocation of additional overhead to us upon completion of this offering, primarily relating to financial reporting and legal expenses and corporate services. These incremental general and administrative expenses are reflected in our unaudited pro forma financial statements. Additional incremental general and administrative expenses consist of approximately $1.9 million of expenses that we expect to incur as a result of operating as a publicly traded partnership that are not reflected in our unaudited pro forma financial statements, such as expenses associated with annual and quarterly reporting; tax return and Schedule K-1 preparation and distribution expenses; Sarbanes-Oxley compliance expenses; expenses associated with listing on the NYSE; independent auditor fees; legal fees; investor relations expenses; registrar and transfer agent fees; and director and officer insurance expenses.

Depreciation

We estimate that our depreciation expense will be $12.5 million for the year ending December 31, 2012, as compared to $10.4 million and $11.2 million for the year ended December 31, 2010 and the twelve months ended September 30, 2011, respectively. The expected increase is attributable to the planned completion of the construction of additional storage capacity at Cushing during the forecast period. Estimated depreciation expense reflects our estimates, which are based on consistent average depreciable asset lives and depreciation methodologies.

Capital Expenditures

 

   

Maintenance Capital Expenditures. We estimate that our maintenance capital expenditures will be $3.7 million for the year ending December 31, 2012, of which $0.9 million is expected to relate to truck replacements. The remaining $2.8 million of maintenance capital expenditures are expected to relate primarily to increased integrity management expenses to comply with new regulations. Maintenance capital expenditures were $1.8 million for the year ended December 31, 2010 and $3.5 million for the twelve months ended September 30, 2011, and included general maintenance, upgrades and integrity management.

 

   

Expansion Capital Expenditures. We have assumed expansion capital expenditures of $33.7 million for the year ending December 31, 2012, as compared to $14.9 million and $29.2 million for the year ended December 31, 2010 and the twelve months ended September 30, 2011, respectively. Our planned expansion capital expenditures relate primarily to the construction of 1.95 million barrels of storage capacity at our Cushing terminal. After the closing of this offering, we expect to fund expansion capital expenditures with funds generated from our operations, borrowings under our new revolving credit facility, the issuance of additional partnership units and debt offerings. For purposes of this forecast, we have assumed that we will fund all of the forecasted expansion capital expenditures with borrowings under our new credit facility. The expansion capital expenditures incurred during the year ended December 31, 2010 and the twelve months ended September 30, 2011 were associated with capacity expansion at our Cushing terminal, and were funded through capital contributions from SemGroup.

 

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Financing

Our forecast for the year ending December 31, 2012 is based on the following significant financing assumptions:

 

   

We expect to have average borrowings of approximately $20.8 million under our new revolving credit facility, which we expect to incur to fund our forecasted $33.7 million of expansion capital expenditures and the payment of an estimated $1.7 million in credit facility arrangement fees and an estimated $0.1 million in administrative agent fees, and an average of $39.7 million in letters of credit outstanding to support our purchasing activities.

 

   

The borrowings under our new revolving credit facility will bear interest at an average rate of 4.5% through December 31, 2012. An increase or decrease of 1.0% in the interest rate will result in increased or decreased, respectively, annual interest expenses of $0.2 million.

 

   

Letters of credit outstanding will bear interest at an average rate of 2.25% and there will be a letter of credit fronting fee of 0.25%.

 

   

We will remain in compliance with the financial and other covenants in our new credit facility.

Regulatory, Industry and Economic Factors

Our forecast for the year ending December 31, 2012 is based on the following significant assumptions related to regulatory, industry and economic factors:

 

   

There will not be any new federal, state or local regulation of the portions of the energy industry in which we operate, or a new interpretation of existing regulation, that will be materially adverse to our business.

 

   

There will not be any major adverse change in the portions of the midstream energy industry that we serve or in general economic conditions, including in the levels of crude oil production and demand in the geographic areas that we serve.

 

   

There will not be any material accidents, weather-related incidents, unscheduled downtime or similar unanticipated events with respect to our facilities or those of third parties on which we depend.

 

   

We will not make any acquisitions or other significant expansion capital expenditures (other than as described above).

 

   

Market, insurance and overall economic conditions will not change substantially.

While we believe that our assumptions supporting our estimated adjusted EBITDA and cash available for distribution for the year ending December 31, 2012 are reasonable in light of our current beliefs concerning future events, the assumptions are inherently uncertain and are subject to significant business, economic, regulatory and competitive risks and uncertainties that could cause actual results to differ materially from those we anticipate. If our assumptions are not realized, the actual adjusted EBITDA and cash available for distribution that we generate could be substantially less than the amounts that we currently expect to generate and could, therefore, be insufficient to permit us to make the full minimum quarterly distribution on all of our units, in which event the market price of our common units could decline materially.

 

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PROVISIONS OF OUR PARTNERSHIP AGREEMENT RELATING TO CASH DISTRIBUTIONS

Set forth below is a summary of the significant provisions of our partnership agreement that relate to cash distributions.

Distributions of Available Cash

General

Our partnership agreement requires that, within 45 days after the end of each quarter, beginning with the quarter ending December 31, 2011, we distribute all of our available cash to unitholders of record on the applicable record date. We will adjust the minimum quarterly distribution for the period from the closing of the offering through December 31, 2011 based on the actual length of the period.

Definition of Available Cash

Available cash generally means, for any quarter, all cash and cash equivalents on hand at the end of that quarter:

 

   

less the amount of cash reserves established by our general partner at the date of determination of available cash for that quarter to:

 

   

provide for the proper conduct of our business (including reserves for our future capital expenditures and anticipated future credit needs);

 

   

comply with applicable law, any of our debt instruments or other agreements or obligations; and

 

   

provide funds for distributions to our unitholders and to our general partner for any one or more of the next four quarters (provided that our general partner may not establish cash reserves for common and subordinated units unless it determines that the establishment of reserves will not prevent us from distributing the minimum quarterly distribution on all common units and any cumulative arrearages on such common units for the current quarter);

 

   

plus, if our general partner so determines, all or any portion of the cash and cash equivalents on hand on the date of determination of available cash for the quarter resulting from working capital borrowings made subsequent to the end of such quarter.

The purpose and effect of the last bullet point above is to allow our general partner, if it so decides, to use cash from working capital borrowings made after the end of the quarter but on or before the date of determination of available cash for that quarter to pay distributions to unitholders. Under our partnership agreement, working capital borrowings are generally borrowings that are made under a credit facility, commercial paper facility or similar financing arrangement with the intent to repay such borrowings within 12 months with funds other than from additional working capital borrowings, and that in all cases are used solely for working capital purposes or to pay distributions to unitholders. The proceeds of working capital borrowings increase operating surplus, and repayments of working capital borrowings are generally operating expenditures (as described below) and thus reduce operating surplus when repayments are made. However, if working capital borrowings, which increase operating surplus, are not repaid during the 12-month period following the borrowing, they will be deemed repaid at the end of such period, thus decreasing operating surplus at such time. When such working capital borrowings are in fact repaid, they will not be treated as a further reduction in operating surplus because operating surplus will have been previously reduced by the deemed repayment.

Intent to Distribute the Minimum Quarterly Distribution

We intend to make a minimum quarterly distribution to the holders of our common units and subordinated units of $0.3625 per unit, or $1.45 on an annualized basis, to the extent we have sufficient cash from our operations after the establishment of cash reserves and the payment of costs and expenses, including

 

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reimbursements of expenses to our general partner. However, there is no guarantee that we will pay the minimum quarterly distribution on our units in any quarter. Even if our cash distribution policy is not modified or revoked, the amount of distributions paid under our policy and the decision to make any distribution is determined by our general partner, taking into consideration the terms of our partnership agreement. Please read “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources” beginning on page 101 for a discussion of the restrictions to be included in our revolving credit facility that may restrict our ability to make distributions.

Operating Surplus and Capital Surplus

General

All cash distributed to unitholders will be characterized as either being paid from “operating surplus” or “capital surplus.” We treat distributions of available cash from operating surplus differently than distributions of available cash from capital surplus.

Operating Surplus

We define operating surplus as:

 

   

$25 million (as described below); plus

 

   

all of our cash receipts after the closing of this offering, excluding cash from interim capital transactions (as defined below); plus

 

   

working capital borrowings made after the end of a quarter but on or before the date of determination of operating surplus for that quarter; plus

 

   

cash distributions paid on equity issued to finance all or a portion of the construction, acquisition or development of a capital improvement or maintenance capital project in respect of the period beginning on the date that we enter into a binding obligation to commence the construction, acquisition or development of a capital improvement or maintenance capital project and ending on the earlier to occur of the date the capital improvement or maintenance capital project commences commercial service and the date that it is abandoned or disposed of; plus

 

   

cash distributions paid on equity issued to pay the construction-, acquisition- or development-period interest on debt incurred, or to pay construction-, acquisition- or development-period distributions on equity issued, to finance the construction, acquisition or development of a capital improvement or maintenance capital project referred to above; less

 

   

all of our operating expenditures (as defined below) after the closing of this offering; less

 

   

the amount of cash reserves established by our general partner to provide funds for future operating expenditures; less

 

   

all working capital borrowings incurred at or after the closing of this offering and not repaid within 12 months after having been incurred; less

 

   

any cash loss realized on the disposition of an investment capital expenditure.

As described above, operating surplus does not reflect actual cash on hand that is available for distribution to our unitholders and is not limited to cash generated by operations. For example, the definition of operating surplus includes a provision that will enable us, if we choose, to distribute as operating surplus up to $25 million of cash we receive in the future from non-operating sources such as asset sales, issuances of securities and long-term borrowings that would otherwise be distributed as capital surplus.

We define interim capital transactions as (i) borrowings, refinancings or refundings of indebtedness (other than working capital borrowings and items purchased on open account or for a deferred purchase price in the

 

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ordinary course of business) and sales of debt securities, (ii) sales or issuances of equity securities, (iii) sales or other dispositions of assets, other than sales or other dispositions of inventory, accounts receivable and other assets in the ordinary course of business and sales or other dispositions of assets as part of normal asset retirements or replacements and (iv) capital contributions received by us.

We define operating expenditures as all of our cash expenditures, including, but not limited to, taxes, compensation of officers, directors and employees of our general partner, reimbursements of expenses to our general partner and its affiliates, interest payments, payments made in the ordinary course of business under interest rate hedge contracts and commodity hedge contracts (provided that payments made in connection with the termination of any interest rate hedge contract or commodity hedge contract prior to the settlement or termination date specified therein will be included in operating expenditures in equal quarterly installments over the remaining scheduled life of the contract), maintenance capital expenditures (as discussed in further detail below) and repayment of working capital borrowings; provided, however, that operating expenditures will not include:

 

   

repayments of working capital borrowings deducted from operating surplus (as described above) when actually repaid;

 

   

payments (including prepayments and prepayment penalties) of principal of and premium on indebtedness other than working capital borrowings;

 

   

expansion capital expenditures;

 

   

investment capital expenditures;

 

   

payment of transaction expenses (including, but not limited to, taxes) relating to interim capital transactions;

 

   

distributions to our unitholders or general partner; or

 

   

repurchases of any class of our units (other than repurchases to satisfy obligations under employee benefit plans) or reimbursement of our general partner for such purchases.

Capital Surplus

Capital surplus is defined in our partnership agreement as any distribution of available cash in excess of our cumulative operating surplus. Accordingly, except as described above, capital surplus would generally be generated by:

 

   

borrowings other than working capital borrowings;

 

   

sales of our equity and debt securities; and

 

   

sales or other dispositions of assets, other than inventory, accounts receivable and other assets sold in the ordinary course of business or as part of ordinary course retirement or replacement of assets.

Characterization of Cash Distributions

Our partnership agreement requires that we treat all available cash distributed as coming from operating surplus until the sum of all available cash distributed since the closing of this offering equals the operating surplus from the closing of this offering through the end of the quarter immediately preceding that distribution. Our partnership agreement requires that we treat any amount distributed in excess of operating surplus, regardless of its source, as capital surplus. We do not anticipate that we will make any distributions from capital surplus.

 

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Capital Expenditures

Maintenance capital expenditures are cash expenditures (including expenditures for the addition to or improvement or replacement of our capital assets or for the acquisition of existing, or the construction of new, capital assets) made to maintain our long-term operating income or operating capacity. We expect that a primary component of maintenance capital expenditures will include expenditures for routine equipment and facility maintenance or replacement due to obsolescence.

Maintenance capital expenditures reduce operating surplus, but expansion capital expenditures and investment capital expenditures do not. Capital expenditures that are made in part for maintenance capital purposes and in part for other purposes will be allocated between maintenance capital expenditures and expenditures made for other purposes by our general partner.

Expansion capital expenditures are cash expenditures (including expenditures for the addition to or improvement or replacement of our capital assets or for the acquisition of existing, or the construction of new, capital assets) made to increase our long-term operating income or operating capacity. Expansion capital expenditures will include interest payments (and related fees) on debt incurred to finance the construction, acquisition or development of a capital improvement and paid in respect of the period beginning on the date that we enter into a binding obligation to commence construction, acquisition or development of the capital improvement and ending on the earlier to occur of the date that such capital improvement commences commercial service and the date that such capital improvement is abandoned or disposed of. Examples of expansion capital expenditures include the acquisition of equipment, or the construction, development or acquisition of additional gathering systems, pipelines, storage facilities and related or similar midstream assets.

Capital expenditures that are made in part for expansion capital purposes and in part for other purposes will be allocated between expansion capital expenditures and expenditures for other purposes by our general partner.

Investment capital expenditures are those capital expenditures that are neither maintenance capital expenditures nor expansion capital expenditures. Investment capital expenditures largely will consist of capital expenditures made for investment purposes. Examples of investment capital expenditures include traditional capital expenditures for investment purposes, such as purchases of securities, as well as other capital expenditures that might be made in lieu of such traditional investment capital expenditures, such as the acquisition of a capital asset for investment purposes or development of facilities that are in excess of those needed for maintenance of our existing operating capacity or operating income, but that are not expected to expand, for more than the short term, our operating capacity or operating income.

Subordination Period

General

Our partnership agreement provides that, during the subordination period (which we define below), the common units will have the right to receive distributions of available cash from operating surplus each quarter in an amount equal to $0.3625 per common unit, which amount is defined in our partnership agreement as the minimum quarterly distribution, plus any arrearages in the payment of the minimum quarterly distribution on the common units from prior quarters, before any distributions of available cash from operating surplus may be made on the subordinated units. These units are deemed “subordinated” because for a period of time, referred to as the subordination period, the subordinated units will not be entitled to receive any distributions until the common units have received the minimum quarterly distribution plus any arrearages from prior quarters. Furthermore, no arrearages will be paid on the subordinated units. The practical effect of the subordinated units is to increase the likelihood that during the subordination period there will be available cash to be distributed on the common units.

 

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Subordination Period

Except as described below, the subordination period will begin on the closing date of this offering and will extend until the first business day following the distribution of available cash in respect of any quarter beginning with the quarter ending December 31, 2014, that each of the following tests are met:

 

   

distributions of available cash from operating surplus on each of the outstanding common units, subordinated units and general partner units equaled or exceeded the annualized minimum quarterly distribution for each of the three consecutive, non-overlapping four-quarter periods immediately preceding that date;

 

   

the adjusted operating surplus (as defined below) generated during each of the three consecutive, non-overlapping four-quarter periods immediately preceding that date equaled or exceeded the sum of the minimum quarterly distributions on all of the outstanding common units, subordinated units and general partner units during those periods on a fully diluted basis; and

 

   

there are no arrearages in payment of the minimum quarterly distribution on the common units.

Early Termination of Subordination Period

Notwithstanding the foregoing, the subordination period will automatically terminate on the first business day following the distribution of available cash in respect of any quarter beginning with the quarter ending December 31, 2012, that each of the following tests are met:

 

   

distributions of available cash from operating surplus on each of the outstanding common units, subordinated units and general partner units equaled or exceeded $2.175 (150% of the annualized minimum quarterly distribution) for the four-quarter period immediately preceding that date;

 

   

the adjusted operating surplus (as defined below) generated during the four-quarter period immediately preceding that date equaled or exceeded the sum of (i) $2.175 (150% of the annualized minimum quarterly distribution) on all of the outstanding common units, subordinated units and general partner units during that period on a fully diluted basis and (ii) the distributions made on the incentive distribution rights; and

 

   

there are no arrearages in payment of the minimum quarterly distributions on the common units.

In addition, if the unitholders remove our general partner other than for cause and no units held by our general partner and its affiliates are voted in favor of such removal:

 

   

the subordination period will end and each subordinated unit will immediately and automatically convert into one common unit;

 

   

any existing arrearages in payment of the minimum quarterly distribution on the common units will be extinguished; and

 

   

our general partner will have the right to convert its general partner interest and its incentive distribution rights into common units or to receive cash in exchange for those interests.

Expiration of the Subordination Period

When the subordination period ends, each outstanding subordinated unit will convert into one common unit and will thereafter participate pro rata with the other common units in distributions of available cash.

 

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Adjusted Operating Surplus

Adjusted operating surplus is intended to reflect the cash generated from operations during a particular period and therefore excludes net drawdowns of reserves of cash established in prior periods. Adjusted operating surplus for a period consists of:

 

   

operating surplus generated with respect to that period (excluding any amounts attributable to the item described in the first bullet point under the caption “—Operating Surplus and Capital Surplus—Operating Surplus” above); less

 

   

any net increase in working capital borrowings with respect to that period; less

 

   

any net decrease in cash reserves for operating expenditures with respect to that period not relating to an operating expenditure made with respect to that period; plus

 

   

any net decrease in working capital borrowings with respect to that period; plus

 

   

any net decrease made in subsequent periods to cash reserves for operating expenditures initially established with respect to that period to the extent such decrease results in a reduction in adjusted operating surplus in subsequent periods; plus

 

   

any net increase in cash reserves for operating expenditures with respect to that period required by any debt instrument for the repayment of principal, interest or premium.

Distributions of Available Cash from Operating Surplus During the Subordination Period

We will make distributions of available cash from operating surplus for any quarter during the subordination period in the following manner:

 

   

first, 98.0% to the common unitholders, pro rata, and 2.0% to our general partner, until we distribute for each outstanding common unit an amount equal to the minimum quarterly distribution for that quarter;

 

   

second, 98.0% to the common unitholders, pro rata, and 2.0% to our general partner, until we distribute for each outstanding common unit an amount equal to any arrearages in payment of the minimum quarterly distribution on the common units for any prior quarters during the subordination period;

 

   

third, 98.0% to the subordinated unitholders, pro rata, and 2.0% to our general partner, until we distribute for each outstanding subordinated unit an amount equal to the minimum quarterly distribution for that quarter; and

 

   

thereafter, in the manner described in “—General Partner Interest and Incentive Distribution Rights” below.

The preceding discussion is based on the assumptions that our general partner maintains its 2.0% general partner interest and that we do not issue additional classes of equity securities.

Distributions of Available Cash from Operating Surplus After the Subordination Period

We will make distributions of available cash from operating surplus for any quarter after the subordination period in the following manner:

 

   

first, 98.0% to all unitholders, pro rata, and 2.0% to our general partner, until we distribute for each outstanding unit an amount equal to the minimum quarterly distribution for that quarter; and

 

   

thereafter, in the manner described in “—General Partner Interest and Incentive Distribution Rights” below.

The preceding discussion is based on the assumptions that our general partner maintains its 2.0% general partner interest and that we do not issue additional classes of equity securities.

 

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General Partner Interest and Incentive Distribution Rights

Our partnership agreement provides that our general partner initially will be entitled to 2.0% of all distributions that we make prior to our liquidation. Our general partner has the right, but not the obligation, to contribute a proportionate amount of capital to us in order to maintain its 2.0% general partner interest if we issue additional units. Our general partner’s 2.0% interest, and the percentage of our cash distributions to which it is entitled from such 2.0% interest, will be proportionately reduced if we issue additional units in the future and our general partner does not contribute a proportionate amount of capital to us in order to maintain its 2.0% general partner interest (other than in connection with the issuance of common units upon exercise by the underwriters of their option to purchase additional common units, the issuance of common units to SemGroup upon expiration of the underwriters’ option to purchase additional common units or the issuance of common units in connection with a reset of the incentive distribution target levels). Our partnership agreement does not require that our general partner fund its capital contribution with cash. It may instead fund its capital contribution by the contribution to us of common units or other property.

Incentive distribution rights represent the right to receive an increasing percentage (13.0%, 23.0% and 48.0%) of quarterly distributions of available cash from operating surplus after the minimum quarterly distribution and the target distribution levels have been achieved. Our general partner will initially hold the incentive distribution rights, but may transfer these rights separately from its general partner interest.

The following discussion assumes that our general partner maintains its 2.0% general partner interest, that there are no arrearages on common units and that our general partner continues to own the incentive distribution rights.

If for any quarter:

 

   

we have distributed available cash from operating surplus to the common and subordinated unitholders in an amount equal to the minimum quarterly distribution; and

 

   

we have distributed available cash from operating surplus on outstanding common units in an amount necessary to eliminate any cumulative arrearages in payment of the minimum quarterly distribution;

then, we will distribute any additional available cash from operating surplus for that quarter among the unitholders and our general partner in the following manner (assuming our general partner has maintained its 2.0% general partner interest):

 

   

first, 98.0% to all unitholders, pro rata, and 2.0% to our general partner, until each unitholder receives a total of $0.416875 per unit for that quarter (the “first target distribution”);

 

   

second, 85.0% to all unitholders, pro rata, and 15.0% to our general partner, until each unitholder receives a total of $0.453125 per unit for that quarter (the “second target distribution”);

 

   

third, 75.0% to all unitholders, pro rata, and 25.0% to our general partner, until each unitholder receives a total of $0.54375 per unit for that quarter (the “third target distribution”); and

 

   

thereafter, 50.0% to all unitholders, pro rata, and 50.0% to our general partner.

 

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Percentage Allocations of Available Cash from Operating Surplus

The following table illustrates the percentage allocations of available cash from operating surplus between our unitholders and our general partner based on the specified target distribution levels. The amounts set forth under “Marginal Percentage Interest in Distributions” are the percentage interests of our general partner and our unitholders in any available cash from operating surplus we distribute up to and including the corresponding amount in the column “Total Quarterly Distribution Per Unit Target Amount.” The percentage interests shown for our unitholders and our general partner for the minimum quarterly distribution are also applicable to quarterly distribution amounts that are less than the minimum quarterly distribution. The percentage interests set forth below for our general partner include its 2.0% general partner interest and assume that our general partner has contributed any additional capital necessary to maintain its 2.0% general partner interest, our general partner has not transferred its incentive distribution rights and that there are no arrearages on common units.

 

     Total Quarterly Distribution
Per Unit Target Amount
   Marginal Percentage
Interest

in Distributions
 
      Unitholders     General
Partner
 

Minimum Quarterly Distribution

   $0.3625      98.0     2.0

First Target Distribution

   above $0.3625 up to $0.416875
     98.0     2.0

Second Target Distribution

   above $0.416875 up to $0.453125
     85.0     15.0

Third Target Distribution

   above $0.453125 up to $0.54375
     75.0     25.0

Thereafter

   above $0.54375      50.0     50.0

General Partner’s Right to Reset Incentive Distribution Levels

Our general partner, as the initial holder of our incentive distribution rights, has the right under our partnership agreement in certain circumstances to elect to relinquish the right to receive incentive distribution payments based on the initial target distribution levels and to reset, at higher levels, the minimum quarterly distribution amount and target distribution levels upon which the incentive distribution payments to our general partner would be based. If our general partner transfers all or a portion of our incentive distribution rights in the future, then the holder or holders of a majority of our incentive distribution rights will be entitled to exercise this right. The following discussion assumes that our general partner holds all of the incentive distribution rights at the time that a reset election is made. Our general partner’s right to reset the minimum quarterly distribution amount and the target distribution levels upon which the incentive distributions payable to our general partner are based may be exercised, without approval of our unitholders or the Conflicts Committee, at any time when there are no subordinated units outstanding and we have made cash distributions to the holders of the incentive distribution rights at the highest level of incentive distribution for each of the four most recently completed fiscal quarters (and the amount of each such distribution did not exceed adjusted operating surplus for such quarter). If our general partner and its affiliates are not the holders of a majority of the incentive distribution rights at the time an election is made to reset the minimum quarterly distribution amount and the target distribution levels, then the proposed reset will be subject to the prior written concurrence of the general partner that the conditions described above have been satisfied. The reset minimum quarterly distribution amount and target distribution levels will be higher than the minimum quarterly distribution amount and the target distribution levels prior to the reset such that our general partner will not receive any incentive distributions under the reset target distribution levels until cash distributions per unit following this event increase as described below. We anticipate that our general partner would exercise this reset right in order to facilitate acquisitions or internal growth projects that would otherwise not be sufficiently accretive to cash distributions per common unit, taking into account the existing levels of incentive distribution payments being made to our general partner.

In connection with the resetting of the minimum quarterly distribution amount and the target distribution levels and the corresponding relinquishment by our general partner of incentive distribution payments based on the target distributions prior to the reset, our general partner will be entitled to receive a number of newly issued common units based on a predetermined formula described below that takes into account the “cash parity” value

 

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of the average of the cash distributions related to the incentive distribution rights received by our general partner for the two quarters immediately preceding the reset event as compared to the average of the cash distributions per common unit during that two-quarter period. Our general partner will also be issued the number of general partner units necessary to maintain its general partner interest in us that existed immediately prior to the reset election.

The number of common units that our general partner would be entitled to receive from us in connection with a resetting of the minimum quarterly distribution amount and the target distribution levels then in effect would be equal to the quotient determined by dividing (x) the average of the aggregate cash distributions received by our general partner in respect of its incentive distribution rights during the two consecutive fiscal quarters ended immediately prior to the date of such reset election by (y) the average of the cash distributions per common unit during these two quarters.

Following a reset election, the minimum quarterly distribution amount will be reset to an amount equal to the average of the cash distributions per common unit for the two fiscal quarters immediately preceding the reset election (which amount we refer to as the “reset minimum quarterly distribution”) and the target distribution levels will be reset to be correspondingly higher such that we would distribute all of our available cash from operating surplus for each quarter thereafter as follows:

 

   

first, 98.0% to all unitholders, pro rata, and 2.0% to our general partner, until each unitholder receives an amount equal to 115.0% of the reset minimum quarterly distribution for that quarter;

 

   

second, 85.0% to all unitholders, pro rata, and 15.0% to our general partner, until each unitholder receives an amount per unit equal to 125.0% of the reset minimum quarterly distribution for the quarter;

 

   

third, 75.0% to all unitholders, pro rata, and 25.0% to our general partner, until each unitholder receives an amount per unit equal to 150.0% of the reset minimum quarterly distribution for the quarter; and

 

   

thereafter, 50.0% to all unitholders, pro rata, and 50.0% to our general partner.

The following table illustrates the percentage allocation of available cash from operating surplus between the unitholders and our general partner at various cash distribution levels (i) pursuant to the cash distribution provisions of our partnership agreement in effect at the closing of this offering, as well as (ii) following a hypothetical reset of the minimum quarterly distribution and target distribution levels based on the assumption that the average quarterly cash distribution amount per common unit during the two fiscal quarters immediately preceding the reset election was $0.60.

 

          Marginal Percentage
Interest in Distributions
    Quarterly Distributions
Per Unit Following
Hypothetical Reset