S-1 1 d485877ds1.htm FORM S-1 FORM S-1
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AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MARCH 27, 2013

Registration No. 333-            

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

Phillips 66 Partners LP

(Exact name of Registrant as Specified in Its Charter)

 

 

 

Delaware   4610   38-3899432

(State or Other Jurisdiction of

Incorporation or Organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification Number)

3010 Briarpark Drive

Houston, Texas 77042

(855) 283-9237

(Address, Including Zip Code, and Telephone Number, including Area Code, of Registrant’s Principal Executive Offices)

 

 

Paula A. Johnson

Vice President, General Counsel and Secretary

3010 Briarpark Drive

Houston, Texas 77042

(281) 293-6600

(Name, Address, Including Zip Code, and Telephone Number, Including Area Code, of Agent for Service)

 

 

Copies to:

 

William N. Finnegan IV

Brett E. Braden

 

G. Michael O’Leary

David C. Buck

Latham & Watkins LLP

811 Main Street, Suite 3700

Houston, Texas 77002

(713) 546-5400

 

Andrews Kurth LLP

600 Travis, Suite 4200

Houston, Texas 77002

(713) 220-4200

 

 

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. (Check one):

 

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

 

 

CALCULATION OF REGISTRATION FEE

 

 

Title of Each Class of

Securities to be Registered

 

Proposed

Maximum

Aggregate

Offering Price(1)(2)

  Amount of
Registration Fee

Common units representing limited partner interests

  $345,000,000   $47,058

 

 

(1) Includes common units issuable upon exercise of the underwriters’ option to purchase additional common units.
(2) Estimated solely for the purpose of calculating the registration fee pursuant to Rule 457(o) of the Securities Act of 1933.

 

 

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.

 

 

 


Table of Contents

The information in this 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 prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.

 

Subject to completion, dated March 27, 2013

Prospectus

Common Units

Representing Limited Partner Interests

 

LOGO

Phillips 66 Partners LP

 

 

This is an initial public offering of common units representing limited partner interests of Phillips 66 Partners LP. We were recently formed by Phillips 66, and no public market currently exists for our common units. We are offering              common units in this offering. We expect that the initial public offering price will be between $         and $         per common unit. We intend to apply to list our common units on the New York Stock Exchange under the symbol “PSXP.” We are an “emerging growth company” as that term is used in the Jumpstart Our Business Startups Act (the “JOBS Act”).

As a result of certain laws and regulations to which we are or may in the future become subject, we may require owners of our common units to certify that they are both U.S. citizens and subject to U.S. federal income taxation on our income. If you are not both a citizenship eligible holder and a rate eligible holder, your common units may be subject to redemption.

 

 

Investing in our common units involves a high degree of risk. Before buying any common units, you should carefully read the discussion of material risks of investing in our common units in “Risk Factors” beginning on page 19. These risks include the following:

 

   

Phillips 66 accounts for substantially all of our revenue. If Phillips 66 changes its business strategy, is unable to satisfy its obligations under our commercial agreements or significantly reduces the volumes transported through our pipelines or terminals or stored at our storage assets, our revenue would decline and our financial condition, results of operations, cash flows, and ability to make distributions to our unitholders would be materially and adversely affected.

 

   

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 and its affiliates, to enable us to pay the minimum quarterly distribution to our unitholders.

 

   

If the underwriters exercise in full their option to purchase additional common units, on a pro forma basis we would not have generated available cash sufficient to pay the aggregate annualized minimum quarterly distributions on all of our subordinated units for the year ended December 31, 2012.

 

   

Phillips 66 may suspend, reduce or terminate its obligations under our commercial agreements, and may avoid making deficiency payments under our Hartford Connector throughput and deficiency agreement, in certain circumstances, which could have a material adverse effect on our financial condition, results of operations, cash flows and ability to make distributions to our unitholders.

 

   

A material decrease in the refining margins at Phillips 66’s refineries could cause Phillips 66 to reduce the volume of crude oil refined in its refineries which, in turn, could materially reduce the volumes of crude oil and refined petroleum products that we transport and store for Phillips 66, which could materially and adversely affect our financial condition, results of operations, cash flows and ability to make distributions to our unitholders.

 

   

Our general partner and its affiliates, including Phillips 66, have conflicts of interest with us and limited fiduciary duties to us and our unitholders, and they may favor their own interests to our detriment and that of our unitholders. Additionally, we have no control over the business decisions and operations of Phillips 66, and Phillips 66 is under no obligation to adopt a business strategy that favors us.

 

   

Unitholders have very limited voting rights and, even if they are dissatisfied, they cannot remove our general partner without its consent.

 

   

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

 

   

Our tax treatment depends on our status as a partnership for federal income tax purposes. If the Internal Revenue Service 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.

 

   

Our unitholders’ share of our income will be taxable to them for federal income tax purposes even if they do not receive any cash distributions from us.

Neither the Securities and Exchange Commission nor any state securities commission 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.

 

     Per
Common Unit
     Total  

Initial public offering price

   $                   $               

Underwriting discounts and commissions(1)

   $                   $               

Proceeds to Phillips 66 Partners LP, before expenses

   $                   $               

 

(1) Excludes an aggregate structuring fee equal to     % of the gross proceeds of this offering payable to J.P. Morgan Securities LLC and Morgan Stanley & Co. LLC. Please read “Underwriting.”

The underwriters may also purchase up to an additional              common units at the public offering price, less the underwriting discounts and commissions and structuring fee payable by us, to cover over allotments, if any, within 30 days from the date of this prospectus.

The underwriters are offering the common units as set forth under “Underwriting.” Delivery of the common units will be made on or about                     , 2013.

 

 

 

J.P. Morgan   Morgan Stanley

                    , 2013


Table of Contents

 

LOGO


Table of Contents

TABLE OF CONTENTS

 

PROSPECTUS SUMMARY

     1   

Overview

     1   

Business Strategies

     2   

Competitive Strengths

     3   

Our Assets and Operations

     4   

Our Commercial Agreements with Phillips 66

     6   

Our Relationship with Phillips 66

     7   

Our Emerging Growth Company Status

     7   

Risk Factors

     8   

The Transactions

     8   

Organizational Structure After the Transactions

     9   

Management of Phillips 66 Partners LP

     10   

Principal Executive Offices and Internet Address

     10   

Summary of Conflicts of Interest and Duties

     10   

THE OFFERING

     12   

SUMMARY HISTORICAL AND PRO FORMA COMBINED FINANCIAL DATA

     17   

RISK FACTORS

     19   

Risks Related to Our Business

     19   

Risks Inherent in an Investment in Us

     33   

Tax Risks

     41   

USE OF PROCEEDS

     47   

CAPITALIZATION

     48   

DILUTION

     49   

CASH DISTRIBUTION POLICY AND RESTRICTIONS ON DISTRIBUTIONS

     50   

General

     50   

Our Minimum Quarterly Distribution

     52   

Unaudited Pro Forma Cash Available for Distribution for the Year Ended December 31, 2012

     54   

Estimated Cash Available for Distribution for the Twelve Months Ending March 31, 2014

     56   

Significant Forecast Assumptions

     58   

PROVISIONS OF OUR PARTNERSHIP AGREEMENT RELATING TO CASH DISTRIBUTIONS

     63   

Distributions of Available Cash

     63   

Operating Surplus and Capital Surplus

     64   

Capital Expenditures

     66   

Subordinated Units and Subordination Period

     67   

 

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Distributions of Available Cash from Operating Surplus During the Subordination Period

     68   

Distributions of Available Cash from Operating Surplus After the Subordination Period

     69   

General Partner Interest and Incentive Distribution Rights

     69   

Percentage Allocations of Available Cash From Operating Surplus

     70   

General Partner’s Right to Reset Incentive Distribution Levels

     70   

Distributions from Capital Surplus

     73   

Adjustment to the Minimum Quarterly Distribution and Target Distribution Levels

     73   

Distributions of Cash Upon Liquidation

     74   

SELECTED HISTORICAL AND PRO FORMA COMBINED FINANCIAL DATA

     77   

Non-GAAP Financial Measure

     79   

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     80   

Overview

     80   

How We Generate Revenue

     80   

How We Evaluate Our Operations

     81   

Factors Affecting the Comparability of Our Financial Results

     82   

Factors Affecting Our Business

     84   

Results of Operations

     85   

Capital Resources and Liquidity

     86   

Off-Balance Sheet Arrangements

     88   

Regulatory Matters

     88   

Critical Accounting Estimates

     89   

Qualitative and Quantitative Disclosures About Market Risk

     91   

BUSINESS

     92   

Overview

     92   

Business Strategies

     92   

Competitive Strengths

     93   

Our Assets and Operations

     94   

Our Commercial Agreements with Phillips 66

     97   

Other Agreements with Phillips 66

     105   

Our Relationship with Phillips 66

     106   

Our Asset Portfolio

     107   

Phillips 66’s Operations

     113   

Competition

     116   

Seasonality

     117   

Insurance

     117   

Pipeline Control Operations

     117   

 

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Table of Contents

Rate and Other Regulation

     117   

Environmental Regulation

     121   

Title to Properties and Permits

     125   

Employees

     125   

Legal Proceedings

     125   

MANAGEMENT

     126   

Management of Phillips 66 Partners LP

     126   

Directors and Executive Officers of Phillips 66 Partners GP LLC

     127   

Board Leadership Structure

     129   

Board Role In Risk Oversight

     129   

Compensation of Our Officers and Directors

     130   

SECURITY OWNERSHIP AND CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     133   

CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS

     134   

Distributions and Payments to Our General Partner and Its Affiliates

     134   

Agreements Governing the Transactions

     136   

Procedures for Review, Approval and Ratification of Related Person Transactions

     139   

CONFLICTS OF INTEREST AND DUTIES

     140   

Conflicts of Interest

     140   

Duties of the General Partner

     146   

DESCRIPTION OF THE COMMON UNITS

     149   

The Units

     149   

Transfer Agent and Registrar

     149   

Transfer of Common Units

     149   

OUR PARTNERSHIP AGREEMENT

     151   

Organization and Duration

     151   

Purpose

     151   

Capital Contributions

     151   

Voting Rights

     151   

Limited Liability

     153   

Issuance of Additional Securities

     154   

Amendment of Our Partnership Agreement

     154   

Merger, Consolidation, Conversion, Sale or Other Disposition of Assets

     156   

Termination and Dissolution

     157   

Liquidation and Distribution of Proceeds

     157   

Withdrawal or Removal of Our General Partner

     157   

Transfer of General Partner Interest

     159   

Transfer of Ownership Interests in Our General Partner

     159   

 

iii


Table of Contents

Transfer of Incentive Distribution Rights

     159   

Change of Management Provisions

     159   

Limited Call Right

     159   

Redemption of Ineligible Holders

     160   

Meetings; Voting

     160   

Status as Limited Partner

     161   

Indemnification

     161   

Reimbursement of Expenses

     162   

Books and Reports

     162   

Right to Inspect Our Books and Records

     162   

Registration Rights

     163   

Exclusive Forum

     163   

UNITS ELIGIBLE FOR FUTURE SALE

     164   

Rule 144

     164   

Our Partnership Agreement and Registration Rights

     164   

Lock-up Agreements

     165   

Registration Statement on Form S-8

     165   

MATERIAL FEDERAL INCOME TAX CONSEQUENCES

     166   

Partnership Status

     167   

Limited Partner Status

     168   

Tax Consequences of Unit Ownership

     168   

Tax Treatment of Operations

     175   

Disposition of Common Units

     176   

Uniformity of Units

     178   

Tax-Exempt Organizations and Other Investors

     179   

Administrative Matters

     179   

Recent Legislative Developments

     182   

State, Local, Foreign and Other Tax Considerations

     183   

INVESTMENT IN PHILLIPS 66 PARTNERS LP BY EMPLOYEE BENEFIT PLANS

     184   

UNDERWRITING

     186   

Commissions and Expenses

     186   

No Sales of Similar Securities

     186   

Indemnification

     187   

New York Stock Exchange

     187   

Price Stabilization, Short Positions

     187   

Affiliations

     188   

FINRA

     188   

Notice to Investors

     188   

 

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VALIDITY OF THE COMMON UNITS

     191   

EXPERTS

     191   

WHERE YOU CAN FIND ADDITIONAL INFORMATION

     191   

FORWARD-LOOKING STATEMENTS

     192   

INDEX TO FINANCIAL STATEMENTS

     F-1   

APPENDIX A: Form of First Amended and Restated Agreement of Limited Partnership of Phillips 66 Partners LP

     A-1   

APPENDIX B: Glossary of Terms

     B-1   

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. We have not, and the underwriters have not, authorized any other person to provide you with information different from that contained in this prospectus and any free writing prospectus. If anyone provides you with different or inconsistent information, you should not rely on it. We are not, and the underwriters are not, making an offer to sell these securities in any jurisdiction where an offer or sale is not permitted.

Through and including            , 2013 (the 25th day after the date of this prospectus), federal securities laws may require all dealers that effect transactions in these securities, whether or not participating in this offering, to deliver a prospectus. This requirement 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.

This prospectus contains forward-looking statements that are subject to a number of risks and uncertainties, many of which are beyond our control. Please read “Risk Factors” and “Forward-Looking Statements.”

Industry and Market Data

The market data and certain other statistical information used throughout this prospectus are based on independent industry publications, government publications or other published independent sources. Some data are also based on our good faith estimates.

 

v


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PROSPECTUS SUMMARY

This summary highlights selected information contained elsewhere in this prospectus. You should carefully read the entire prospectus, including “Risk Factors” and the historical and unaudited pro forma combined financial statements and related notes included elsewhere in this prospectus before making an investment decision. Unless otherwise indicated, the information in this prospectus assumes (1) an initial public offering price of $         per common unit (the mid-point of the price range set forth on the cover of this prospectus) and (2) that the underwriters do not exercise their option to purchase additional common units. You should read “Risk Factors” beginning on page 19 for more information about important factors that you should consider before purchasing our common units.

Unless the context otherwise requires, references in this prospectus to “Phillips 66 Partners LP,” “our partnership,” “we,” “our,” “us,” or like terms, when used in a historical context, refer to Phillips 66 Partners Predecessor, our predecessor for accounting purposes, which we sometimes refer to as “our Predecessor.” When used in the present tense or future tense, these terms refer to Phillips 66 Partners LP and its subsidiaries. References to “our general partner” refer to Phillips 66 Partners GP LLC. References to “Phillips 66” refer collectively to Phillips 66 and its subsidiaries, other than us, our subsidiaries and our general partner. References to “DCP Midstream” refer collectively to the operations of both DCP Midstream Partners, LP, a publicly traded Delaware limited partnership, and DCP Midstream, LLC, a joint venture between Phillips 66 and Spectra Energy Corp and the parent company of DCP Midstream GP, LLC, the general partner of DCP Midstream Partners, LP. We have provided definitions for some of the terms we use to describe our business and industry and other terms used in this prospectus in the “Glossary of Terms” beginning on page B-1 of this prospectus.

Phillips 66 Partners LP

Overview

We are a growth-oriented, traditional master limited partnership recently formed by Phillips 66 to own, operate, develop and acquire primarily fee-based crude oil, refined petroleum product and natural gas liquids (“NGL”) pipelines and terminals and other transportation and midstream assets. Our initial assets consist of crude oil and refined petroleum product pipeline, terminal and storage systems in the Central and Gulf Coast regions of the United States that are integral to the Phillips 66 refining and marketing operations they support.

We generate revenue primarily by charging tariffs and fees for transporting crude oil and refined petroleum products through our pipelines and terminaling and storing crude oil and refined petroleum products at our terminals. We do not take ownership of the crude oil or refined petroleum products that we transport, terminal and store, and we do not engage in the trading of any commodities. At the closing of this offering, we will have multiple commercial agreements with Phillips 66 that will initially be the source of substantially all of our revenue. These agreements will be long-term, fee-based agreements with minimum volume commitments and inflation escalators. We believe these agreements will promote stable and predictable cash flows. Please read “—Our Commercial Agreements with Phillips 66” below for a description of these agreements.

For the year ended December 31, 2012, on a pro forma basis, we had revenue of approximately $109.2 million, net income of approximately $62.2 million and EBITDA of approximately $71.2 million. Phillips 66 accounted for 99.6% of our pro forma revenue for that period. Please read “Selected Historical and Pro Forma Combined Financial Data” for the definition of the term EBITDA and a reconciliation of EBITDA to our most directly comparable financial measures calculated and presented in accordance with U.S. generally accepted accounting principles (“GAAP”).

 

 

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Our relationship with Phillips 66 is one of our principal strengths. Phillips 66 is a large, independent downstream energy company with an investment grade credit rating and refining and marketing, transportation, midstream and chemicals businesses with a key focus on safe and reliable operations. Phillips 66’s transportation and midstream assets and operations include crude oil, refined petroleum product, natural gas and NGL pipelines; crude oil, petroleum coke, refined petroleum product and liquefied petroleum gas terminals; truck and rail assets; NGL fractionators; Phillips 66’s 50% equity interest in DCP Midstream, LLC, one of the largest natural gas gathering and processing companies in the United States; and a one-third equity interest in each of DCP Sand Hills Pipeline, LLC (“Sand Hills”) and DCP Southern Hills Pipeline, LLC (“Southern Hills”), joint ventures between Phillips 66, DCP Midstream and Spectra Energy Corp that are currently developing two significant NGL pipeline infrastructure projects.

Phillips 66 has stated that it intends to grow its transportation and midstream businesses and will use us as a primary vehicle for achieving that growth. In light of this strategy, we believe that Phillips 66 will offer us opportunities to purchase additional transportation and midstream assets that it may acquire or develop in the future or that it currently owns. For example, Phillips 66 has agreed that it will offer us the right to acquire its one-third equity interest in each of Sand Hills and Southern Hills before it sells any of those interests to any third party during the five-year period following the closing of this offering. We refer to these rights as our right of first offer and to these one-third equity interests as our right of first offer assets. Phillips 66 is under no obligation to offer to sell us additional assets (including our right of first offer assets, unless and until it otherwise intends to dispose of such assets), and we are under no obligation to buy any additional assets from Phillips 66. For a further description of our right of first offer assets, please read “Business—Our Asset Portfolio—Our Right of First Offer Assets.”

Business Strategies

Our primary business objectives are to generate stable and predictable cash flows and increase our quarterly cash distribution per unit over time. We intend to accomplish these objectives by executing the following strategies:

 

 

Maintain safe and reliable operations.    We are committed to maintaining and improving the safety, reliability and efficiency of our operations, which we believe to be key components in generating stable cash flows. We strive for operational excellence by utilizing Phillips 66’s existing programs to integrate health, occupational safety, process safety and environmental principles throughout our business with a commitment to continuous improvement. We will continue to employ Phillips 66’s rigorous training, integrity and audit programs to drive ongoing improvements in both personal and process safety as we strive for zero incidents.

 

 

Focus on fee-based businesses supported by contracts with minimum volume commitments and inflation escalators.    We are focused on generating stable and predictable cash flows by providing fee-based transportation and midstream services to Phillips 66 and third parties. At the closing of this offering, we will have multiple long-term, fee-based commercial agreements with Phillips 66 that include minimum volume commitments and inflation escalators. We believe these agreements will substantially mitigate volatility in our cash flows by reducing our direct exposure to commodity price fluctuations.

 

 

Grow through strategic acquisitions.    We plan to pursue strategic acquisitions of assets from Phillips 66 as well as third parties. In addition to our right of first offer assets, we believe Phillips 66 will offer us opportunities to purchase additional transportation and midstream assets that it may acquire or develop in the future or that it currently owns. We also may have opportunities to pursue the acquisition or development of additional assets jointly with Phillips 66.

 

 

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Optimize existing assets and pursue organic growth opportunities.    We will seek to enhance the profitability of our existing assets by pursuing opportunities to increase throughput and storage volumes, as well as by managing costs and improving operating efficiencies. We also intend to consider opportunities to increase revenue on our pipeline, terminal and storage systems by evaluating and capitalizing on organic expansion projects that may arise in the markets we serve.

Competitive Strengths

We believe we are well positioned to execute our business strategies based on the following competitive strengths:

 

 

Strategic relationship with Phillips 66.    We have a strategic relationship with Phillips 66, a large, independent downstream energy company with an investment grade credit rating. Following this offering, Phillips 66 will own our general partner, a     % limited partner interest in us (or     % if the underwriters’ option to purchase additional common units is exercised in full) and all of our incentive distribution rights. We believe that our relationship with Phillips 66 is likely to provide us with attractive growth opportunities, as well as an investment grade commercial counterparty that initially will be the source of substantially all of our revenue.

 

 

Stable and predictable cash flows.    Our assets consist of both common carrier and proprietary pipelines and terminal and storage facilities that generate stable revenue from tariffs and fees. We will initially generate substantially all of our revenue under tariffs and fees that are supported by long-term commercial agreements with Phillips 66 that include minimum volume commitments and inflation escalators. We believe these agreements will promote cash flow stability and predictability. On a pro forma basis, Phillips 66’s minimum commitments under these agreements would have accounted for approximately 87% of our total revenue for the year ended December 31, 2012, had those agreements been in effect during that period.

 

 

Highly integrated assets.    Our initial assets are integral to the operations of Phillips 66’s wholly owned Lake Charles and Sweeny refineries and its jointly owned Wood River refinery. We believe these are well-positioned refineries with access to attractively priced crude oil and high demand markets for refined petroleum products. Our crude oil and refined petroleum product pipelines, terminals and storage facilities are directly connected to these refineries and provide Phillips 66 with a cost effective way to access crude oil supply at the Lake Charles refinery and distribute refined petroleum products at the Sweeny and Wood River refineries.

 

 

High-quality, well-maintained asset base.    We continually invest in the maintenance and integrity of our assets and utilize various programs to help us efficiently monitor and maintain our asset base. We employ Phillips 66’s pipeline and facility integrity program, which focuses on risk analysis, assessment, inspection, preventive measures, repair and data integration to prevent, control and mitigate unintentional releases of hazardous materials. We also use Phillips 66’s technologically advanced pipeline control center to monitor our operations.

 

 

Financial flexibility.    We will retain a significant portion of the net proceeds from this offering to use for general partnership purposes, including to fund potential future expansion capital expenditures and potential future acquisitions from Phillips 66 and third parties. Additionally, in connection with this offering, we will have in place an undrawn revolving credit facility with $         million of available capacity. We believe that, following this offering, we will have the available liquidity and financial flexibility to execute our growth strategy.

 

 

Experienced leadership team.    Our management team has substantial experience in the management and operation of pipelines, terminals, storage facilities and other transportation and midstream assets. Our management team also has expertise in acquiring and integrating assets as well as executing growth strategies in the transportation and midstream sector. Our management team includes many senior employees of Phillips 66, who average over 28 years of experience in the energy industry.

 

 

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Table of Contents

Our Assets and Operations

Our initial assets consist of the following three systems:

 

 

Clifton Ridge crude system.    A crude oil pipeline, terminal and storage system located in Sulphur, Louisiana, that is the primary source for delivery of crude oil to Phillips 66’s Lake Charles refinery.

 

 

Sweeny to Pasadena products system.    A refined petroleum product pipeline, terminal and storage system extending from Phillips 66’s Sweeny refinery in Old Ocean, Texas, to our refined petroleum product terminal in Pasadena, Texas, and ultimately connecting to the Explorer and Colonial refined petroleum product pipeline systems and other third-party pipeline and terminal systems. This system is the sole distribution outlet for diesel and gasoline produced at Phillips 66’s Sweeny refinery.

 

 

Hartford Connector products system.    A refined petroleum product pipeline, terminal and storage system located in Hartford, Illinois, that distributes diesel and gasoline produced at the Wood River refinery (a refinery owned by a joint venture between Phillips 66 and Cenovus Energy Inc.) to third-party pipeline and terminal systems, including the Explorer refined petroleum product pipeline system.

Pipeline assets

The following table sets forth certain information regarding our pipeline assets, each of which currently has, or will have, as of the closing of this offering, an associated commercial agreement with Phillips 66:

 

System name

  Length
(miles)
    Capacity
(MBD)
    Commodity
handled
    Associated
Phillips  66
Refinery
    Significant third-
party pipeline
system

connections
 

Clifton Ridge crude system

    11        300 (1)      Crude oil        Lake Charles       
 
Shell Houma to
Houston
  
  

Sweeny to Pasadena products system

    120 (2)      263       

 

 

Refined

petroleum

products

 

 

  

    Sweeny       

 

Explorer;

Colonial

 

  

Hartford Connector products system

    4        80 (3)     

 

 

Refined

petroleum

products

 

 

  

    Wood River        Explorer   

 

(1) Represents the capacity of our Clifton Ridge to Lake Charles refinery pipeline.
(2) Comprising two separate side-by-side 60-mile pipelines.
(3) Represents the capacity of our Wood River to Hartford pipeline.

 

 

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Terminal and storage assets

The following table sets forth certain information regarding our terminal and storage assets, each of which currently has, or will have, as of the closing of this offering, an associated commercial agreement with Phillips 66:

 

System name

   Tank shell
storage
capacity
(Mbbls)
     Active
terminaling
capacity
(MBD)(1)
     Commodity
handled
     Associated
Phillips  66

Refinery
     Significant third-
party pipeline
system
connections
 

Clifton Ridge crude system

     3,552         12         Crude oil         Lake Charles        
 
Shell Houma to
Houston
  
  

Sweeny to Pasadena products system

     3,210         65        

 

 

Refined

petroleum

products

 

 

  

     Sweeny        
 
Explorer;
Colonial
  
  

Hartford Connector products system

     1,075         17        

 

 

Refined

petroleum

products

 

 

  

     Wood River         Explorer   

 

(1) Active terminaling capacity represents the amount of truck loading and unloading capacity currently available for use by our customers.

Marine assets

The following table sets forth certain information regarding our marine assets, each of which currently has, or will have, as of the closing of this offering, an associated commercial agreement with Phillips 66:

 

System name

   Dock
throughput
capacity
(MBPH)
     Commodity
handled
     Associated
Phillips 66 Refinery
 

Clifton Ridge crude system

        

Clifton Ridge ship dock

     48         Crude oil         Lake Charles   

Pecan Grove barge dock

     6         Crude oil; Base oils         Lake Charles   

Hartford Connector products system

        

Hartford barge dock

     3        

 

 

Dyed diesel;

Naphtha;

Base oils

 

 

  

     Wood River   

Right of first offer assets

Phillips 66 has granted us a right of first offer on its one-third equity interest in Sand Hills, which is currently constructing a major 720-mile NGL pipeline that will provide new NGL transportation from the Permian Basin and the Eagle Ford shale area to markets on the Gulf Coast, and its one-third equity interest in Southern Hills, which is currently converting to NGL service a refined petroleum product pipeline that extends more than 800 miles from the Midcontinent region to the Texas Gulf Coast. These pipelines interconnect with strategically located third-party NGL infrastructure, and move product to Mont Belvieu, Texas. We believe these pipelines will provide needed takeaway capacity for the transportation of NGL from established shale basins, improve the reliability of the existing NGL pipeline network in the Midcontinent and Gulf Coast regions of the United States and enhance the distribution of NGL products to meet the increasing demand for NGL from the petrochemical industry and export markets.

 

 

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Our Commercial Agreements with Phillips 66

Our assets are physically connected to, and integral to the operation of, Phillips 66’s wholly owned Lake Charles and Sweeny refineries and its jointly owned Wood River refinery. At the closing of this offering, we will have multiple commercial agreements with Phillips 66 that will include minimum volume commitments and inflation escalators and that initially will be the source of substantially all of our revenue. Under these long-term, fee-based agreements, we will provide transportation, terminaling and storage services to Phillips 66, and Phillips 66 will commit to provide us with minimum quarterly throughput volumes of crude oil and refined petroleum products.

On a pro forma basis, Phillips 66’s minimum commitments under these agreements would have accounted for approximately 87% of our revenue for the year ended December 31, 2012, had those agreements been in effect during that period. The following table sets forth additional information regarding our commercial agreements with Phillips 66:

Commercial agreements

 

Agreement

   Initial term
(years)
    Maximum
additional
renewal
terms
(years)(1)
     Phillips 66
minimum
volume
commitment
(MBD)
     Phillips 66
capacity
reservation
(MBD)
 

Transportation services agreements

          

Clifton Ridge transportation services agreement

     10        10         

Clifton Ridge to Lake Charles refinery pipeline

          190           

Pecan Grove to Clifton Ridge pipeline(2)

                    

Shell to Clifton Ridge pipeline(2)

                    

Sweeny to Pasadena transportation services agreement

     10        10         

Sweeny to Pasadena pipelines(3)

          200           

Hartford Connector throughput and deficiency agreement

     23 (4)              

Wood River refinery to Hartford pipeline

          43         12.2   

Hartford to Explorer pipeline

          24         31.2   

Terminaling services agreements

          

Clifton Ridge terminaling services agreement

     5        15         

Clifton Ridge terminal storage(5)

          190           

Clifton Ridge ship dock / Pecan Grove barge dock(6)

          150           

Master terminaling services agreement

     5        15         

Pasadena terminal(7)

          135           

Pasadena and Hartford terminal truck racks(8)

          55           

Hartford barge dock(2)

                    

 

(1) Renewable at Phillips 66’s option only.
(2) This asset does not have a minimum volume commitment from Phillips 66 under the applicable commercial agreement.
(3) Represents Phillips 66’s aggregate minimum volume commitment for transportation services on our 60-mile 12-inch and 18-inch Sweeny to Pasadena pipelines.
(4) The term of our Hartford Connector throughput and deficiency agreement began in January 2008. At the closing of this offering, we will amend this agreement to reflect Phillips 66’s quarterly minimum volume commitment and the fees to be paid to us under the agreement.
(5) Represents Phillips 66’s minimum volume commitment for storage services at our Clifton Ridge terminal.
(6) Represents Phillips 66’s aggregate minimum volume commitment for ship and barge offloading services at our Clifton Ridge ship dock and our Pecan Grove barge dock.
(7) Represents Phillips 66’s minimum volume commitment for pumpover services at our Pasadena terminal.
(8) Represents Phillips 66’s aggregate minimum volume commitment for truck rack throughput at our Pasadena and Hartford terminals.

For more information related to our commercial agreements with Phillips 66, as well as the revenue we expect to receive in connection with these agreements for the twelve months ending March 31, 2014, please read “Cash Distribution Policy and Restrictions on Distributions—Significant Forecast Assumptions” and “Business—Our Commercial Agreements with Phillips 66.”

 

 

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Our Relationship with Phillips 66

One of our principal strengths is our relationship with Phillips 66. Phillips 66 is a large, independent downstream energy company with an investment grade credit rating and refining and marketing, transportation, midstream and chemicals businesses with a key focus on safe and reliable operations. Phillips 66 is one of the largest independent petroleum refiners in the United States and globally, with a net crude oil processing capacity of 2.2 million barrels per day, as of January 1, 2013. Phillips 66 also has extensive transportation and midstream operations that transport and store crude oil; transport, store and distribute refined petroleum products; transport natural gas; and transport, store, fractionate and market NGL. For more information related to Phillips 66’s operations, please read “Business—Phillips 66’s Operations.”

Following the closing of this offering, Phillips 66 will retain a significant interest in us through its ownership of our general partner, a     % limited partner interest in us (or     % if the underwriters’ option to purchase additional common units is exercised in full) and all of our incentive distribution rights. We believe Phillips 66 will promote and support the successful execution of our business strategies given its significant ownership in us following this offering, the importance of our initial assets to Phillips 66’s refining and marketing operations and its stated intention to use us as a primary vehicle to grow its transportation and midstream businesses.

In addition to the commercial agreements we will enter into with Phillips 66 upon the closing of this offering, we will enter into an omnibus agreement with Phillips 66 under which Phillips 66 will grant us a right of first offer to acquire its one-third equity interest in each of Sand Hills and Southern Hills, which are currently completing two significant NGL pipeline infrastructure projects. The omnibus agreement will also address our reimbursement of Phillips 66 for certain corporate services and Phillips 66’s indemnification of us for certain matters, including environmental, title and tax matters.

While our relationship with Phillips 66 and its affiliates is a significant strength, it is also a source of potential risks and conflicts. Please read “Risk Factors—Risks Inherent in an Investment in Us” and “Conflicts of Interest and Duties.”

Our Emerging Growth Company Status

As a company with less than $1.0 billion in revenue during its last fiscal year, we qualify as an “emerging growth company” as defined in the Jumpstart Our Business Startups Act of 2012, or the JOBS Act. As an emerging growth company, we may, for up to five years, take advantage of specified exemptions from reporting and other regulatory requirements that are otherwise applicable generally to public companies. These exemptions include:

 

 

the presentation of only two years of audited financial statements and only two years of related Management’s Discussion and Analysis of Financial Condition and Results of Operations;

 

 

exemption from the auditor attestation requirement on the effectiveness of our system of internal control over financial reporting;

 

 

exemption from the adoption of new or revised financial accounting standards until they would apply to private companies;

 

 

exemption from compliance with any new requirements adopted by the Public Company Accounting Oversight Board requiring mandatory audit firm rotation or a supplement to the auditor’s report in which the auditor would be required to provide additional information about the audit and the financial statements of the issuer; and

 

 

reduced disclosure about executive compensation arrangements.

 

 

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We may take advantage of these provisions until we are no longer an emerging growth company, which will occur on the earliest of (i) the last day of the fiscal year following the fifth anniversary of this offering, (ii) the last day of the fiscal year in which we have more than $1.0 billion in annual revenue, (iii) the date on which we have more than $700.0 million in market value of our common units held by non-affiliates and (iv) the date on which we issue more than $1.0 billion of non-convertible debt over a three-year period.

We have elected to take advantage of all of the applicable JOBS Act provisions, except that we will elect to opt out of the exemption that allows emerging growth companies to extend the transition period for complying with new or revised financial accounting standards (this election is irrevocable).

Accordingly, the information that we provide you may be different than what you may receive from other public companies in which you hold equity interests.

Risk Factors

An investment in our common units involves risks associated with our business, our partnership structure and the tax characteristics of our common units. You should carefully consider the risks described in “Risk Factors” and the other information in this prospectus before investing in our common units.

The Transactions

We were formed in February 2013 by Phillips 66 to own, operate, develop and acquire primarily fee-based crude oil, refined petroleum product and NGL pipelines and terminals and other transportation and midstream assets. In connection with this offering, Phillips 66 will contribute all of our Predecessor’s assets and operations to us.

Additionally, at or prior to the closing of this offering, the following transactions will occur:

 

 

we will issue              common units and              subordinated units to Phillips 66, representing an aggregate     % limited partner interest in us, and              general partner units, representing a 2% general partner interest in us, and all of our incentive distribution rights to our general partner;

 

 

we will issue              common units to the public in this offering, representing a     % limited partner interest in us, and will apply the net proceeds as described in “Use of Proceeds”;

 

 

we will enter into a new $         million revolving credit facility;

 

 

we will enter into multiple long-term commercial agreements with Phillips 66 and amend an existing commercial agreement with Phillips 66;

 

 

we will enter into an omnibus agreement with Phillips 66 and certain of its affiliates, including our general partner; and

 

 

we will enter into an operational services agreement with Phillips 66 Pipeline LLC, a wholly owned subsidiary of Phillips 66.

We will use any net proceeds from the exercise of the underwriters’ option to purchase additional common units from us for general partnership purposes. If the underwriters exercise in full their option to purchase additional common units from us, the ownership interest of the public unitholders will increase to              common units, representing an aggregate     % limited partner interest in us, our general partner will own              general partner units, representing a 2% general partner interest in us, and the ownership interest of Phillips 66 will remain at              common units and              subordinated units, representing an aggregate     % limited partner interest in us.

 

 

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Organizational Structure After the Transactions

After giving effect to the transactions described above, assuming the underwriters’ option to purchase additional common units from us is not exercised, our units will be held as follows:

 

Public common units

       

Phillips 66 common units

       

Phillips 66 subordinated units

       

General partner units

     2
  

 

 

 

Total

     100
  

 

 

 

The following simplified diagram depicts our organizational structure after giving effect to the transactions described above.

 

LOGO

 

 

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Management of Phillips 66 Partners LP

We are managed and operated by the board of directors and executive officers of Phillips 66 Partners GP LLC, our general partner. Phillips 66 is the sole owner of our general partner and has the right to appoint the entire board of directors of our general partner, including the independent directors appointed in accordance with the listing standards of the New York Stock Exchange (“NYSE”). Unlike shareholders in a publicly traded corporation, our unitholders will not be entitled to elect our general partner or the board of directors of our general partner. Many of the executive officers and directors of our general partner also currently serve as executive officers of Phillips 66. For more information about the directors and executive officers of our general partner, please read “Management—Directors and Executive Officers of Phillips 66 Partners GP LLC.”

In order to maintain operational flexibility, our operations will be conducted through, and our operating assets will be owned by, various operating subsidiaries. However, neither we nor our subsidiaries will have any employees. Our general partner has the sole responsibility for providing the personnel necessary to conduct our operations, whether through directly hiring employees or by obtaining the services of personnel employed by Phillips 66 or others. All of the personnel that will conduct our business immediately following the closing of this offering will be employed or contracted by our general partner and its affiliates, including Phillips 66, but we sometimes refer to these individuals in this prospectus as our employees because they provide services directly to us.

Principal Executive Offices and Internet Address

Our principal executive offices are located at 3010 Briarpark Drive, Houston, Texas 77042, and our telephone number is (855) 283-9237. Following the completion of this offering, our website will be located at www.            .com. We expect to make our periodic reports and other information filed with or furnished to the Securities and Exchange Commission (“SEC”) available, 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 into this prospectus and does not constitute a part of this prospectus.

Summary of Conflicts of Interest and Duties

Under our partnership agreement, our general partner has a duty to manage us in a manner it believes is in the best interests of our partnership. However, because our general partner is a wholly owned subsidiary of Phillips 66, the officers and directors of our general partner have a duty to manage the business of our general partner in a manner that is in the best interests of Phillips 66. As a result of this relationship, conflicts of interest may arise in the future between us and our unitholders, on the one hand, and our general partner and its affiliates, including Phillips 66, 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. In addition, our general partner may determine to manage our business in a way that directly benefits Phillips 66’s refining or marketing businesses, whether by causing us not to seek higher tariff rates or not to connect our pipelines with those of other third parties or otherwise, rather than indirectly benefitting Phillips 66 solely through its ownership interests in us. All of these actions are permitted under our partnership agreement and will not be a breach of any duty (fiduciary or otherwise) of our general partner. For a more detailed description of the conflicts of interest and fiduciary duties of our general partner, please read “Conflicts of Interest and Duties.”

Delaware law provides that Delaware limited partnerships may, in their partnership agreements, expand, restrict or eliminate the fiduciary duties owed by the general partner to limited partners and the partnership. Our partnership agreement contains various provisions replacing the fiduciary duties that would otherwise be owed by our general partner with contractual standards governing the duties of the general partner and contractual

 

 

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methods of resolving conflicts of interest. The effect of these provisions is to restrict the remedies available to unitholders for actions that might otherwise constitute breaches of our general partner’s fiduciary duties. Our partnership agreement also provides that affiliates of our general partner, including Phillips 66 and its affiliates (including DCP Midstream and Chevron Phillips Chemical Company LLC, or CPChem, a joint venture with Chevron U.S.A. Inc., a wholly owned subsidiary of Chevron Corporation), are not restricted from competing with us, and neither our general partner nor its affiliates have any obligation to present business opportunities to us. 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 our partnership agreement that might otherwise be considered a breach of fiduciary or other duties under Delaware law. Please read “Conflicts of Interest and Duties—Duties of the General Partner” for a description of the fiduciary duties imposed on our general partner by Delaware law, the replacement of those duties with contractual standards under our partnership agreement and certain legal rights and remedies available to holders of our common units and subordinated units. For a description of our other relationships with our affiliates, please read “Certain Relationships and Related Party Transactions.”

 

 

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THE OFFERING

 

Common units offered to the public

             common units.

 

               common units if the underwriters exercise in full their option to purchase additional common units from us.

 

Units outstanding after this offering

             common units and              subordinated units, representing a     % and     %, respectively, limited partner interest in us (or              common units and              subordinated units, representing a     % and     % limited partner interest in us, respectively, if the underwriters exercise in full their option to purchase additional common units from us). The general partner will own              general partner units (or              general partner units if the underwriters exercise in full their option to purchase additional common units from us), representing a 2% general partner interest in us.

 

Use of proceeds

We expect to receive net proceeds of approximately $         million from the sale of common units offered by this prospectus based on the initial public offering price of $         per common unit (the mid-point of the price range set forth on the cover of this prospectus), after deducting underwriting discounts, structuring fees and estimated offering expenses. We intend to use the net proceeds as follows:

 

   

$         million will be used to pay revolving credit facility origination and commitment fees; and

 

   

the remainder will be retained by us for general partnership purposes, including to fund potential future expansion capital expenditures and potential future acquisitions from Phillips 66 and third parties.

 

  If the underwriters exercise their option to purchase additional common units in full, the additional net proceeds to us would be approximately $         million. The net proceeds from any exercise by the underwriters of their option to purchase additional common units from us will be retained by us for general partnership purposes.

 

Cash distributions

We intend to make a minimum quarterly distribution of $         per unit 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.

 

  For the quarter in which this offering closes, we will pay a prorated distribution on our units covering the period from the completion of this offering through                     , 2013, based on the actual length of that period.

 

 

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  In general, we will pay any cash distributions we make each quarter in the following manner:

 

   

first, 98% to the holders of common units and 2% to our general partner, until each common unit has received a minimum quarterly distribution of $         plus any arrearages from prior quarters;

 

   

second, 98% to the holders of subordinated units and 2% to our general partner, until each subordinated unit has received a minimum quarterly distribution of $        ; and

 

   

third, 98% to all unitholders, pro rata, and 2% to our general partner, until each unit has received a distribution of $        .

 

  If cash distributions to our unitholders exceed $         per unit in any quarter, our general partner will receive, in addition to distributions on its 2% general partner interest, increasing percentages, up to 48%, 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, has the right to reset the target distribution levels described above 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.”

 

  If we do not generate sufficient available cash from operations, we may, but are under no obligation to, borrow funds to pay the minimum quarterly distribution to our unitholders.

 

 

Pro forma cash available for distribution attributable to us that was generated during the year ended December 31, 2012, was approximately $61.7 million. The amount of available cash we 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% interest is approximately $         million (or an average of approximately $         million per quarter) (or, if the underwriters exercise in full their option to purchase additional common units from us, approximately $         million (or an average of approximately $         million per quarter)). As a result, assuming the underwriters do not exercise their option to purchase additional common units from us, for the year ended December 31, 2012, on a pro forma basis, we would have generated available cash sufficient to pay the aggregate annualized minimum quarterly distribution on all of our common units and subordinated units and the corresponding distributions on our general partner’s 2% interest during those periods. However, if the underwriters exercise in full their option to purchase additional common units from us, we would have had a shortfall of approximately $                 in the aggregate with respect to the payment of the aggregate annualized minimum quarterly distribution, which would have still allowed us to pay the aggregate annualized minimum quarterly distribution on all of our common units, but only

 

 

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    % on our subordinated units, and the corresponding distributions on our general partner’s 2% interest during that period. Please read “Cash Distribution Policy and Restrictions on Distributions—Unaudited Pro Forma Cash Available for Distribution for the Year Ended December 31, 2012.”

 

  We believe, based on our financial forecast and related assumptions included in “Cash Distribution Policy and Restrictions on Distributions—Estimated Cash Available for Distribution for the Twelve Months Ending March 31, 2014,” that we will have sufficient available cash to pay the aggregate minimum quarterly distribution of $         million (or $         million if the underwriters exercise in full their option to purchase additional common units from us) on all of our common units and subordinated units and the corresponding distributions on our general partner’s 2% interest for the twelve months ending March 31, 2014. However, we do not have a legal obligation to pay distributions at our minimum quarterly distribution rate or at any other rate except as provided in our partnership agreement, and there is no guarantee that we will make quarterly cash distributions to our unitholders. Please read “Cash Distribution Policy and Restrictions on Distributions.”

 

Subordinated units

Phillips 66 will initially own all of our subordinated units. The principal difference between our common units and subordinated units is that for any quarter during the subordination period, the subordinated units will not be entitled to receive any distribution until the common units have received the minimum quarterly distribution for such quarter plus any arrearages in the payment of the minimum quarterly distribution from prior quarters during the subordination period. Subordinated units will not accrue arrearages.

 

Conversion of subordinated units

The subordination period will end on the first business day after the date that we have earned and paid distributions of available cash of at least (1) $         (the annualized minimum quarterly distribution) on each of the outstanding common units, subordinated units and general partner units for each of three consecutive, non-overlapping four quarter periods ending on or after                     , 2016, or (2) $         (150% of the annualized minimum quarterly distribution) on each of the outstanding common units, subordinated units and general partner units and the related distributions on the incentive distribution rights for any four-quarter period ending on or after                     , 2014, in each case provided there are no arrearages in payment of the minimum quarterly distributions on our common units at that time.

 

  The subordination period also will end upon the removal of our general partner other than for cause if no subordinated units or common units held by the holders of subordinated units or their affiliates are voted in favor of that removal.

 

 

When the subordination period ends, each outstanding subordinated unit will convert into one common unit, and common units will no

 

 

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longer be entitled to arrearages. Please read “Provisions of Our Partnership Agreement Relating to Cash Distributions—Subordinated Units and Subordination Period.”

 

Issuance of additional units

Our partnership agreement authorizes us to issue an unlimited number of additional units without the approval of our unitholders. Our unitholders will not have preemptive or participation rights to purchase their pro rata share of any additional units issued. Please read “Units Eligible for Future Sale” and “Our Partnership Agreement—Issuance of Additional Securities.”

 

Limited voting rights

Our general partner will manage and operate us. Unlike the holders of common stock in a corporation, our unitholders will have only limited voting rights on matters affecting our business. Our unitholders will have no right to elect our general partner or its directors on an annual or other 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 units, including any units owned by our general partner and its affiliates, voting together as a single class. Upon consummation of this offering, Phillips 66 will own an aggregate of     % of our common and subordinated units (or     % of our common and subordinated units, if the underwriters exercise their option to purchase additional common units in full). This will give Phillips 66 the ability to prevent the removal of our general partner. Please read “Our Partnership Agreement—Voting Rights.”

 

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 has the right, but not the obligation, to purchase all of the remaining common units at a price equal to the greater of (1) the average of the daily closing price of our common units over the 20 trading days preceding the date that is three business days before notice of exercise of the call right is first mailed and (2) the highest per-unit price paid by our general partner or any of its affiliates for common units during the 90-day period preceding the date such notice is first mailed. Please read “Our Partnership Agreement—Limited Call Right.”

 

Redemption of ineligible holders

Units held by persons who our general partner determines are not “citizenship eligible holders” or “rate eligible holders” will be subject to redemption. Citizenship eligible holders are individuals or entities whose nationality, citizenship or other related status does not create a substantial risk of cancellation or forfeiture of any property, including any governmental permit, endorsement or other authorization, in which we have an interest, and will generally include individuals and entities who are U.S. citizens. Rate eligible holders are:

 

   

individuals or entities subject to U.S. federal income taxation on the income generated by us; or

 

   

entities not subject to U.S. federal income taxation on the income generated by us, so long as all of the entity’s owners are domestic individuals or entities subject to such taxation.

 

 

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  We will have the right, which we may assign to any of our affiliates, but not the obligation, to redeem all of the common units of any holder that is not a citizenship eligible holder or a rate eligible holder or that has failed to certify or has falsely certified that such holder is a citizenship eligible holder or a rate eligible holder. The redemption price will be equal to the market price of the common units as of the date three days before the date the notice of redemption is mailed. The redemption price will be paid in cash or by delivery of a promissory note, as determined by our general partner. The units held by any person the general partner determines is not a citizenship eligible holder will not be entitled to voting rights.

 

  Please read “Our Partnership Agreement—Redemption of Ineligible Holders.”

 

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             , you will be allocated, on a cumulative basis, an amount of federal taxable income for that period that will be     % or less of the cash distributed to you with respect to that period. For example, if you receive an annual distribution of $         per unit, we estimate that your average allocable federal taxable income per year will be no more than approximately $         per unit. Thereafter, the ratio of allocable taxable income to cash distributions to you could substantially increase. Please read “Material Federal Income Tax Consequences—Tax Consequences of Unit Ownership—Ratio of Taxable Income to Distributions” for the basis of this estimate.

 

Material federal income tax consequences

For a discussion of the 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.”

 

Exchange listing

We intend to apply to list our common units on the New York Stock Exchange under the symbol “PSXP.”

 

 

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SUMMARY HISTORICAL AND PRO FORMA COMBINED FINANCIAL DATA

The following table shows summary historical combined financial data of Phillips 66 Partners LP Predecessor, our predecessor for accounting purposes (our “Predecessor”), and summary unaudited pro forma combined financial data of Phillips 66 Partners LP for the periods and as of the dates indicated. The summary historical combined financial statements of our Predecessor for the years ended December 31, 2012 and 2011, are derived from the audited combined financial statements of our Predecessor appearing elsewhere in this prospectus. The following table should be read together with, and is qualified in its entirety by reference to, the 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.”

The summary unaudited pro forma combined financial statements presented in the following table as of, and for the year ended, December 31, 2012, are derived from the unaudited pro forma combined financial statements included elsewhere in this prospectus. The unaudited pro forma combined balance sheet assumes the offering and the related transactions occurred as of December 31, 2012, and the unaudited pro forma combined statement of income for the year ended December 31, 2012, assumes the offering and the related transactions occurred as of January 1, 2012. These transactions include, and the unaudited pro forma combined financial statements give effect to, the following:

 

 

Phillips 66’s contribution of all of our Predecessor’s assets to us;

 

 

our entry into a new $         million revolving credit facility, which we have assumed was not drawn during the pro forma period presented, estimated commitment fees that would have been paid had our revolving credit been in place during the pro forma period presented, and the amortization of estimated deferred issuance costs associated with the revolving credit facility;

 

 

our entry into multiple long-term commercial agreements with Phillips 66, our amendment of an existing commercial agreement with Phillips 66, and the recognition of transportation and terminaling revenue under those agreements at historical rates that were not recognized by our Predecessor;

 

 

our entry into an omnibus agreement with Phillips 66 and certain of its affiliates, including our general partner;

 

 

our entry into an operational services agreement with Phillips 66 Pipeline LLC;

 

 

the consummation of this offering and our issuance of              common units to the public,              general partner units and the incentive distribution rights to our general partner and              common units and              subordinated units to Phillips 66; and

 

 

the application of the net proceeds of this offering as described in “Use of Proceeds.”

The unaudited pro forma combined financial statements do not give effect to an estimated $3.6 million in incremental general and administrative expenses that we expect to incur annually as a result of being a separate publicly traded partnership. In addition, while we give pro forma effect to the costs we will incur under the omnibus agreement and operational services agreement that we will enter into with Phillips 66 as of the closing of this offering, those adjustments in the aggregate have yielded a similar result to the costs that our Predecessor incurred historically.

 

 

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     Phillips 66 Partners LP
Predecessor historical
    Phillips 66
Partners LP pro
forma
 
     Year ended December 31,  

(in millions, except unit amounts)

       2012             2011         2012  
                 (unaudited)  

Combined statements of income:

      

Revenue:

      

Transportation and terminaling services—Phillips 66

   $ 79.7      $ 75.6      $ 108.8   

Transportation and terminaling services—third parties

     0.4        0.4        0.4   

Total revenue

     80.1        76.0        109.2   

Costs and expenses:

      

Total costs and expenses

     38.7        37.2        46.6   

Net income

   $ 41.1      $ 38.5      $ 62.2   

Net income per limited partner unit (basic and diluted):

      

Common units

       $     

Subordinated units

       $     

Combined balance sheets (at period end):

      

Cash and cash equivalents

   $ —        $ —        $ 274.3 (1) 

Property, plant and equipment, net

     135.8        127.3        135.8   

Total assets

     144.9        134.7        421.5   

Total liabilities

     2.9        4.3        2.5   

Net investment

     142.0        130.4        —     

Partners’ capital

     —          —          419.0   

Total liabilities and net investment/partners’ capital

     144.9        134.7        421.5   

Combined statements of cash flows:

      

Net cash provided by (used in):

      

Operating activities

   $ 44.5      $ 43.7     

Investing activities

     (15.0     (10.5  

Financing activities

     (29.5     (33.2  

Other financial data:

      

EBITDA(2)

   $ 48.0      $ 44.6      $ 71.2   

 

(1) Represents the retained portion of the net proceeds of this offering after giving effect to the application of the net proceeds as described in “Use of Proceeds.”
(2) For a definition of the non-GAAP financial measure of EBITDA and a reconciliation of EBITDA to our most directly comparable financial measures calculated and presented in accordance with GAAP, please read “Selected Historical and Pro Forma Combined Financial Data—Non-GAAP Financial Measure.”

 

 

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RISK FACTORS

Investing in our common units involves a high degree of risk. You should carefully consider the risks described below with all of the other information included in this prospectus before deciding to invest in our common units. Limited partner interests are inherently different from the 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 a similar business. If any of the following risks actually occur, they may materially harm our business and our financial condition and results of operations. In this event, we might not be able to pay distributions on our common units, the trading price of our common units could decline, and you could lose part or all of your investment.

Risks Related to Our Business

Phillips 66 accounts for substantially all of our revenue. If Phillips 66 changes its business strategy, is unable to satisfy its obligations under our commercial agreements or significantly reduces the volumes transported through our pipelines or terminals or stored at our storage assets, our revenue would decline and our financial condition, results of operations, cash flows, and ability to make distributions to our unitholders would be materially and adversely affected.

For the year ended December 31, 2012, Phillips 66 accounted for 99.6% of our pro forma revenue. As we expect to initially derive substantially all of our revenue from multiple commercial agreements with Phillips 66, any event, whether in our areas of operation or elsewhere, that materially and adversely affects Phillips 66’s financial condition, results of operations or cash flows may adversely affect our ability to sustain or increase cash distributions to our unitholders. Accordingly, we are indirectly subject to the operational and business risks of Phillips 66, the most significant of which include the following:

 

 

the effects of changing commodity prices and refining and petrochemical margins;

 

 

the ability to obtain credit and financing on acceptable terms in light of current uncertainty and illiquidity in credit and capital markets, which could also adversely affect the financial strength of business partners;

 

 

a deterioration in Phillips 66’s credit profile could increase Phillips 66’s costs of borrowing money and limit Phillips 66’s access to the capital markets and commercial credit, which could also trigger co-venturer rights under Phillips 66’s joint venture arrangements;

 

 

the substantial capital expenditures and operating costs required to comply with existing and future environmental laws and regulations, which could also impact or limit Phillips 66’s current business plans and reduce product demand;

 

 

the effects of domestic and worldwide political and economic developments could materially reduce Phillips 66’s profitability and cash flows;

 

 

large capital projects can take many years to complete, and market conditions could deteriorate significantly between the project approval date and the project startup date, negatively impacting project returns;

 

 

investments in joint ventures decrease Phillips 66’s ability to manage risk and may adversely affect the distributions that Phillips 66 receives from the joint venture;

 

 

significant losses resulting from the hazards and risks of operations may not be fully covered by insurance, and could adversely affect Phillips 66’s operations and financial results;

 

 

interruptions of supply and increased costs as a result of Phillips 66’s reliance on third-party transportation of crude oil and refined products;

 

 

increased regulation of hydraulic fracturing could result in reductions or delays in domestic production of crude oil and natural gas, which could adversely impact Phillips 66’s results of operations;

 

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competitors that produce their own supply of feedstocks, have more extensive retail outlets, or have greater financial resources may have a competitive advantage over Phillips 66;

 

 

potential losses from Phillips 66’s forward-contract and derivative transactions may have an adverse impact on its results of operations and financial condition;

 

 

a significant interruption in one or more of Phillips 66’s facilities could adversely affect business;

 

 

any decision by Phillips 66 to temporarily or permanently curtail or shut down operations at one or more of its domestic refineries or other facilities and reduce or terminate its obligations under our commercial agreements;

 

 

Phillips 66’s performance depends on the uninterrupted operation of its refineries and other facilities, which are becoming increasingly dependent on information technology systems; and

 

 

potential indemnification of ConocoPhillips by Phillips 66 for various matters related to Phillips 66’s spin-off may have an adverse impact on its results of operations and financial condition.

Phillips 66 is not obligated to use our services with respect to volumes of crude oil or products in excess of the minimum volume commitments under its commercial agreements with us. In addition, other than our Hartford Connector throughput and deficiency agreement, the initial terms of Phillips 66’s obligations under those agreements generally range from five to ten years. If Phillips 66 fails to use our assets and services after expiration of those agreements, or should our commercial agreements be invalidated for any reason, and we are unable to generate additional revenue from third parties, our ability to make cash distributions to unitholders may be materially and adversely affected.

Additionally, Phillips 66 continually considers opportunities presented by third parties with respect to its assets. These opportunities may include offers to purchase and joint venture propositions. Phillips 66 may also change its operations by constructing new facilities, suspending or reducing certain operations, modifying or closing facilities or terminating operations. Changes may be considered to meet market demands, to satisfy regulatory requirements or environmental and safety objectives, to improve operational efficiency or for other reasons. Phillips 66 actively manages its assets and operations, and, therefore, changes of some nature, possibly material to its business relationship with us, are likely to occur at some point in the future.

We have no control over Phillips 66, our largest source of revenue and our primary customer, and Phillips 66 may elect to pursue a business strategy that does not favor us and our business. Please read “—Risks Inherent in an Investment in Us—Our general partner and its affiliates, including Phillips 66, have conflicts of interest with us and limited fiduciary duties to us and our unitholders, and they may favor their own interests to our detriment and that of our unitholders. Additionally, we have no control over the business decisions and operations of Phillips 66, and Phillips 66 is under no obligation to adopt a business strategy that favors us.”

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 and its affiliates, to enable us to pay the minimum quarterly distribution to our unitholders.

In order to pay the minimum quarterly distribution of $         per unit per quarter, or $         per unit on an annualized basis, we will require available cash of approximately $         million per quarter, or approximately $         million per year, based on the number of common units and subordinated units and the general partner interest to be outstanding immediately after completion of this offering (or $         million per quarter, or $         million per year, respectively, if the underwriters exercise in full their option to purchase additional common units from us). 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 volume of crude oil and refined petroleum products we transport;

 

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the tariff rates with respect to volumes that we transport; and

 

 

changes in revenue we realize under the loss allowance provisions of our regulated tariffs resulting from changes in underlying commodity prices.

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

 

 

the amount of our operating expenses and general and administrative expenses, including reimbursements to Phillips 66 in respect of those expenses;

 

 

the application by Phillips 66 of any remaining credit amounts to any volumes handled by our assets after the expiration or termination of our commercial agreement;

 

 

the application by Phillips 66 of credit amounts under our Hartford Connector throughput and deficiency agreement, which may be applied towards deficiency payments in future periods;

 

 

the level of capital expenditures we make;

 

 

the cost of acquisitions, if any;

 

 

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 our revolving credit facility and other debt service requirements;

 

 

the amount of cash reserves established by our general partner;

 

 

changes in commodity prices; and

 

 

other business risks affecting our cash levels.

If the underwriters exercise in full their option to purchase additional common units, on a pro forma basis we would not have generated available cash sufficient to pay the aggregate annualized minimum quarterly distributions on all of our subordinated units for the year ended December 31, 2012.

The amount of pro forma available cash generated during the year ended December 31, 2012 would have been sufficient to allow us to pay the aggregate annualized minimum quarterly distribution on all of our common units and subordinated units and the corresponding distributions on our general partner’s 2% interest during that period. However, if the underwriters exercise in full their option to purchase additional common units from us, we would have had a shortfall of approximately $                     in the aggregate with respect to the payment of the aggregate annualized minimum quarterly distribution, which would have still allowed us to pay the aggregate annualized minimum quarterly distribution on all of our common units, but only     % on our subordinated units, and the corresponding distributions on our general partner’s 2% interest during that period. For a calculation of our ability to make cash distributions based on our pro forma results for the year ended December 31, 2012, please read “Cash Distribution Policy and Restrictions on Distributions.”

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

The forecast of cash available for distribution set forth in “Cash Distribution Policy and Restrictions on Distributions” includes our forecast of our results of operations and cash available for distribution for the twelve months ending March 31, 2014. Our ability to pay the full minimum quarterly distribution in the forecast period

 

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is based on a number of assumptions that may not prove to be correct and that are discussed in “Cash Distribution Policy and Restrictions on Distributions.” Our financial forecast has been prepared by management, and we have neither received nor requested 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, regulatory and competitive risks, including those discussed in this prospectus, which could cause our actual results to be materially less than the amount forecasted. If we do not generate the forecasted results, we may not be able to make the minimum quarterly distribution or pay any amount on our common units or subordinated units, and the market price of our common units may decline materially.

Phillips 66 may suspend, reduce or terminate its obligations under our commercial agreements, and may avoid making deficiency payments under our Hartford Connector throughput and deficiency agreement, in certain circumstances, which could have a material adverse effect on our financial condition, results of operations, cash flows and ability to make distributions to our unitholders.

Our commercial agreements and operational services agreement with Phillips 66 include provisions that permit Phillips 66 to suspend, reduce or terminate its obligations under the applicable agreement if certain events occur. These events include Phillips 66 being prevented from transporting its full minimum volume commitment because of capacity constraints on our pipelines, our being subject to certain force majeure events that would prevent us from performing some or all of the required services under the applicable agreement and, subject to the provision of twelve months advance notice to us and certain other conditions, Phillips 66’s determination to suspend refining operations at one of its refineries in which any of our assets are integrated, either permanently or indefinitely for a period that will continue for at least twelve months. Phillips 66 has the discretion to make such decisions notwithstanding the fact that they may significantly and adversely affect us. These actions could result in a reduction or suspension of Phillips 66’s obligations under one or more commercial agreements. Additionally, if Phillips 66 decides to restructure its supply, refining or sales operations at a refinery in which any of our assets are integrated in such a way as to materially and adversely affect the economics of its performance under the applicable commercial agreement, the parties agree to negotiate in good faith regarding a reduction in Phillips 66’s commitment under such agreement or for a substitution of assets. Under our commercial agreements, Phillips 66’s minimum volume commitments will cover less than 100% of the operating capacity of our assets.

Under all of our commercial agreements, if the minimum capacity of any of our pipelines, terminals or storage assets falls below the level of Phillips 66’s applicable minimum commitment, Phillips 66’s minimum commitment may be reduced accordingly. Phillips 66’s and our obligations will also be proportionately reduced or suspended under any of these commercial agreements to the extent that either party is unable to perform under such agreement upon a declaration of a force majeure event. Accordingly, under our commercial agreements, these events could result in Phillips 66 no longer being required to transport or store its minimum volume commitments on our pipelines or terminals and at our storage assets or being required to pay the full amount of fees that would have been associated with its minimum volume commitments.

Any such reduction, suspension or termination of Phillips 66’s obligations would have a material adverse effect on our financial condition, results of operations, cash flows and ability to make distributions to our unitholders. Please read “Business—Our Commercial Agreements with Phillips 66.”

In addition, under our Hartford Connector throughput and deficiency agreement, if Phillips 66 transports any volumes in excess of 55,200 barrels per day on either our Wood River to Hartford pipeline or our Hartford to Explorer pipeline, Phillips 66 will accrue a transportation credit for such excess volumes equal to the amount of such excess volumes on such pipeline multiplied by the applicable tariff rate then in effect. Each transportation credit may be applied against any deficiency payments that may be owed during any of the next eight quarters. If that were to occur, Phillips 66 would not be obligated to pay us a deficiency payment on the applicable pipeline, regardless of Phillips 66’s minimum volume commitment, until any such remaining transportation credits were fully used or until the expiration of the applicable eight quarter period. Please read “Business—Our Commercial Agreements with Phillips 66.”

 

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Certain components of our revenue have exposure to direct commodity price risk, and our exposure to direct commodity price risk may increase in the future.

We have exposure to direct commodity price risk through the loss allowance provisions of our regulated tariffs and the commodity imbalance provisions of our commercial agreements. Based on our financial forecast included under the caption “Cash Distribution Policy and Restrictions on Distributions—Estimated Cash Available for Distribution for the Twelve Months Ending March 31, 2014,” for the twelve months ending March 31, 2014, we have forecasted that approximately 16% of our forecasted revenue for the period will be derived from our loss allowance provisions. Any future losses due to our commodity price risk exposure could materially and adversely affect our results of operations and financial condition and our ability in the future to make distributions to our unitholders. For more information about these loss allowance and commodity imbalance provisions, please read “Cash Distribution Policy and Restrictions on Distributions—Significant Forecast Assumptions” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Qualitative and Quantitative Disclosures About Market Risk.”

In addition, we may acquire or develop additional assets in the future that have a greater exposure to fluctuations in commodity prices than our current operations. Although we intend to continue to contractually minimize our exposure to direct commodity price risk in the future, our efforts to negotiate such contracts may not be successful. Increased exposure to the volatility of oil and refined product prices in the future could have a material adverse effect on our revenue and cash flow and our ability to make distributions to our unitholders.

Our operations and Phillips 66’s refining operations are subject to many risks and operational hazards, some of which may result in business interruptions and shutdowns of our or Phillips 66’s facilities and damages for which we may not be fully covered by insurance. If a significant accident or event occurs that results in a business interruption or shutdown for which we are not adequately insured, our operations and financial results could be materially and adversely affected.

Our operations are subject to all of the risks and operational hazards inherent in transporting, terminaling and storing crude oil and refined petroleum products, including:

 

 

damages to pipelines, terminals and facilities, related equipment and surrounding properties caused by earthquakes, tornados, hurricanes, floods, fires, severe weather, explosions and other natural disasters and acts of terrorism;

 

 

maintenance, repairs, mechanical or structural failures at our or Phillips 66’s facilities or at third-party facilities on which our or Phillips 66’s operations are dependent, including electrical shortages, power disruptions and power grid failures;

 

 

damages to and loss of availability of interconnecting third-party pipelines, terminals and other means of delivering crude oil, feedstocks and refined petroleum products;

 

 

disruption or failure of information technology systems and network infrastructure due to various causes, including unauthorized access or attack;

 

 

curtailments of operations due to severe seasonal weather, including weather events in the Gulf of Mexico;

 

 

riots, strikes, lockouts or other industrial disturbances;

 

 

inadvertent damage to pipelines from construction, farm and utility equipment; and

 

 

other hazards.

These risks could result in substantial losses due to personal injury and/or loss of life, severe damage to and destruction of property and equipment and pollution or other environmental damage, as well as business interruptions or shutdowns of our facilities. Any such event or unplanned shutdown could have a material adverse effect on our business, financial condition and results of operations. In addition, Phillips 66’s refining

 

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operations, on which our operations are substantially dependent, are subject to similar operational hazards and risks inherent in refining crude oil. A serious accident at our facilities or at Phillips 66’s facilities could result in serious injury or death to our employees or contractors or those of Phillips 66 or its affiliates and could expose us to significant liability for personal injury claims and reputational risk. We have no control over the operations at Phillips 66’s refineries and their associated facilities.

We do not maintain insurance coverage against all potential losses and could suffer losses for uninsurable or uninsured risks or in amounts in excess of existing insurance coverage. We carry separate policies for certain property damage, business interruption and third-party liabilities, which includes pollution liabilities, and are also insured under certain of Phillips 66’s liability policies and are subject to Phillips 66’s policy limits under these policies. The occurrence of an event that is not fully covered by insurance or failure by one or more insurers to honor its coverage commitments for an insured event could have a material adverse effect on our business, financial condition and results of operations.

A material decrease in the refining margins at Phillips 66’s refineries could cause Phillips 66 to reduce the volume of crude oil refined in its refineries which, in turn, could materially reduce the volumes of crude oil and refined petroleum products that we transport and store for Phillips 66, which could materially and adversely affect our financial condition, results of operations, cash flows and ability to make distributions to our unitholders.

The volumes of crude oil and refined petroleum products that we transport and store depend substantially on Phillips 66’s refining margins. Refining margins are dependent both upon the price of crude oil or other refinery feedstocks and the price of refined petroleum products. These prices are affected by numerous factors beyond our or Phillips 66’s control, including the global supply and demand for crude oil, gasoline and other refined petroleum products, competition from alternative energy sources and the impact of new and more stringent regulations and standards affecting the refining industry. In order to maintain or increase production levels at Phillips 66’s refineries, Phillips 66 must continually contract for new crude oil supplies or consider connecting to alternative sources of crude oil. Adverse developments in major oil producing regions around the world could have a significantly greater impact on our financial condition, results of operations and cash flows because of our lack of industry and geographic diversity and substantial reliance on Phillips 66 as a customer.

Renewable fuels and alternative energy mandates could reduce demand for refined petroleum products. Tax incentives and other subsidies for renewable fuels may make renewable fuels and alternative energy more competitive with refined petroleum products, which may reduce refining margins. If the demand for refined petroleum products, particularly in Phillips 66’s primary market areas, decreases significantly, or if there were a material increase in the price of crude oil supplied to Phillips 66’s refineries without an increase in the value of the products produced by those refineries, either temporary or permanent, which causes Phillips 66 to reduce production of products at its refineries, there would likely be a reduction in the volumes of crude oil and refined petroleum products that we transport and store for Phillips 66. If such conditions continue for an extended period of time, Phillips 66 would be unlikely to renew or extend such agreements after their terms expire. Any such reduction in the volumes of crude oil and refined petroleum products we transport for Phillips 66 or reduction, suspension or termination of Phillips 66’s obligations under our commercial agreements could materially and adversely affect our financial condition, results of operations, cash flows and ability to make distributions to our unitholders. For more information about how changes in supply and demand for crude oil and refined petroleum products and crude oil sourcing dynamics may affect us, please read “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Factors that Impact Our Business.”

 

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If we are unable to make acquisitions on economically acceptable terms from Phillips 66 or third parties, our future growth would be limited, and any acquisitions we may make may reduce, rather than increase, our cash flows and ability to make distributions to unitholders.

A portion of our strategy to grow our business and increase distributions to unitholders is dependent on our ability to make acquisitions that result in an increase in distributable cash flow per unit. The acquisition component of our growth strategy is based, in large part, on our expectation of ongoing divestitures of transportation and storage assets by industry participants, including Phillips 66. A material decrease in such divestitures would limit our opportunities for future acquisitions and could adversely affect our ability to grow our operations and increase cash distributions to our unitholders. If we are unable to make acquisitions from Phillips 66 or third parties, because (i) we are unable to identify attractive acquisition candidates or negotiate acceptable purchase contracts, (ii) we are unable to obtain financing for these acquisitions on economically acceptable terms or (iii) we are outbid by competitors, our future growth and ability to increase distributions will be limited. Furthermore, even if we do consummate acquisitions that we believe will be accretive, they may in fact result in a decrease in distributable cash flow per unit as a result of incorrect assumptions in our evaluation of such acquisitions or unforeseen consequences or other external events beyond our control. If we consummate any future acquisitions, unitholders will not have the opportunity to evaluate the economic, financial and other relevant information that we will consider in evaluating any such acquisitions.

Our right of first offer to acquire certain of Phillips 66’s existing assets is subject to risks and uncertainty, and ultimately we may not acquire any of those assets.

Our omnibus agreement provides us with a right of first offer on Phillips 66’s direct one-third equity interest in each of Sand Hills and Southern Hills for a period of five years following the closing of this offering. The consummation and timing of any future acquisitions of these interests will depend upon, among other things, Phillips 66’s willingness to offer these interests for sale, our ability to negotiate acceptable purchase agreements and commercial agreements with respect to the interests and our ability to obtain financing on acceptable terms. We can offer no assurance that we will be able to successfully consummate any future acquisitions pursuant to our right of first offer, and Phillips 66 is under no obligation to accept any offer that we may choose to make. We may decide not to exercise our right of first offer if and when any interests are offered for sale, and our decision will not be subject to unitholder approval. In addition, our right of first offer may be terminated by Phillips 66 at any time after it no longer controls our general partner. Even if we do successfully consummate any acquisitions pursuant to our right of first offer, DCP Midstream will continue to be the operator of the Sand Hills and Southern Hills pipelines and we will have limited ability to exercise influence over the operations or associated costs of the pipelines. Please read “Certain Relationships and Related Party Transactions—Agreements Governing the Transactions—Omnibus Agreement—Right of First Offer.”

Any reduction in volumes transported for Phillips 66 on interconnecting, third-party pipelines could cause a reduction of volumes transported on our pipelines.

At times, Phillips 66 is dependent upon connections to third-party pipelines to receive and deliver crude oil and refined petroleum products for transportation on our pipelines. Any reduction of capacities of these interconnecting pipelines due to testing, line repair, reduced operating pressures or other causes could result in reduced volumes of crude oil and refined petroleum products transported on our pipelines. In addition, it is possible that due to prorationing on third-party interconnecting pipelines, the allocations to Phillips 66 and other existing shippers on these pipelines could be reduced, which could also reduce volumes transported on our pipelines. Any significant reduction in volumes available for transportation on our pipelines would materially and adversely affect our revenue and cash flow and our ability to make distributions to our unitholders.

 

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If our tariffs are successfully challenged, we could be required to reduce our tariff rates, which would reduce our revenue and our ability to make distributions to our unitholders.

Under our commercial agreements, Phillips 66 has agreed not to challenge, or to cause others to challenge or assist others in challenging, our tariff rates in effect during the term of the agreements, except to the extent changes to the base tariff rate are inconsistent with FERC’s indexing methodology or other rate changing methodologies. This agreement does not prevent other shippers or interested persons from challenging our tariffs, including our tariff rates and proration rules; nor does it prevent regulators from reviewing our tariffs on their own initiative. At the end of the term of each of our commercial agreements, if the agreement is not renewed, Phillips 66 will be free to challenge, or to cause other parties to challenge or assist others in challenging, our tariffs in effect at that time. If our tariff rates are successfully challenged, we could be required to reduce our tariff rates, which would reduce our revenue and our ability to make distributions to our unitholders.

Our expansion of existing assets and construction of new assets may not result in revenue increases and will be subject to regulatory, environmental, political, legal and economic risks, which could adversely affect our operations and financial condition.

In order to optimize our existing asset base, we intend to evaluate and capitalize on organic opportunities for expansion projects in order to increase revenue on our pipeline, terminal and storage systems. The expansion of an existing pipeline, terminal or storage facility, such as by adding horsepower, pump stations or loading racks, or the construction of a new pipeline, terminal or storage asset, involves numerous regulatory, environmental, political and legal uncertainties, most of which are beyond our control. If we undertake these projects, they may not be completed on schedule or at all or at the budgeted cost. Moreover, we may not receive sufficient long-term contractual commitments from customers to provide the revenue needed to support such projects and we may be unable to negotiate acceptable interconnection agreements with third-party pipelines to provide destinations for increased throughput. Even if we receive such commitments or make such interconnections, we may not realize an increase in revenue for an extended period of time. As a result, new facilities may not be able to attract enough throughput to achieve our expected investment return, which could materially and adversely affect our results of operations and financial condition and our ability in the future to make distributions to our unitholders.

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

We do not own all of the land on which our pipelines are located, and we are, therefore, subject to the possibility of more onerous terms and increased costs to retain necessary land use if we do not have valid leases or 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, and some of our agreements may grant us those rights for only 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.

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

We will be dependent upon the earnings and cash flow generated by our operations in order to meet any debt service obligations and to allow us to make cash distributions to our unitholders. We expect to enter into a revolving credit facility in connection with this offering. The operating and financial restrictions and covenants in our revolving credit facility and any future financing agreements could restrict our ability to finance our future operations or capital needs or to expand or pursue our business activities, which may, in turn, limit our ability to make cash distributions to our unitholders.

The provisions of our revolving credit facility could affect our ability to obtain future financing and pursue attractive business opportunities and our flexibility in planning for, and reacting to, changes in business

 

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conditions. In addition, a failure to comply with the provisions of our revolving credit facility could result in an event of default which would enable our lenders to declare the outstanding principal of that debt, together with accrued interest, to be immediately due and payable. If the payment of our debt is accelerated, defaults under our other debt instruments, if any, may be triggered, and our assets may be insufficient to repay such debt in full, and the holders of our units could experience a partial or total loss of their investment. Please read “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Capital Resources and Liquidity” for additional information about our revolving credit facility.

Debt we incur in the future may limit our flexibility to obtain financing and to pursue other business opportunities.

Our future level of 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, investments or capital expenditures, selling assets or issuing equity, which could materially and adversely affect our financial condition, results of operations, cash flows and ability to make distributions to unitholders, as well as the trading price of our common units. We may not be able to effect any of these actions on satisfactory terms or at all.

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 have available for distribution depends 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 net losses for financial accounting purposes, and we may not make cash distributions during periods when we record net income for financial accounting purposes.

Increases in interest rates could adversely impact our unit price, our ability to issue equity or incur debt for acquisitions or other purposes, and our ability to make cash distributions at our intended levels.

Interest rates may increase in the future. As a result, interest rates on our debt could be higher than current levels, causing our financing costs to increase accordingly. In addition, we may in the future refinance outstanding borrowings under our revolving credit facility with fixed-term indebtedness. Interest rates payable on fixed-term indebtedness typically are higher than the short-term variable interest rates that we will pay on borrowings under our revolving credit facility. Furthermore, as with other yield-oriented securities, our unit price will be impacted by our cash distributions and the implied distribution yield. The distribution yield is often used by investors to compare and rank yield-oriented securities for investment decision-making purposes. Therefore, changes in interest rates, either positive or negative, may affect the yield requirements of investors who invest in our units,

 

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and a rising interest rate environment could have an adverse impact on our unit price and our ability to issue equity or incur debt for acquisitions or other purposes and to make cash distributions at our intended levels.

Our assets and operations are subject to federal, state, and local laws and regulations relating to environmental protection and safety that could require us to make substantial expenditures.

Our assets and operations involve the transportation of crude oil and refined petroleum products, which is subject to increasingly stringent federal, state, and local laws and regulations related to protection of the environment and that require us to comply with various safety requirements regarding the design, installation, testing, construction, and operational management of our pipeline systems, terminals and storage facilities. These regulations have raised operating costs for the crude oil and refined petroleum products industry and compliance with such laws and regulations may cause us and Phillips 66 to incur potentially material capital expenditures associated with the construction, maintenance, and upgrading of equipment and facilities. Environmental laws and regulations, in particular, are subject to frequent change, and many of them have become and will continue to become more stringent.

We could incur potentially significant additional expenses should we determine that any of our assets are not in compliance with applicable laws and regulations. Our failure to comply with these or any other environmental or safety-related regulations could result in the assessment of administrative, civil, or criminal penalties, the imposition of investigatory and remedial liabilities, and the issuance of injunctions that may subject us to additional operational constraints. Any such penalties or liability could have a material adverse effect on our business, financial condition, or results of operations. Please read “Business—Environmental Regulation” and “Business—Rate and Other Regulation—Pipeline Safety.”

Our pipeline systems are subject to stringent environmental regulations governing spills, releases and pipeline integrity that could require us to make substantial expenditures.

Transportation of crude oil and refined petroleum products involves inherent risks of spills and releases from our facilities, and can subject us to various federal and state laws governing spills and releases, including reporting and remediation obligations. The costs associated with such obligations can be substantial, as can costs associated with related enforcement matters, including possible fines and penalties. Transportation of such products over water or proximate to navigable water bodies involves inherent risks (including risks of spills) and could subject us to the provisions of the Oil Pollution Act of 1990 (the “Oil Pollution Act”) and similar state environmental laws should a spill occur from our pipelines. Among other things, the Oil Pollution Act requires us to prepare a facility response plan identifying the personnel and equipment necessary to remove to the maximum extent practicable a “worst case discharge.” Some of our facilities are required to maintain such facility response plans. To meet this requirement, we and Phillips 66 have contracted with various spill response service companies in the areas in which we transport or store crude oil and refined petroleum products; however, these companies may not be able to adequately contain a “worst case discharge” in all instances, and we cannot ensure that all of their services would be available for our or Phillips 66’s use at any given time. Many factors that could inhibit the availability of these service providers, include, but are not limited to, weather conditions, governmental regulations or other global events. In these and other cases, we may be subject to liability in connection with the discharge of crude oil or products into navigable waters.

If any of these events occur or are discovered in the future, whether in connection with any of our pipelines, terminals or storage facilities, or any other facility to which we send or have sent wastes or by-products for treatment or disposal, we could be liable for all costs and penalties associated with the remediation of such facilities under federal, state and local environmental laws or common law. We may also be liable for personal injury or property damage claims from third parties alleging contamination from spills or releases from our facilities or operations. In addition, we will be subject to a deductible of $100,000 per claim before we are entitled to indemnification from Phillips 66 for certain environmental liabilities under our omnibus agreement. Even if we are insured or indemnified against such risks, we may be responsible for costs or penalties to the

 

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extent our insurers or indemnitors do not fulfill their obligations to us. Please read “Business—Environmental Regulation—Waste Management and Related Liabilities.”

Evolving environmental laws and regulations on climate change could adversely affect our financial performance.

Potential additional regulations regarding climate change could affect our operations. Currently, various legislative and regulatory measures to address greenhouse gas emissions (including carbon dioxide, methane and other gases) are in various phases of review, discussion or implementation in the United States. These measures include Environmental Protection Agency (“EPA”) programs to control greenhouse gas emissions and state actions to develop statewide or regional programs, each of which could impose reductions in greenhouse gas emissions. These actions could result in increased (1) costs to operate and maintain our facilities, (2) capital expenditures to install new emission controls on our facilities and (3) costs to administer and manage any potential greenhouse gas emissions regulations or carbon trading or tax programs. In addition, in 2010, the EPA promulgated a rule establishing greenhouse gas emission standards for new-model passenger cars, light-duty trucks, and medium-duty passenger vehicles. Also in 2010, the EPA promulgated a rule establishing greenhouse gas emission thresholds for the permitting of certain stationary sources, which could require greenhouse gas emission controls for those sources. The EPA has also issued its plan for establishing specific greenhouse gas emission requirements under the Clean Air Act. Under this plan, the EPA was expected to propose broad standards for refineries by the end of 2012, and is expected to issue final standards in 2013. In the EPA’s most recent update to the United States Court of Appeals for the D.C. Circuit on December 5, 2012, the EPA stated that its draft is still undergoing review. The EPA did not provide a target date for releasing this rule. These developments could have an indirect adverse effect on our business if Phillips 66’s refinery operations are adversely affected due to increased regulation of Phillips 66’s facilities or reduced demand for crude oil, refined petroleum products and NGL, and a direct adverse effect on our business from increased regulation of our facilities. Please read “Business—Environmental Regulation—Air Emissions and Climate Change.”

Terrorist or cyber-attacks and threats, escalation of military activity in response to these attacks or acts of war could have a material adverse effect on our business, financial condition or results of operations.

Terrorist attacks and threats, cyber-attacks, escalation of military activity or acts of war may have significant effects on general economic conditions, fluctuations in consumer confidence and spending and market liquidity, each of which could materially and adversely affect our business. Future terrorist or cyber-attacks, rumors or threats of war, actual conflicts involving the United States or its allies, or military or trade disruptions may significantly affect our operations and those of our customers. Strategic targets, such as energy-related assets and transportation assets, may be at greater risk of future attacks than other targets in the United States. We do not maintain specialized insurance for possible liability resulting from a cyber-attack on our assets that may shut down all or part of our business. Disruption or significant increases in energy prices could result in government-imposed price controls. It is possible that any of these occurrences, or a combination of them, could have a material adverse effect on our business, financial condition and results of operations.

We may be unable to obtain or renew permits necessary for our operations, which could inhibit our ability to do business.

Our facilities operate under a number of federal and state permits, licenses and approvals with terms and conditions containing a significant number of prescriptive limits and performance standards in order to operate. All of these permits, licenses, approval limits and standards require a significant amount of monitoring, record keeping and reporting in order to demonstrate compliance with the underlying permit, license, approval limit or standard. Noncompliance or incomplete documentation of our compliance status may result in the imposition of fines, penalties and injunctive relief. A decision by a government agency to deny or delay issuing a new or renewed material permit or approval, or to revoke or substantially modify an existing permit or approval, could

 

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have a material adverse effect on our ability to continue operations and on our financial condition, results of operations and cash flows.

Evolving environmental laws and regulations on hydraulic fracturing could have an indirect effect on our financial performance.

Hydraulic fracturing is an important and increasingly common practice that is used to stimulate production of crude oil and/or natural gas from dense subsurface rock formations. Typically regulated by state agencies, the EPA has asserted federal regulatory authority pursuant to the Safe Drinking Water Act, as amended (“SDWA”), over certain hydraulic fracturing activities involving the use of diesel fuel. In addition, legislation has been introduced from time to time in Congress to provide for federal regulation of hydraulic fracturing under the SDWA and to require disclosure of the chemicals used in the hydraulic fracturing process. At the state level, several states have already adopted laws and/or regulations that require disclosure of the chemicals used in hydraulic fracturing, and many states are considering legal requirements that could impose more stringent permitting, disclosure and well construction requirements on oil and/or natural gas drilling activities. The EPA is also moving forward with various related regulatory actions, including approving, on April 17, 2012, new regulations requiring, among other matters, “green completions” of hydraulically-fractured wells by 2015 and certain emission requirements for some midstream equipment beginning in 2012. We do not believe these new regulations will have a direct effect on our operations, but because oil and/or natural gas production using hydraulic fracturing is growing rapidly in the United States if new or more stringent federal, state or local legal restrictions relating to such drilling activities or to the hydraulic fracturing process are adopted in areas where our shippers’ producer customers operate, those producers could incur potentially significant added costs to comply with such requirements and experience delays or curtailment in the pursuit of production or development activities, which could reduce demand for our transportation and midstream services.

New and proposed regulations governing fuel efficiency and renewable fuels could have an indirect but material adverse effect on our business.

Increases in fuel mileage standards and the increased use of renewable fuels could also decrease demand for refined petroleum products, which could have an indirect, but material, adverse effect on our business, financial condition and results of operations. For example, in 2007, Congress passed the Energy Independence and Security Act (“EISA”), which, among other things, sets a target of 35 miles per gallon for the combined fleet of cars and light trucks in the United States by model year 2020, and contains a second Renewable Fuel Standard commonly referred to as RFS2. In December 2011, the EPA and the National Highway Traffic Safety Administration jointly proposed regulations that would establish average industry fleet fuel economy standards as high as 49.6 miles per gallon by model year 2025. RFS2 presents production and logistics challenges for both the renewable fuels and petroleum refining industries. RFS2 has required, and may in the future continue to require, additional capital expenditures or expenses by Phillips 66 to accommodate increased renewable fuels use. Phillips 66 may experience a decrease in demand for refined petroleum products due to an increase in combined fleet mileage or due to refined petroleum products being replaced by renewable fuels.

Many of our assets have been in service for many years and require significant expenditures to maintain them. As a result, our maintenance or repair costs may increase in the future.

Our pipelines, terminals and storage assets are generally long-lived assets, and many of them have been in service for many years. The age and condition of our assets could result in increased maintenance or repair expenditures in the future. Any significant increase in these expenditures could adversely affect our results of operations, financial position or cash flows, as well as our ability to make cash distributions to our unitholders.

 

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We may incur greater than anticipated costs and liabilities in order to comply with safety regulation, including pipeline integrity management program testing and related repairs.

The U.S. Department of Transportation, or the DOT, through its Pipeline and Hazardous Materials Safety Administration, or PHMSA, has adopted regulations requiring, among other things, pipeline operators to develop integrity management programs for transmission pipelines located where a leak or rupture could harm “high consequence areas” (“HCAs”). The regulations require operators, including us, to, among other matters, perform ongoing assessments of pipeline integrity; repair and remediate pipelines as necessary; and implement preventive and mitigating actions.

Although some of our facilities fall within a class that is currently not subject to these requirements, we may incur significant costs and liabilities associated with repair, remediation, preventative or mitigation measures associated with our non-exempt pipelines. This work is part of our normal integrity management program and we do not expect to incur any extraordinary costs during 2013 to complete the testing required by existing DOT regulations and their state counterparts. We have not estimated the costs for any repair, remediation, preventative or mitigating actions that may be determined to be necessary as a result of the testing program, which could be substantial, or any lost cash flows resulting from shutting down our pipelines during the pendency of such repairs. Additionally, should we fail to comply with DOT or comparable state regulations, we could be subject to penalties and fines.

The Pipeline Safety, Regulatory Certainty, and Job Creation Act of 2011 increases penalties for safety violations, establishes additional safety requirements for newly constructed pipelines and requires studies of certain safety issues that could result in the adoption of new regulatory requirements for existing pipelines. PHMSA has also published an advanced notice of proposed rulemaking to solicit comments on the need for changes to its safety regulations, including whether to revise the integrity management requirements or to include additional pipelines in HCAs. Such legislative and regulatory changes could have a material effect on our operations and costs of transportation services.

The tariff rates of our regulated assets are subject to review and possible adjustment by federal and state regulators, which could adversely affect our revenue.

Our Clifton Ridge to Lake Charles refinery pipeline, Sweeny to Pasadena pipeline, Wood River to Hartford pipeline and Hartford to Explorer pipeline provide interstate service that is subject to regulation by FERC under the Interstate Commerce Act, or the ICA, and the Energy Policy Act, or EPAct 1992. FERC uses prescribed rate methodologies for developing regulated tariff rates for interstate oil and product pipelines. Our tariff rates approved by FERC may not recover all of our costs of providing services. In addition, these methodologies and changes to FERC’s approved rate methodologies, or challenges to our application of an approved methodology, could also adversely affect our rates.

Shippers may protest (and FERC may investigate) the lawfulness of new or changed tariff rates. FERC can suspend those tariff rates for up to seven months. It can also require refunds of amounts collected pursuant to rates that are ultimately found to be unlawful and prescribe new rates prospectively. FERC and interested parties can also challenge tariff rates that have become final and effective. FERC also can order new rates to take effect prospectively and order reparations for past rates that exceed the just and reasonable level up to two years prior to the date of a complaint. Due to the complexity of rate making, the lawfulness of any rate is never assured. A successful challenge of our rates could adversely affect our revenues.

FERC also regulates the terms and conditions of service, including access rights, for interstate transportation on common carrier pipelines subject to its jurisdiction. Our pipelines are common carriers and, as a consequence, we may be required to provide service to customers with credit and other performance characteristics with whom we would choose not to do business if permitted to do so.

 

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Certain of our pipelines provide intrastate service that is subject to regulation by the Illinois Commerce Commission, the Texas Railroad Commission and the Louisiana Public Service Commission. The Illinois Commerce Commission, the Texas Railroad Commission and the Louisiana Public Service Commission could limit our ability to increase our rates or to set rates based on our costs or could order us to reduce our rates and could require the payment of refunds to shippers. Such regulation or a successful challenge to our intrastate pipeline rates could adversely affect our financial position, cash flows or results of operations. Please read “Business—Rate and Other Regulation.”

Phillips 66’s level of indebtedness, the terms of its borrowings and its credit ratings could adversely affect our ability to grow our business and our ability to make cash distributions to our unitholders. Our ability to obtain credit in the future may also be adversely affected by Phillips 66’s credit rating.

Phillips 66 must devote a portion of its cash flows from operating activities to service its indebtedness, and therefore cash flows may not be available for use in pursuing its growth strategy. Furthermore, a higher level of indebtedness at Phillips 66 in the future would increase the risk that it may default on its obligations to us under our transportation services agreements. As of December 31, 2012, Phillips 66 had long-term indebtedness of $6.96 billion. The covenants contained in the agreements governing Phillips 66’s outstanding and future indebtedness may limit its ability to borrow additional funds for development and make certain investments and may directly or indirectly impact our operations in a similar manner. Furthermore, if Phillips 66 were to default under certain of its debt obligations, there is a risk that Phillips 66’s creditors would attempt to assert claims against our assets during the litigation of their claims against Phillips 66. The defense of any such claims could be costly and could materially impact our financial condition, even absent any adverse determination. If these claims were successful, our ability to meet our obligations to our creditors, make distributions and finance our operations could be materially and adversely affected.

Phillips 66’s long-term credit ratings are currently investment grade. If these ratings are lowered in the future, the interest rate and fees Phillips 66 pays on its credit facilities may increase. In addition, although we will not have any indebtedness rated by any credit rating agency at the closing of this offering, we may have rated debt in the future. Credit rating agencies will likely consider Phillips 66’s debt ratings when assigning ours because of Phillips 66’s ownership interest in us, the significant commercial relationships between Phillips 66 and us, and our reliance on commercial agreements with Phillips 66 for substantially all of our revenue. If one or more credit rating agencies were to downgrade the outstanding indebtedness of Phillips 66, we could experience an increase in our borrowing costs or difficulty accessing the capital markets. Such a development could adversely affect our ability to grow our business and to make cash distributions to our unitholders.

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 (“Exchange Act”). We prepare our 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.

 

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Although we will be required to disclose changes made in our internal control and procedures on a quarterly basis, we will not be required to make our first annual assessment of our internal control over financial reporting pursuant to Section 404 until our annual report for the fiscal year ending December 31, 2014.

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 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 material adverse effect on the trading price of our common units.

Risks Inherent in an Investment in Us

Our general partner and its affiliates, including Phillips 66, have conflicts of interest with us and limited fiduciary duties to us and our unitholders, and they may favor their own interests to our detriment and that of our unitholders. Additionally, we have no control over the business decisions and operations of Phillips 66, and Phillips 66 is under no obligation to adopt a business strategy that favors us.

Following the offering, Phillips 66 will own a 2% general partner interest and a     % limited partner interest in us (or     % if the underwriters’ option to purchase additional common units is exercised in full) and will own and control our general partner. Additionally, Phillips 66 will continue to own a 50% equity interest in DCP Midstream, LLC, and a 50% equity interest in CPChem. Although our general partner has a duty to manage us in a manner that is in the best interests of our partnership and our unitholders, the directors and officers of our general partner also have a duty to manage our general partner in a manner that is in the best interests of its owner, Phillips 66. Conflicts of interest may arise between Phillips 66 and its affiliates, including our general partner, on the one hand, and us and our unitholders, on the other hand. In resolving these conflicts, the general partner may favor its own interests and the interests of its affiliates, including Phillips 66, over the interests of our common unitholders. These conflicts include, among others, the following situations:

 

 

neither our partnership agreement nor any other agreement requires Phillips 66 to pursue a business strategy that favors us or utilizes our assets, which could involve decisions by Phillips 66 to increase or decrease refinery production, shut down or reconfigure a refinery, pursue and grow particular markets, or undertake acquisition opportunities for itself. Phillips 66’s directors and officers have a fiduciary duty to make these decisions in the best interests of the stockholders of Phillips 66;

 

 

Phillips 66, as our primary customer, has an economic incentive to cause us to not seek higher tariff rates, even if such higher rates or fees would reflect rates and fees that could be obtained in arm’s-length, third-party transactions;

 

 

Phillips 66 may be constrained by the terms of its debt instruments from taking actions, or refraining from taking actions, that may be in our best interests;

 

 

our partnership agreement replaces the fiduciary duties that would otherwise be owed by our general partner with contractual standards governing its duties, limiting our general partner’s liabilities and restricting 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 will determine the amount and timing of asset purchases and sales, borrowings, issuance of additional partnership securities and the creation, reduction or increase of cash reserves, each of which can affect the amount of cash that is distributed to our unitholders;

 

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our general partner will determine the amount and timing of many of our cash expenditures and whether a cash expenditure is classified as an expansion capital expenditure, which would not reduce operating surplus, or a maintenance capital expenditure, which would reduce our operating surplus. This determination can affect the amount of cash from operating surplus that is distributed to our unitholders and to our general partner, the amount of adjusted operating surplus generated in any given period and the ability of the subordinated units to convert into common units;

 

 

our general partner will determine 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 expiration of the subordination period;

 

 

our partnership agreement permits us to classify up to $         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 it and its affiliates own more than 80% of the common units;

 

 

our general partner controls the enforcement of obligations owed to us by our general partner and its affiliates, including our commercial agreements with Phillips 66;

 

 

our general partner decides whether to retain separate counsel, accountants or others to perform services for us; and

 

 

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, which we refer to as our conflicts committee, or our unitholders. This election may result in lower distributions to our common unitholders in certain situations.

Under the terms of our partnership agreement, the doctrine of corporate opportunity, or any analogous doctrine, does not apply to our general partner or any of its affiliates, including its executive officers, directors and owners. Any such person or entity that becomes aware of a potential transaction, agreement, arrangement or other matter that may be an opportunity for us will not have any duty to communicate or offer such opportunity to us. Any such person or entity will not be liable to us or to any limited partner for breach of any fiduciary duty or other duty by reason of the fact that such person or entity pursues or acquires such opportunity for itself, directs such opportunity to another person or entity or does not communicate such opportunity or information to us. This may create actual and potential conflicts of interest between us and affiliates of our general partner and result in less than favorable treatment of us and our unitholders. Please read “Certain Relationships and Related Party Transactions—Agreements Governing the Transactions—Omnibus Agreement” and “Conflicts of Interest and Duties.”

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. As a result, we expect to rely primarily upon external financing sources, including commercial bank borrowings and the issuance

 

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of debt and equity securities, to fund our acquisitions and expansion capital expenditures. Therefore, to the extent we are unable to finance our growth externally, our cash distribution policy will significantly impair our ability to grow. In addition, because we will 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 on our ability to issue additional units, including units ranking senior to our common units as to distributions or in liquidation or that have special voting rights and other rights, and our unitholders will have no preemptive or other rights (solely as a result of their status as unitholders) to purchase any such additional units. The incurrence of additional commercial borrowings or other debt to finance our growth strategy would result in increased interest expense, which, in turn, may reduce the amount of cash available to distribute to our unitholders.

Our partnership agreement replaces our general partner’s fiduciary duties to holders of our common units with contractual standards governing its duties.

Our partnership agreement contains provisions that eliminate the fiduciary standards to which our general partner would otherwise be held by state fiduciary duty law and replaces those duties with several different contractual standards. 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, free of any duties to us and our unitholders other than the implied contractual covenant of good faith and fair dealing, which means that a court will enforce the reasonable expectations of the parties where the language in our partnership agreement does not provide for a clear course of action. This provision 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. By purchasing a common unit, a unitholder is treated as having consented to the provisions in our partnership agreement, including the provisions discussed above. Please read “Conflicts of Interest and Duties—Duties of the General Partner.”

Our partnership agreement 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 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 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 it acted 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 engaged in fraud or willful misconduct 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 our partnership agreement or its fiduciary duties to us or our limited partners if a transaction with an affiliate or the resolution of a conflict of interest is approved in accordance with, or otherwise meets the standards set forth in, our partnership agreement.

 

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In connection with a situation involving a transaction with an affiliate or a conflict of interest, our partnership agreement provides that any determination by our general partner must be made in good faith, and that our conflicts committee and the board of directors of our general partner are entitled to a presumption that they acted in good faith. 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. Please read “Conflicts of Interest and Duties.”

If you are not both a citizenship eligible holder and a rate eligible holder, your common units may be subject to redemption.

In order to avoid (1) any material adverse effect on the maximum applicable rates that can be charged to customers by our subsidiaries on assets that are subject to rate regulation by FERC or analogous regulatory body, and (2) any substantial risk of cancellation or forfeiture of any property, including any governmental permit, endorsement or other authorization, in which we have an interest, we have adopted certain requirements regarding those investors who may own our common units. Citizenship eligible holders are individuals or entities whose nationality, citizenship or other related status does not create a substantial risk of cancellation or forfeiture of any property, including any governmental permit, endorsement or authorization, in which we have an interest, and will generally include individuals and entities who are U.S. citizens. Rate eligible holders are individuals or entities subject to U.S. federal income taxation on the income generated by us or entities not subject to U.S. federal income taxation on the income generated by us, so long as all of the entity’s owners are subject to such taxation. Please read “Description of the Common Units—Transfer of Common Units.” If you are not a person who meets the requirements to be a citizenship eligible holder and a rate eligible holder, you run the risk of having your units redeemed by us at the market price as of the date three days before the date the notice of redemption is mailed. The redemption price will be paid in cash or by delivery of a promissory note, as determined by our general partner. In addition, if you are not a person who meets the requirements to be a citizenship eligible holder, you will not be entitled to voting rights. Please read “Our Partnership Agreement—Redemption of Ineligible Holders.”

Cost reimbursements, which will be determined in our general partner’s sole discretion, and fees due our general partner and its affiliates for services provided will be substantial and will reduce our cash available for distribution to you.

Under our partnership agreement, we are required to reimburse our general partner and its affiliates for all costs and expenses that they incur on our behalf for managing and controlling our business and operations. Except to the extent specified under our omnibus agreement and operational services agreement, our general partner determines the amount of these expenses. Under the terms of the omnibus agreement we will be required to reimburse Phillips 66 for the provision of certain general and administrative services to us. Under our operational services agreement, we will be required to reimburse Phillips 66 for the provision of certain maintenance, operating, administrative and construction services in support of our operations. Our general partner and its affiliates also may provide us other services for which we will be charged fees as determined by our general partner. Payments to our general partner and its affiliates will be substantial and will reduce the amount of cash available for distribution to unitholders.

Unitholders have very limited voting rights and, even if they are dissatisfied, they cannot remove our general partner without its consent.

Unlike the holders of common stock in a corporation, unitholders have only limited voting rights on matters affecting our business and, therefore, limited ability to influence management’s decisions regarding our business. For example, unlike holders of stock in a public corporation, unitholders will not have “say-on-pay” advisory voting rights. Unitholders did not elect our general partner or the board of directors of our general partner and will have no right to elect our general partner or the board of directors of our general partner on an annual or other continuing basis. The board of directors of our general partner is chosen by the member of our general

 

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partner, which is a wholly owned subsidiary of Phillips 66. Furthermore, if the unitholders are dissatisfied with the performance of our general partner, they will have little ability to remove our general partner. As a result of these limitations, the price at which our common units will trade could be diminished because of the absence or reduction of a takeover premium in the trading price.

The unitholders will be unable initially to remove our general partner without its consent because our general partner and its affiliates will own sufficient units upon completion of the offering to be able to prevent its removal. The vote of the holders of at least 66 2/3% of all outstanding common units and subordinated units voting together as a single class is required to remove our general partner. At closing, our general partner and its affiliates will own     % of the common units and subordinated units (or     % if the underwriters’ option to purchase additional common units is exercised in full). Also, if our general partner is removed without cause during the subordination period and common units and subordinated units held by our general partner and its affiliates are not voted in favor of that removal, all remaining subordinated units will automatically be converted into common units, and any existing arrearages on the common units will be extinguished. A removal of our general partner under these circumstances would adversely affect the common units by prematurely eliminating their distribution and liquidation preference over the subordinated units, which would otherwise have continued until we had met certain distribution and performance tests.

“Cause” is narrowly defined under our partnership agreement to mean that a court of competent jurisdiction has entered a final, non-appealable judgment finding the general partner liable for actual fraud 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 unitholders’ dissatisfaction with our general partner’s performance in managing our partnership will most likely result in the termination of the subordination period.

Furthermore, unitholders’ voting rights are further restricted by the partnership agreement provision 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.

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.

Our general partner units or the control of our general partner may be transferred to a third party without unitholder consent.

Our general partner may transfer its general partner units 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, there is no restriction in our partnership agreement on the ability of Phillips 66 to transfer its membership interest in our general partner to a third party. The new owner of our general partner would then be in a position to replace the board of directors and officers of our general partner with its own choices.

The incentive distribution rights of our general partner may be transferred to a third party without unitholder consent.

Our general partner may transfer 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 may not have the same incentive to grow our partnership and increase quarterly distributions to unitholders over time as it would if it had retained ownership of its incentive distribution rights. For example, a transfer of incentive distribution rights by our general partner could reduce the likelihood of Phillips 66 accepting offers made by us relating to assets subject to the right of first offer contained

 

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in our omnibus agreement or offering us the right to purchase other assets from Phillips 66, as Phillips 66 would have less of an economic incentive to grow our business, which in turn would impact our ability to grow our asset base.

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

The assumed initial public offering price of $         per common unit (the mid-point of the price range set forth on the cover of this prospectus) exceeds our pro forma net tangible book value of $         per unit. Based on an assumed initial public offering price of $         per common unit, you will incur immediate and substantial dilution of $         per common unit (or $         if the underwriters’ option to purchase additional common units is exercised in full). This dilution results primarily because the assets contributed by Phillips 66 are recorded in accordance with GAAP, at their historical cost, and not their fair value. Please read “Dilution.”

We may issue additional units without unitholder approval, which would dilute unitholder interests.

At any time, we may issue an unlimited number of limited partner interests of any type without the approval of our unitholders and our unitholders will have no preemptive or other rights (solely as a result of their status as unitholders) to purchase any such limited partner interests. Further, there are no limitations in our partnership agreement on our ability to issue equity securities that rank equal or senior to our common units as to distributions or in liquidation or that have special voting rights and other rights. The issuance by us of additional common units or other equity securities of equal or senior rank will have the following effects:

 

 

our 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 our common units may decline.

Phillips 66 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 completion of this offering, Phillips 66 will hold              common units and              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. Additionally, we have agreed to provide Phillips 66 with certain registration rights under applicable securities laws. Please read “Units Eligible for Future Sale.” 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.

Our general partner’s discretion in establishing cash reserves may reduce the amount of cash available for distribution to unitholders.

Our partnership agreement requires our general partner to deduct from operating surplus cash reserves that it determines are necessary to fund our future operating expenditures. In addition, the partnership agreement permits the general partner to reduce available cash by establishing cash reserves for the proper conduct of our business, to comply with applicable law or agreements to which we are a party, or to provide funds for future distributions to partners. These cash reserves will affect the amount of cash available for distribution to unitholders.

 

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Affiliates of our general partner, including Phillips 66, DCP Midstream and CPChem, may compete with us, and neither our general partner nor its affiliates have any obligation to present business opportunities to us.

Neither our partnership agreement nor our omnibus agreement will prohibit Phillips 66 or any other affiliates of our general partner, including DCP Midstream and CPChem, from owning assets or engaging in businesses that compete directly or indirectly with us. Under the terms of our partnership agreement, the doctrine of corporate opportunity, or any analogous doctrine, will not apply to our general partner or any of its affiliates, including Phillips 66, DCP Midstream and CPChem. Any such entity that becomes aware of a potential transaction, agreement, arrangement or other matter that may be an opportunity for us will not have any duty to communicate or offer such opportunity to us. Consequently, Phillips 66 and other affiliates of our general partner, including DCP Midstream and CPChem, may acquire, construct or dispose of additional midstream assets in the future without any obligation to offer us the opportunity to purchase any of those assets. As a result, competition from Phillips 66 and other affiliates of our general partner, including DCP Midstream and CPChem, could materially and adversely impact our results of operations and cash available for distribution to unitholders.

Our general partner may cause us to borrow funds in order to make cash distributions, even where the purpose or effect of the borrowing benefits the general partner or its affiliates.

In some instances, our general partner may cause us to borrow funds in order to permit the payment of cash distributions. These borrowings are permitted even if the purpose and effect of the borrowing is to enable us to make a distribution on the subordinated units, to make incentive distributions or to hasten the expiration of the subordination period.

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

If at any time our general partner and its affiliates own more than 80% of our then-outstanding common units, our general partner will have the right, but not the obligation, which it may assign to any of its affiliates or to us, to acquire all, but not less than all, of the common units held by unaffiliated persons at a price 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 the underwriters’ option to purchase additional common units from us is not exercised, our general partner and its affiliates will own approximately     % of our common units. At the end of the subordination period (which could occur as early as             , 2014), assuming no additional issuances of common units (other than upon the conversion of the subordinated units) and the underwriters’ option to purchase additional common units from us is not exercised, our general partner and its affiliates will own approximately     % of our outstanding common units. For additional information about the call right, please read “Our Partnership Agreement—Limited Call Right.”

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 non-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 jurisdictions. You could be liable for 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 the general partner, to approve some amendments to our partnership agreement or to take other actions under our partnership agreement constitute “control” of our business.

 

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Please read “Our Partnership Agreement—Limited Liability” for a discussion of the implications of the limitations of liability on a unitholder.

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

Under certain circumstances, unitholders may have to repay amounts wrongfully 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 the 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. Transferees of common units are liable for the obligations of the transferor to make contributions to the partnership that are known to the transferee at the time of the transfer and for unknown obligations if the liabilities could be determined from our partnership agreement. Liabilities to partners on account of their partnership interest and liabilities that are non-recourse to the partnership are not counted for purposes of determining whether a distribution is permitted.

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 publicly traded common units, assuming the underwriters’ option to purchase additional common units from us is not exercised. In addition, Phillips 66 will own              common units and              subordinated units, representing an aggregate     % limited partner interest in us (or     % if the underwriters’ option to purchase additional common units is exercised in full). We do not know the extent to which investor interest will lead to the development of an active 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 offered hereby will be determined by negotiations between us and the representatives 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;

 

 

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

 

 

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.”

 

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Our general partner, or any transferee holding incentive distribution rights, may elect to cause us to issue common units and general partner units to it in connection with a resetting of the target distribution levels related to its incentive distribution rights, without the approval of our conflicts committee 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 distributions on its incentive distribution rights at the highest level to which it is entitled (48%, in addition to distributions paid on its 2% general partner interest) for each of the prior four consecutive fiscal quarters, to reset the initial target distribution levels at higher levels based on our distributions at the time of the exercise of the reset election. Following a reset election, 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 a number of common units and general partner units. The number of common units to be issued to our general partner will be equal to that number of common units that 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 such two quarters. Our general partner will also be issued the number of general partner units necessary to maintain our general partner’s interest in us at the level 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 be sufficiently accretive to cash distributions per common unit without such conversion. 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 distributions based on the initial target distribution levels. This risk could be elevated if our incentive distribution rights have been transferred to a third party. 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 in connection with resetting the target distribution levels. Additionally, our general partner has the right to transfer all or any portion of our incentive distribution rights at any time, and such transferee shall have the same rights as the general partner relative to resetting target distributions if our general partner concurs that the tests for resetting target distributions have been fulfilled. Please read “Provisions of Our Partnership Agreement Relating to Cash Distributions—General Partner’s Right to Reset Incentive Distribution Levels.”

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

We intend to apply to list our common units on the NYSE. Because we will be a publicly traded limited partnership, the NYSE does not require us to have a majority of independent directors on our general partner’s board of directors or to establish a compensation committee or a nominating and corporate governance committee. Additionally, any future issuance of additional common units or other securities, including to affiliates, will not be subject to the NYSE’s shareholder approval rules that apply to a corporation. Accordingly, unitholders will not have the same protections afforded to certain corporations that are subject to all of the NYSE corporate governance requirements. Please read “Management—Management of Phillips 66 Partners LP.”

Tax Risks

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

 

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Our tax treatment depends on our status as a partnership for federal income tax purposes. If the Internal Revenue Service (“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 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 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 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%, and would likely pay 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 treated as a corporation for federal income tax purposes, there would be 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.

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 for federal, state or local income tax purposes, the minimum quarterly distribution amount and the target distribution levels may be adjusted to reflect the impact of that law on us.

If we were 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 may substantially 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 levels 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. For example, from time to time, members of Congress propose and consider substantive changes to the existing federal income tax laws that affect publicly traded partnerships. Any modification to the federal income tax laws and interpretations thereof may or may not be retroactively applied and could make it more difficult or impossible to meet the exception for us to be treated as a partnership for federal income tax purposes. Please read “Material Federal Income Tax Consequences—Partnership Status.” We are unable to predict whether any such changes will ultimately be enacted. However, it is possible that a change in law could affect us, and any such changes could negatively impact the value of an investment in our common units.

 

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Our unitholders’ share of our income will be taxable to them for federal income tax purposes even if they do not receive any cash distributions from us.

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

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, our 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 our common units could be more or less than expected.

If our unitholders sell common units, they will recognize a gain or loss for federal income tax purposes equal to the difference between the amount realized and their tax basis in those common units. Because distributions in excess of their allocable share of our net taxable income decrease their tax basis in their common units, the amount, if any, of such prior excess distributions with respect to the common units a unitholder sells will, in effect, become taxable income to the unitholder if it sells such common units at a price greater than its tax basis in those common units, even if the price received is less than its 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 realized includes a unitholder’s share of our nonrecourse liabilities, a unitholder that sells common units may incur a tax liability in excess of the amount of cash received from the sale. Please read “Material Federal Income Tax Consequences—Disposition of Common Units—Recognition of Gain or Loss” 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 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.

 

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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. Latham & Watkins LLP 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” for a further discussion of the effect of the depreciation and amortization positions we will adopt.

We prorate our items of income, gain, loss and deduction for 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 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, and, accordingly, our counsel is unable to opine as to the validity of this method. Recently, however, the U.S. Treasury Department issued proposed regulations that provide a safe harbor pursuant to which publicly traded partnerships may use a similar monthly simplifying convention to allocate tax items among transferor and transferee unitholders. Nonetheless, the proposed regulations do not specifically authorize the use of the proration method we will adopt. If the IRS were to challenge this method or new Treasury regulations were issued, we may be required to change the allocation of items of income, gain, loss and deduction among our unitholders. Latham & Watkins 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.”

A unitholder whose common units are loaned to a “short seller” to effect 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 effect 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. Latham & Watkins LLP has not rendered an opinion regarding the treatment of a unitholder where common units are loaned to a short seller to effect a short sale of common units; therefore, our 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.

 

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We will adopt certain valuation methodologies and monthly conventions for 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, or our allocation of the Section 743(b) adjustment attributable to our tangible and intangible assets, and 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 being 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.

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 relief was not available, as described below) 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 federal income tax purposes. If treated as a new partnership, we must make new tax elections, including a new election under Section 754 of the Internal Revenue Code and could be subject to penalties if we are unable to determine that a termination occurred. The IRS has recently announced a publicly traded partnership technical termination relief program whereby, if a publicly traded partnership that technically terminated requests publicly traded partnership technical termination relief and such relief is granted by the IRS, among other things, the partnership will only have to provide one Schedule K-1 to unitholders for the year notwithstanding two partnership tax years. Please read “Material Federal Income Tax Consequences—Disposition of Common Units—Constructive Termination” 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 control 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 initially expect to conduct business in

 

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Illinois, Louisiana and Texas. Both Illinois and Louisiana currently impose a personal income tax on individuals. As we make acquisitions or expand our business, we may control assets or conduct business in additional states that impose a personal income tax. It is your responsibility to file all 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. Please consult your tax advisor.

 

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USE OF PROCEEDS

We expect to receive net proceeds of approximately $         million from the sale of              common units offered by this prospectus, based on an assumed initial public offering price of $         per common unit (the mid-point of the price range set forth on the cover of the prospectus), after deducting underwriting discounts, structuring fees and estimated offering expenses. Our estimate assumes the underwriters’ option to purchase additional common units from us is not exercised. We intend to use these proceeds as follows:

 

 

$         million will be used to pay revolving credit facility origination and commitment fees; and

 

 

the remainder will be retained by us for general partnership purposes, including to fund potential future expansion capital expenditures and potential future acquisitions from Phillips 66 and third parties.

If the underwriters exercise in full their option to purchase additional common units from us, we expect to receive net proceeds of approximately $         million, after deducting underwriting discounts and structuring fees. We will use any net proceeds from the exercise of the underwriters’ option to purchase additional common units from us for general partnership purposes. If the underwriters exercise in full their option to purchase additional common units from us, the ownership interest of the public unitholders will increase to              common units, representing an aggregate     % limited partner interest in us, Phillips 66 will continue to own              common units and              subordinated units, which will represent an aggregate     % limited partner interest in us, and our general partner will own              general partner units, representing a 2% general partner interest in us.

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, structuring fees and offering expenses, to increase or decrease by $         million.

 

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CAPITALIZATION

The following table shows:

 

 

the historical cash and cash equivalents and capitalization of our Predecessor as of December 31, 2012; and

 

 

our pro forma capitalization as of December 31, 2012, giving effect to the pro forma adjustments described in our unaudited pro forma combined financial statements included elsewhere in this prospectus, including this offering and the application of the net proceeds of this offering in the manner described under “Use of Proceeds” and the other transactions described under “Prospectus Summary—The Transactions.”

This table is derived from, should be read together with and is qualified in its entirety by reference to the historical combined financial statements and the accompanying notes and the unaudited pro forma combined financial statements and the accompanying notes included elsewhere in this prospectus.

 

As of December 31, 2012

(in millions)

   Historical      Pro forma(1)  

Cash and cash equivalents

   $ —         $ 274.3 (2) 
  

 

 

    

 

 

 

Long-term debt:

     

Revolving credit facility

   $ —         $ —     
  

 

 

    

 

 

 

Total long-term debt (including current maturities)

     —           —     
  

 

 

    

 

 

 

Net investment/equity(2):

     

Net investment

     142.0      

Held by public:

     

Common units

     

Held by Phillips 66:

     

Common units

     

Subordinated units

     
  

 

 

    

 

 

 

General Partner units

     
  

 

 

    

 

 

 

Total equity

     142.0      
  

 

 

    

 

 

 

Total capitalization

   $ 142.0       $     
  

 

 

    

 

 

 

 

(1) Assumes the mid-point of the price range set forth on the cover of this prospectus.
(2) Assumes the underwriters’ option to purchase additional common units from us is not exercised.

 

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DILUTION

Dilution is the amount by which the offering price per common unit in this offering will exceed the pro forma net tangible book value per unit after the offering. On a pro forma basis as of             , 2013, after giving effect to the offering of common units and the related transactions, our net tangible book value was approximately $         million, or $         per unit. Purchasers of common units in this offering will experience substantial and immediate dilution in pro forma net tangible book value per common unit for financial accounting purposes, as illustrated in the following table.

 

Assumed initial public offering price per common unit(1)

      $            

Pro forma net tangible book value per unit before the offering(2)

   $               

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

     
  

 

 

    

Less: Pro forma net tangible book value per unit after the offering(3)

     
     

 

 

 

Immediate dilution in net tangible book value per common unit to purchasers in the offering(4)(5)

      $     
     

 

 

 

 

(1) The mid-point of the price range set forth on the cover of this prospectus.
(2) Determined by dividing the number of units (             common units,              subordinated units and              general partner units) to be issued to the general partner and its affiliates for their contribution of assets and liabilities to us into the pro forma net tangible book value of the contributed assets and liabilities.
(3) Determined by dividing the number of units to be outstanding after this offering (             common units,              subordinated units and              general partner units) and the application of the related net proceeds into our pro forma net tangible book value, after giving effect to the application of the net proceeds of this offering.
(4) 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 $         and $        , respectively.
(5) Assumes the underwriters’ option to purchase additional common units from us is not exercised. If the underwriters’ option to purchase additional common units from us is exercised in full, the immediate dilution in net tangible book value per common unit to purchasers in this offering will be $        .

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

 

     Units acquired     Total consideration  

(in millions)

   Number    %     Amount      %  

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

            $                   

Purchasers in this offering

                  
  

 

  

 

 

   

 

 

    

 

 

 

Total

        100   $                  100
  

 

  

 

 

   

 

 

    

 

 

 

 

(1) Upon the consummation of the transactions contemplated by this prospectus, our general partner and its affiliates will own              common units,              subordinated units and              general partner units.
(2) Assumes the underwriters’ option to purchase additional common units from us is not exercised.
(3) The assets contributed by the general partner and its affiliates were recorded at historical cost in accordance with accounting principles generally accepted in the United States. Book value of the consideration provided by the general partner and its affiliates, as of             , 2013, after giving effect to the application of the net proceeds of the offering, is $         million.

 

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CASH DISTRIBUTION POLICY AND RESTRICTIONS ON DISTRIBUTIONS

The following discussion of our cash distribution policy should be read in conjunction with the specific assumptions included in this section. In addition, “Forward-Looking Statements” and “Risk Factors” should be read for information regarding statements that do not relate strictly to historical or current facts and regarding certain risks inherent in our business.

For additional information regarding our historical and pro forma results of operations, please refer to our historical combined financial statements and the accompanying notes and the unaudited pro forma combined financial statements and the accompanying notes included elsewhere in this prospectus.

General

Rationale for our cash distribution policy

Our partnership agreement requires that we distribute all of our available cash quarterly. This requirement forms the basis of our cash distribution policy and reflects a basic judgment that our unitholders will be better served by distributing our available cash rather than retaining it, because, among other reasons, we believe we will generally finance any expansion capital expenditures from external financing sources. Under our current cash distribution policy, we intend to make a minimum quarterly distribution to the holders of our common units and subordinated units of $         per unit, or $         per unit 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 the payment of expenses to our general partner. However, other than the requirement in our partnership agreement to distribute all of our available cash each quarter, we have no legal obligation to make quarterly cash distributions in this or any other amount, and our general partner has considerable discretion to determine the amount of our available cash each quarter. In addition, our general partner may change our cash distribution policy at any time, subject to the requirement in our partnership agreement to distribute all of our available cash quarterly. Generally, our available cash is our (1) cash on hand at the end of a quarter after the payment of our expenses and the establishment of cash reserves and (2) 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 than would be the case if we were subject to federal income tax. If we do not generate sufficient available cash from operations, we may, but are under no obligation to, borrow funds to pay the minimum quarterly distribution to our unitholders.

Limitations on cash distributions and our ability to change our cash distribution policy

Although our partnership agreement requires that we distribute all of our available cash quarterly, there is no guarantee that we will make quarterly cash distributions to our unitholders at our minimum quarterly distribution rate or at any other rate, and we have no legal obligation to do so. Our current cash distribution policy is subject to certain restrictions, as well as the considerable discretion of our general partner in determining the amount of our available cash each quarter. The following factors will affect our ability to make cash distributions, as well as the amount of any cash distributions we make:

 

 

We expect that our cash distribution policy will be subject to restrictions on cash distributions under our revolving credit facility. We expect that one such restriction would prohibit us from making cash distributions while an event of default has occurred and is continuing under our revolving credit facility, notwithstanding our cash distribution policy. Please read “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Capital Resources and Liquidity—Revolving Credit Facility.”

 

 

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. Specifically, our general partner will have the authority to establish cash reserves for the prudent conduct of our business and for future cash distributions to our unitholders, and the establishment of or increase in those reserves could

 

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result in a reduction in cash distributions from levels we currently anticipate pursuant to our stated cash distribution policy. Any decision to establish cash reserves made by our general partner in good faith will be binding on our unitholders.

 

 

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, may be amended. During the subordination period our partnership agreement may not be amended without the approval of our public common unitholders, except in a limited number of circumstances when our general partner can amend our partnership agreement without any unitholder approval. For a description of these limited circumstances, please read “Our Partnership Agreement—Amendment of Our Partnership Agreement—No Unitholder Approval.” However, after the subordination period has ended, our partnership agreement may be amended with the consent of our general partner and the approval of a majority of the outstanding common units, including common units owned by our general partner and its affiliates. At the closing of this offering, Phillips 66 will own our general partner and will indirectly own an aggregate of approximately     % of our outstanding common units and subordinated units (or     % if the underwriters’ option to purchase additional common units is exercised in full). Please read “Our Partnership Agreement—Amendment of Our Partnership Agreement.”

 

 

Under Section 17-607 of the Delaware Revised Uniform Limited Partnership Act, or the Delaware 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 due to cash flow shortfalls attributable to a number of operational, commercial or other factors as well as increases in our operating and maintenance or general and administrative expenses, principal and interest payments on our debt, tax expenses, working capital requirements and anticipated cash needs. Our cash available for distribution to unitholders is directly impacted by our cash expenses necessary to run our business and will be reduced dollar-for-dollar to the extent such uses of cash increase. Please read “Provisions of Our Partnership Agreement Relating to Cash Distributions—Distributions of Available Cash.”

 

 

Our ability to make cash distributions to our unitholders depends on the performance of our subsidiaries and their ability to distribute cash to us. The ability of our subsidiaries to make cash distributions to us may be restricted by, among other things, the provisions of future indebtedness, applicable state partnership and limited liability company laws and other laws and regulations.

 

 

If and to the extent our available cash materially declines from quarter to quarter, we may elect to change our current cash distribution policy and reduce the amount of our quarterly distributions in order to service or repay our debt or fund expansion capital expenditures.

To the extent that our general partner determines not to distribute the full minimum quarterly distribution on our common units with respect to any quarter during the subordination period, the common units will accrue an arrearage equal to the difference between the minimum quarterly distribution and the amount of the distribution actually paid on the common units with respect to that quarter. The aggregate amount of any such arrearages must be paid on the common units before any distributions of available cash from operating surplus may be made on the subordinated units and before any subordinated units may convert into common units. The subordinated units will not accrue any arrearages. Any shortfall in the payment of the minimum quarterly distribution on the common units with respect to any quarter during the subordination period may decrease the likelihood that our quarterly distribution rate would increase in subsequent quarters. Please read “Provisions of Our Partnership Agreement Relating to Cash Distributions—Subordinated Units and Subordination Period.”

Our ability to grow is dependent on our ability to access external expansion capital

Our partnership agreement requires us to distribute all of our available cash to our unitholders on a quarterly basis. As a result, we expect that we will rely primarily upon our cash reserves (including the net proceeds that

 

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we will retain from this offering) and external financing sources, including borrowings under our revolving credit facility and the issuance of debt and equity securities, to fund future acquisitions and other expansion capital expenditures. To the extent we are unable to finance growth with external sources of capital, the requirement in our partnership agreement to distribute all of our available cash and our current cash distribution policy will significantly impair our ability to grow. In addition, because we will distribute all of our available cash, our growth may not be as fast as businesses that reinvest all of their available cash to expand ongoing operations. We expect that our revolving credit facility will restrict our ability to incur additional debt, including through the issuance of debt securities. Please read “Risk Factors—Risks Related to Our Business—Restrictions in our revolving credit facility could adversely affect our business, financial condition, results of operations, ability to make cash distributions to our unitholders and the value of our units.” To the extent we issue additional units, the payment of distributions on those additional units may increase the risk that we will be unable to maintain or increase our cash distributions per unit. There are no limitations in our partnership agreement on our ability to issue additional units, including units ranking senior to our common units, and our unitholders will have no preemptive or other rights (solely as a result of their status as unitholders) to purchase any such additional units. If we incur additional debt (under our revolving credit facility or otherwise) to finance our growth strategy, we will have increased interest expense, which in turn will reduce the available cash that we have to distribute to our unitholders. Please read “Risk Factors—Risks Related to Our Business—Debt we incur in the future may limit our flexibility to obtain financing and to pursue other business opportunities.”

Our Minimum Quarterly Distribution

Upon the consummation of this offering, our partnership agreement will provide for a minimum quarterly distribution of $         per unit for each whole quarter, or $         per unit on an annualized basis. Our ability to make cash distributions at the minimum quarterly distribution rate will be subject to the factors described above under “—General—Limitations on Cash Distributions and Our Ability to Change Our Cash Distribution Policy.” Quarterly distributions, if any, will be made within 45 days after the end of each calendar quarter to holders of record on or about the first day of each such month in which such distributions are made. We do not expect to make distributions for the period that begins on             , 2013, and ends on the day prior to the closing of this offering. We will adjust the amount of our first distribution for the period from the closing of this offering through             , 2013, based on the actual length of the period.

The amount of available cash needed to pay the minimum quarterly distribution on all of our common units, subordinated units and general partner units to be outstanding immediately after this offering for one quarter and on an annualized basis (assuming no exercise and full exercise of the underwriters’ option to purchase additional common units) is summarized in the table below:

 

      No exercise of option to purchase
additional

common units
     Full exercise of option to purchase
additional

common units
 
      Aggregate minimum quarterly
distributions
     Aggregate minimum
quarterly distributions
 

(in millions)

   Number
of units
   One
quarter
     Annualized
(four
quarters)
     Number
of units
   One
quarter
     Annualized
(four
quarters)
 

Publicly held common units

      $                    $                       $                    $                

Common units held by Phillips 66

                 

Subordinated units held by Phillips 66

                 

General partner units

                 
  

 

  

 

 

    

 

 

    

 

  

 

 

    

 

 

 

Total

      $         $            $         $     
  

 

  

 

 

    

 

 

    

 

  

 

 

    

 

 

 

 

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As of the date of this offering, our general partner will be entitled to 2% of all distributions that we make prior to our liquidation. Our general partner’s initial 2% interest in these distributions may be 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 initial 2% general partner interest. Our general partner will also initially hold all of the incentive distribution rights, which entitle the holder to increasing percentages, up to a maximum of 48%, of the cash we distribute in excess of $         per unit per quarter.

During the subordination period, before we make any quarterly distributions to our subordinated unitholders, our common unitholders are entitled to receive payment of the full minimum quarterly distribution for such quarter plus any arrearages in distributions of the minimum quarterly distribution from prior quarters. Please read “Provisions of Our Partnership Agreement Relating to Cash Distributions—Subordinated Units and Subordination Period.” We cannot guarantee, however, that we will pay distributions on our common units at our minimum quarterly distribution rate or at any other rate in any quarter.

Although holders of our common units may pursue judicial action to enforce provisions of our partnership agreement, including those related to requirements to make cash distributions as described above, our partnership agreement provides that any determination made by our general partner in its capacity as our general partner must be made in good faith and that any such determination will not be subject to any other standard imposed by the Delaware Act or any other law, rule or regulation or at equity. Our partnership agreement provides that, in order for a determination by our general partner to be made in “good faith,” our general partner must believe that the determination is in the best interests of our partnership. Please read “Conflicts of Interest and Duties.”

The provision in our partnership agreement requiring us to distribute all of our available cash quarterly may not be modified without amending our partnership agreement; however, as described above, 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, the amount of reserves our general partner establishes in accordance with our partnership agreement and the amount of available cash from working capital borrowings.

Additionally, our general partner may reduce the minimum quarterly distribution and the target distribution levels if legislation is enacted or modified that results in our becoming taxable as a corporation or otherwise subject to taxation as an entity for federal, state or local income tax purposes. In such an event, the minimum quarterly distribution and the target distribution levels may be reduced proportionately by the percentage decrease in our available cash resulting from the estimated tax liability we would incur in the quarter in which such legislation is effective. The minimum quarterly distribution will also be proportionately adjusted in the event of any distribution, combination or subdivision of common units in accordance with the partnership agreement, or in the event of a distribution of available cash from capital surplus. Please read “Provisions of Our Partnership Agreement Relating to Cash Distributions—Adjustment to the Minimum Quarterly Distribution and Target Distribution Levels.” The minimum quarterly distribution is also subject to adjustment if the holder(s) of the incentive distribution rights (initially only our general partner) elect to reset the target distribution levels related to the incentive distribution rights. In connection with any such reset, the minimum quarterly distribution will be reset to an amount equal to the average cash distribution amount per common unit for the two quarters immediately preceding the reset. Please read “Provisions of Our Partnership Agreement Relating to Cash Distributions—General Partner’s Right to Reset Incentive Distribution Levels.”

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 $         per unit for the twelve months ending March 31, 2014. In those sections, we present two tables, consisting of:

 

 

“Unaudited Pro Forma Cash Available for Distribution,” 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, 2012, derived from our unaudited pro forma combined financial statements that are included in this prospectus, as adjusted to give pro forma effect to this offering and the related formation transactions; and

 

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“Estimated Cash Available for Distribution for the Twelve Months Ending March 31, 2014,” in which we provide our estimated forecast of our ability to generate sufficient cash available for distribution for us to pay the minimum quarterly distribution on all units and the corresponding distributions on our general partner’s 2% interest for the twelve months ending March 31, 2014.

Unaudited Pro Forma Cash Available for Distribution for the Year Ended December 31, 2012

If we had completed the transactions contemplated in this prospectus on January 1, 2012, pro forma cash available for distribution generated for the year ended December 31, 2012, would have been approximately $61.7 million. Assuming the underwriters do not exercise their option to purchase additional common units from us, this amount would have been sufficient to pay the minimum quarterly distribution of $         per unit per quarter ($         per unit on an annualized basis) on all of our common units and subordinated units and the corresponding distributions on our general partner’s 2% interest for the year ended December 31, 2012. However, if the underwriters exercise in full their option to purchase additional common units from us, we would have had a shortfall of approximately $                     in the aggregate with respect to the payment of the aggregate annualized minimum quarterly distribution ($         per unit per quarter or $         per unit on an annualized basis if the option is exercised), which would have still allowed us to pay the aggregate annualized minimum quarterly distribution on all of our common units, but only     % on our subordinated units, and the corresponding distributions on our general partner’s 2% interest during that period.

We based the pro forma adjustments 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 dates indicated. In addition, cash available to pay distributions is primarily a cash accounting concept, while our unaudited pro forma combined financial statements have been prepared on an accrual basis. As a result, you should view the amount of pro forma cash available for distribution only as a general indication of the amount of cash available to pay distributions that we might have generated had we been formed on January 1, 2012.

The following table illustrates, on a pro forma basis, for the year ended December 31, 2012, the amount of cash that would have been available for distribution to our unitholders and our general partner, assuming in each case that this offering and the other transactions contemplated in this prospectus had been consummated on January 1, 2012.

 

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Phillips 66 Partners LP

Unaudited Pro Forma Cash Available for Distribution

 

(in millions)

   Year ended
December 31,
2012
 

Pro forma net income(1)

   $ 62.2   

Plus:

  

Depreciation

     6.6   

Amortization of deferred rentals(2)

     0.2   

Interest expense(3)

     1.8   

Provision for income taxes(4)

     0.4   
  

 

 

 

EBITDA(5)

     71.2   

Plus:

  

Adjustments related to minimum volume commitments(6)

       

Offering proceeds retained to fund expansion capital expenditures

     10.9   

Less:

  

Cash interest paid(3)

     1.4   

Income taxes paid(4)

     0.4   

Maintenance capital expenditures(7)

     4.1   

Expansion capital expenditures(7)

     10.9   

Incremental costs of being a separate publicly traded partnership

     3.6   
  

 

 

 

Pro forma cash available for distribution

   $ 61.7   
  

 

 

 

Pro forma cash distributions:

  
  

 

 

 

Annualized minimum quarterly distribution per unit

   $     
  

 

 

 

Estimated Cash Available for Distribution:

  

Distributions to public common unitholders

  

Distributions to Phillips 66:

  

Common units

  

Subordinated units

  

General Partner units

  

Aggregate annualized minimum quarterly distributions(8)

  
  

 

 

 

Excess (shortfall) of pro forma cash available for distribution over aggregate annualized minimum quarterly distributions

  

Percent of annualized minimum quarterly distributions payable to:

  

Common unitholders

      

Subordinated unitholders

      

 

(1) See our unaudited pro forma combined financial statements included elsewhere in this prospectus for an explanation of the adjustments used to derive pro forma net income.
(2) Represents the amortization of previously deferred rentals over the remaining term of the applicable agreement.
(3) Interest expense and cash interest paid both include commitment fees that would have been paid by our Predecessor had our revolving credit facility been in place during the period presented. Interest expense also includes the amortization of estimated deferred issuance costs to be incurred in connection with establishing our revolving credit facility.
(4) Consists of Texas margin tax.
(5) For a definition of the non-GAAP financial measure of EBITDA and a reconciliation of EBITDA to our most directly comparable financial measures calculated and presented in accordance with GAAP, please read “Selected Historical and Pro Forma Combined Financial Data—Non-GAAP Financial Measure.”
(6) Under several of our commercial agreements with Phillips 66, Phillips 66 will be required to transport a minimum volume each calendar quarter. If it fails to transport volumes at the minimum commitment, Phillips 66 will make a quarterly deficiency payment. The quarterly deficiency payment may be applied as a credit for volumes transported in excess of Phillips 66’s minimum volume commitment during any of the succeeding four quarters, after which time the unused credits will expire. For GAAP accounting purposes, we defer the revenue associated with these quarterly deficiency payments until either: (i) the credit has been satisfied through transportation of future volumes in excess of minimum commitments, or (ii) the credit expires through the lapse of time. For the purpose of calculating pro forma cash available for distribution, the quarterly deficiency payment is included in cash available for distribution when we receive the cash, rather than when it is recognized as revenue in accordance with GAAP. When a credit is used or expires in a future period, we will deduct the amount of the credit in calculating cash available for distribution as an offset to the corresponding increase in revenue recognized in accordance with GAAP.

 

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(7) Historically, we did not necessarily make a distinction between maintenance capital expenditures and expansion capital expenditures in exactly the same way as will be required under our partnership agreement. We believe that the amount of maintenance capital expenditures shown above approximates, but may not precisely reflect, the maintenance capital expenditures we would have recorded in accordance with our partnership agreement for the year ended December 31, 2012. For a discussion of maintenance and expansion capital expenditures, please read “Provisions of Our Partnership Agreement Relating to Cash Distributions—Capital Expenditures.”
(8) Assumes the issuance of              general partner units and the incentive distribution rights to our general partner,              common units and              subordinated units to Phillips 66 and              common units to the public and that the underwriters’ option to purchase additional common units from us is not exercised. If the underwriters’ option to purchase additional common units is exercised in full, for the year ended December 31, 2012, on a pro forma basis, we would have had a shortfall of approximately $             in the aggregate with respect to the payment of the aggregate annualized minimum quarterly distribution, which would have still allowed us to pay the aggregate annualized minimum quarterly distribution on all of our common units, but only     % on our subordinated units, and the corresponding distributions on our general partner’s 2% interest.

Estimated Cash Available for Distribution for the Twelve Months Ending March 31, 2014

We forecast our estimated cash available for distribution for the twelve months ending March 31, 2014, will be approximately $        . This amount would exceed by $         million the amount needed to pay the aggregate annualized minimum quarterly distributions of $         million on all of our outstanding common and subordinated units and the corresponding distributions on our general partner’s 2% interest for the twelve months ending March 31, 2014. If the underwriters exercise their option to purchase additional common units in full, our forecasted estimated cash available for distribution would exceed by $         million the amount needed to pay the aggregate annualized minimum quarterly distributions of $         million on all of our outstanding common and subordinated units and the corresponding distributions on our general partner’s 2% interest for the forecast period. The number of outstanding units on which we have based our estimate does not include any common units that may be issued under the long-term incentive plan that our general partner will adopt prior to the closing of this offering.

We have not historically made public projections as to future operations, earnings or other results. However, management has prepared the forecast of estimated cash available for distribution for the twelve months ending March 31, 2014, and related assumptions set forth below to substantiate our belief that we will have sufficient available cash to pay the minimum quarterly distribution to all our unitholders and the corresponding distributions on our general partner’s 2% interest for the twelve months ending March 31, 2014. Please read below under “—Significant Forecast Assumptions” for further information as to the assumptions we have made for the financial forecast. This forecast is a forward-looking statement and should be read together with our historical and unaudited pro forma combined financial statements and the accompanying notes included elsewhere in this prospectus and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” This forecast was not prepared with a view toward complying with the published guidelines of the SEC or guidelines established by the American Institute of Certified Public Accountants with respect to prospective financial information, but, in the view of our management, 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 sufficient cash available for distribution to pay the minimum quarterly distribution to all unitholders and our general partner for the forecasted period. However, this information is not fact and should not be relied upon as being necessarily indicative of our 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 registration statement has been prepared by, and is the responsibility of, our management. Ernst & Young LLP has neither compiled nor performed any procedures with respect to the accompanying prospective financial information and, accordingly, Ernst & Young LLP does not express an opinion or any other form of assurance with respect thereto. The Ernst & Young LLP report included in this registration statement 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 our estimated cash available for distribution.

 

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

Phillips 66 Partners LP

Estimated Cash Available for Distribution

 

(in millions)

   Twelve months
ending
March 31, 2014
 

Revenue:

  

Transportation and terminaling services—Phillips 66

   $ 115.0   

Transportation and terminaling services—third parties

     —     
  

 

 

 

Total revenue

     115.0   
  

 

 

 

Costs and expenses:

  

Operating and maintenance expense

     27.1   

Depreciation expense

     6.0   

General and administrative expense

     12.7   

Taxes other than income taxes

     1.2   

Interest expense, net(1)

     1.5   
  

 

 

 

Total Costs and Expenses

     48.5   
  

 

 

 

Income before income taxes

     66.5   

Provision for income taxes(2)

     0.4   
  

 

 

 

Net income

     66.1   

Plus:

  

Interest expense, net(1)

     1.5   

Depreciation expense

     6.0   

Amortization of deferred rentals(3)

     0.3   

Provision for income taxes(2)

     0.4   
  

 

 

 

EBITDA(4)

     74.3   

Plus:

  

Adjustments related to minimum volume commitments(5)

     0.9   

Less:

  

Cash interest paid, net(1)

     1.0   

Income taxes paid

     0.4   

Maintenance capital expenditures

     7.7   

Expansion capital expenditures

     —     
  

 

 

 

Estimated cash available for distribution

   $ 66.1   
  

 

 

 

Distributions to public common unitholders

   $     

Distributions to Phillips 66:

  

Common units

  

Subordinated units

  

General partner units

  

Aggregate annualized minimum quarterly distributions

   $     

Excess of cash available for distribution over aggregate annualized minimum quarterly distributions(6)

   $     

 

(1) Interest expense and cash interest paid both include commitment fees to establish a revolving credit facility. Interest expense also includes the amortization of estimated deferred issuance costs to be incurred in connection with establishing our revolving credit facility. Includes interest income on approximately $            million of the net proceeds of this offering that we will retain.
(2) Consists of Texas margin tax.
(3) Represents the amortization of previously deferred rental payments over the remaining term of the applicable lease.
(4) For a definition of the non-GAAP financial measure of EBITDA and a reconciliation of EBITDA to our most directly comparable financial measures calculated and presented in accordance with GAAP, please read “Selected Historical and Pro Forma Combined Financial Data—Non-GAAP Financial Measure.”

 

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(5) Under several of our commercial agreements with Phillips 66, Phillips 66 will be required to transport a minimum volume each calendar quarter. If it fails to transport volumes at the minimum commitment, Phillips 66 will make a quarterly deficiency payment. The quarterly deficiency payment may be applied as a credit for volumes transported in excess of Phillips 66’s minimum volume commitment during any of the succeeding four quarters, after which time the unused credits will expire. For GAAP accounting purposes, we defer the revenue associated with these quarterly deficiency payments until either: (i) the credit has been satisfied through transportation of future volumes in excess of minimum commitments, or (ii) the credit expires through the lapse of time. For the purpose of calculating estimated cash available for distribution, the quarterly deficiency payment is included in cash available for distribution when we receive the cash, rather than when it is recognized as revenue in accordance with GAAP. When a credit is used or expires in a future period, we will deduct the amount of the credit in calculating cash available for distributions as an offset to the corresponding increase in revenue recognized in accordance with GAAP.
(6) If the underwriters exercise their option to purchase additional common units in full, our forecasted estimated cash available for distribution would exceed by $         million the amount needed to pay the aggregate annualized minimum quarterly distribution of $         million on all of our outstanding common and subordinated units and the corresponding distributions on our general partner’s 2% interest for the forecast period.

Significant Forecast Assumptions

The forecast has been prepared by and is the responsibility of management. The forecast 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 during the twelve months ending March 31, 2014. While the assumptions discussed below are not all-inclusive, they include those that we believe are material to our forecasted results of operations, and any assumptions not discussed below were not deemed to be material. We believe we have a reasonable, objective basis for these assumptions. We believe our actual results of operations will approximate those reflected in our forecast, but we can give no assurance that our forecasted results will be achieved. There will likely be differences between our forecast and our actual results and those differences could be material. If the forecasted results are not achieved, we may not be able to make cash distributions on our common units at the minimum quarterly distribution rate or at all.

General considerations

As discussed in this prospectus, substantially all of our revenue and a significant portion of our expenses will be determined by contractual arrangements that we will enter into with Phillips 66 at the closing of this offering. Accordingly, our forecasted results are not directly comparable with historical periods. Please read “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Factors Affecting the Comparability of Our Financial Results.” Substantially all of our revenue will be derived from long-term, fee-based commercial agreements with Phillips 66 that include minimum volume commitments and inflation escalators.

The majority of our regulated tariffs include a provision for loss allowance, the calculation of which includes a commodity price component. As a result, the revenue we realize under our loss allowance provisions could increase or decrease as a result of changes in underlying commodity prices. For purposes of estimating our cash available for distribution for the twelve months ending March 31, 2014, we have assumed commodity prices of $112 per barrel of Light Louisiana Sweet (“LLS”) crude oil and $122 per barrel for refined petroleum products and have held these prices constant over the forecast period. These prices were based on recent quoted spot prices for LLS crude oil and refined petroleum products prices from various third-party pricing services which are the reference prices in our commercial agreements with Phillips 66, but do not necessarily reflect the actual prices that will be used to calculate our loss allowance revenue under our commercial agreements with Phillips 66, which will be based on a monthly average of these quoted prices for the month during which the underlying volumes were transported for Phillips 66. West Texas Intermediate (“WTI”) crude oil continues to trade at a significant discount relative to crude oils such as LLS. For example, the recent quoted spot price for WTI was $92.27. For the year ended December 31, 2012, the average differential for LLS over WTI was $17.61. Based on the assumption in the forecast, for the twelve months ending March 31, 2014, we forecast that approximately 16% of our forecasted revenue will be derived from these loss allowance provisions. Based on forecasted volumes and prices, as well as the new commercial agreements with Phillips 66 that we expect to enter into in

 

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connection with this offering, a $10 per barrel change in each applicable commodity price would change our revenue by approximately $1.6 million for the twelve-month period ending March 31, 2014.

In addition, we occasionally experience volumetric gains and losses, which we refer to as commodity imbalances, on our assets due to pressure and temperature changes, evaporation and variances in meter readings and other measurement methods. The commodity imbalance provisions of our commercial agreements value these commodity imbalances based on underlying commodity prices, similar to the loss allowance provisions of our regulated tariffs. However, we have not historically experienced any material commodity imbalance losses on our assets and have not forecasted any volumetric gains or losses from commodity imbalances.

Revenue

We estimate that we will generate revenue of $115.0 million for the twelve months ending March 31, 2014, compared with pro forma revenue of $109.2 million for the year ended December 31, 2012. Based on our assumptions for the twelve months ending March 31, 2014, we expect substantially all of our revenue will be generated by fees and tariffs paid by Phillips 66 under our commercial agreements. We expect 83% of our forecasted revenue to be supported by Phillips 66’s minimum commitments under our commercial agreements. The increase in revenue is due primarily to:

 

 

an approximate $1.9 million increase in loss allowance revenue primarily attributable to increased volumes;

 

 

an approximate $1.2 million increase related to tariff and fee adjustments;

 

 

an approximate $0.5 million increase in revenue attributable to increased volumes; and

 

 

an approximate $2.3 million increase related to new biodiesel blending activities at our Pasadena and Hartford terminals.

Volumes

To forecast revenue, we used our historical volumes handled on behalf of Phillips 66 and third parties for the year ended December 31, 2012, and made adjustments taking into account: refinery maintenance schedules, new biodiesel blending capability at the Pasadena and Hartford terminals and internal forecasts for crude supply and refined petroleum product demand. The forecasted revenue also takes into consideration the commercial agreements with Phillips 66 that will be in effect at the closing of this offering. In some cases, we have forecasted volumes from Phillips 66 in excess of the minimum volume commitment under these commercial agreements. We expect that any variances between actual revenue and forecasted revenue will be driven by differences between actual volumes and forecasted volumes (subject to the minimum volume commitments of Phillips 66), by changes in uncommitted volumes from Phillips 66, and by changes in product mix and corresponding changes in fees and tariffs associated with product mix.

 

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The following table compares forecasted volumes for the twelve months ending March 31, 2014, to actual volumes for the year ended December 31, 2012, contrasted against our minimum volume commitments.

Volumes handled

 

     Actual
year ended
December 31,
2012
     Forecasted
twelve months
ending March 31,
2014
     Phillips 66
minimum
volume
commitment
     Phillips 66
capacity
reservation
 

Pipelines(MBD)(1)

           

Crude oil throughput

     240         292         190         —     

Refined product throughput

     278         272         267         43.4 (2) 
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     518         564         457         43.4 (2) 
  

 

 

    

 

 

    

 

 

    

 

 

 

Terminals(MBD)

           

Crude oil

           

Storage volumes

     193         209         190         —     

Terminaling throughput

     174         171         150         —     

Refined products

           

Terminaling throughput

     252         245         190         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     619         625         530         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Represents the sum of volumes transported through each separately tariffed pipeline segment.
(2) Represents Phillips 66’s capacity reservation under our Hartford Connector throughput and deficiency agreement.

Clifton Ridge crude system revenue

We estimate that our total crude oil transportation and terminaling revenue on our Clifton Ridge crude system for the twelve months ending March 31, 2014, will be $46.8 million, compared with $42.1 million for the year ended December 31, 2012, on a pro forma basis. Of the total revenue forecasted for this system, $39.2 million, or 84%, will be supported by the shipment of minimum committed volumes under the Clifton Ridge transportation and terminaling services agreements that we will enter into with Phillips 66 at the closing of this offering. The balance of the estimated revenue represents forecasted volumes from Phillips 66 in excess of the minimum commitments under these agreements, as well as pipeline loss allowance not subject to minimum commitments.

Sweeny to Pasadena products system revenue

We estimate that our total refined petroleum product transportation and terminaling revenue on our Sweeny to Pasadena products system for the twelve months ending March 31, 2014, will be $50.0 million, the same as the year ended December 31, 2012, on a pro forma basis. Of the total revenue forecasted for this system, $43.8 million, or 88%, will be supported by the shipment of minimum committed volumes under the Sweeny to Pasadena transportation services agreement and master terminaling services agreement that we will enter into with Phillips 66 at the closing of this offering. The balance of the estimated revenue represents forecasted volumes from Phillips 66 in excess of the minimum commitments under these agreements.

Hartford Connector products system revenue

We estimate that our total refined petroleum product transportation and terminaling revenue on our Hartford Connector products system for the twelve months ending March 31, 2014, will be $18.2 million, compared with $17.1 million for the year ended December 31, 2012, on a pro forma basis. Of the total revenue forecasted for this system, $12.5 million, or 69%, will be supported by the shipment of minimum committed volumes under the Hartford Connector throughput and deficiency agreement and our master terminaling services agreement that we will enter into with Phillips 66 at the closing of this offering. The balance of this estimated revenue represents biodiesel blending and pipeline loss allowance, as well as tank and dock usage fees.

 

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Operating and maintenance expense

Our operating and maintenance expenses include labor expenses, repairs and maintenance expenses, equipment rentals, utility costs and insurance premiums. We estimate that we will incur operating and maintenance expense of $27.1 million for the twelve months ending March 31, 2014, compared with $28.1 million for the year ended December 31, 2012, on a pro forma basis. Our operating and maintenance expense includes approximately $5.9 million of the operational and administrative support fee of $13.7 million that we will pay to Phillips 66 under the omnibus agreement that we will enter into at the closing of this offering for the provision of certain services to us. Our commercial agreements with Phillips 66 also contain inflation escalators that should substantially mitigate inflation-related increases in operating costs in rising operating cost environments.

General and administrative expenses

We estimate that our total general and administrative expenses will be $12.7 million for the twelve months ending March 31, 2014, compared with $9.1 million for the year ended December 31, 2012, on a pro forma basis. The increase in our forecasted general and administrative expenses of approximately $3.6 million compared to pro forma general and administrative expenses for the year ended December 31, 2012, relate primarily to incremental annual expenses as a result of being a separate publicly traded partnership, which are discussed in more detail under the second bullet point below.

For the forecast period, we expect that our forecasted general and administrative expenses will consist of:

 

 

approximately $7.8 million in general and administrative expense included in the operational and administrative support fee of $13.7 million that we will pay to Phillips 66 under the omnibus agreement that we will enter into at the closing of this offering for the provision of certain services to us. For a more complete description of this agreement and the services covered by it, please read “Certain Relationships and Related Party Transactions—Agreements Governing the Transactions—Omnibus Agreement” and “—Operational Services Agreement.”

 

 

approximately $3.6 million of incremental annual expenses as a result of being a separate publicly traded partnership, which includes employee-related expenses and costs associated with annual and quarterly reports to unitholders, financial statement audit, tax return and Schedule K-1 preparation and distribution, investor relations activities, registrar and transfer agent fees, independent director compensation and incremental employee salary and benefit costs.

Depreciation expense

We estimate that depreciation expense will be approximately $6.0 million for the twelve months ending March 31, 2014, compared with approximately $6.6 million for the year ended December 31, 2012, on a pro forma basis. Depreciation expense is reduced for the twelve months ending March 31, 2014, compared to the year ended December 31, 2012, due to asset retirements in 2012.

Taxes other than income tax

We estimate that taxes other than income tax will be approximately $1.2 million for the twelve months ending March 31, 2014, compared with approximately $1.0 million for the year ended December 31, 2012, on a pro forma basis.

 

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Financing

We estimate that net interest expense for the twelve months ending March 31, 2014, will be $1.5 million. Our interest expense for the twelve months ending March 31, 2014, is based on the following assumptions:

 

 

we will not draw any amounts under our revolving credit facility during the twelve-month forecast period;

 

 

our interest expense will include annual commitment fees associated with undrawn capacity, as well as the amortization of estimated deferred issuance costs incurred in connection with our revolving credit facility;

 

 

we will have interest income based on the net proceeds of this offering that we will retain to fund future acquisitions; and

 

 

we will remain in compliance with the financial and other covenants in our revolving credit facility.

Capital expenditures

We estimate that total capital expenditures for the twelve months ending March 31, 2014, will be $7.7 million, compared with capital expenditures of $15.0 million for the year ended December 31, 2012. This forecast estimate is based on the following assumptions:

 

 

Maintenance capital expenditures.    We estimate that our maintenance capital expenditures will be $7.7 million for the twelve months ending March 31, 2014, and will be primarily associated with investments in our Clifton Ridge crude system, including the replacement of buried piping with above ground piping, installation of dredge piping and installation of enhanced measurement and monitoring equipment. We estimate that our maintenance capital expenditures were $4.1 million for the year ended December 31, 2012.

 

 

Expansion capital expenditures.    We have assumed no expansion capital expenditures for the twelve months ending March 31, 2014. Although we currently have no budgeted expansion capital expenditures, we are currently considering various potential expansion opportunities with Phillips 66. Please read “Business—Our Asset Portfolio—Potential Expansion Opportunities with our Initial Assets.” We estimate that our expansion capital expenditures were $10.9 million for the year ended December 31, 2012, and were related to installation of biodiesel tanks and associated equipment at our Hartford and Pasadena terminals. Please read “Certain Relationships and Related Party Transactions—Agreements Governing the Transactions—Omnibus Agreement.”

Regulatory, industry and economic factors

Our forecast of estimated EBITDA for the twelve months ending March 31, 2014, is based on the following significant assumptions related to regulatory, industry and economic factors:

 

 

Phillips 66 will not default under any of our commercial agreements or reduce, suspend or terminate its obligations, nor will any events occur that would be deemed a force majeure event, under such agreements;

 

 

there will not be any new federal, state or local regulation, or any interpretation of existing regulation, of the portions of the refining or midstream energy industries in which we operate that will be materially adverse to our business;

 

 

there will not be any material accidents, weather-related incidents, unscheduled downtime or similar unanticipated events with respect to our assets or Phillips 66 refineries;

 

 

there will not be a shortage of skilled labor; and

 

 

there will not be any material adverse changes in the refining industry, the midstream energy sector or market, or overall economic conditions.

 

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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             , 2013, we distribute all of our available cash to unitholders of record on the applicable record date. We will adjust the amount of our distribution for the period from the closing of this offering through             , 2013, 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 to:

 

   

provide for the proper conduct of our business (including reserves for our future capital expenditures, future acquisitions, anticipated future debt service requirements and refunds of collected rates reasonably likely to be refunded as a result of a settlement or hearing related to FERC rate proceedings or rate proceedings under applicable law subsequent to that quarter);

 

   

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

 

   

provide funds for distributions to our unitholders and to our general partner for any one or more of the next four quarters (provided that our general partner may not establish cash reserves for distributions if the effect of the establishment of such reserves will 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 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, and in all cases are used solely for working capital purposes or to pay distributions to partners and with the intent of the borrower to repay such borrowings within twelve months with funds other than from additional working capital borrowings.

Intent to distribute the minimum quarterly distribution

Under our current cash distribution policy, we intend to make a minimum quarterly distribution to the holders of our common units and subordinated units of $         per unit, or $         per unit 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 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. The amount of distributions paid under our cash distribution policy and the decision to make any distribution will be 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—Capital Resources and Liquidity—Revolving Credit Facility” for a discussion of the restrictions included in our revolving credit facility that may restrict our ability to make distributions.

 

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General partner interest and incentive distribution rights

Initially, our general partner will be entitled to 2% of all quarterly distributions from inception that we make prior to our liquidation. This general partner interest will be represented by              general partner units (or              general partner units if the underwriters exercise their option to purchase additional common units from us). Our general partner has the right, but not the obligation, to contribute a proportionate amount of capital to us to maintain its current general partner interest. The general partner’s initial 2% interest in these distributions will be reduced if we issue additional units in the future and our general partner does not contribute a proportionate amount of capital to us to maintain its 2% general partner interest (other than the issuance of common units upon any exercise by the underwriters of their option to purchase additional common units in this offering).

Our general partner also currently holds incentive distribution rights that entitle it to receive increasing percentages, up to a maximum of 48%, of the cash we distribute from operating surplus (as defined below) in excess of $         per unit per quarter. The maximum distribution of 48% does not include any distributions that our general partner or its affiliates may receive on common, subordinated or general partner units that they own. Please read “—General Partner Interest and Incentive Distribution Rights” for additional information.

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:

 

 

$         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), provided that cash receipts from the termination of a commodity hedge or interest rate hedge prior to its specified termination date shall be included in operating surplus in equal quarterly installments over the remaining scheduled life of such commodity hedge or interest rate hedge; 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 (including incremental distributions on incentive distribution rights) paid in respect of equity issued, other than equity issued in this offering, to finance all or a portion of expansion capital expenditures in respect of the period from the date that we enter into a binding obligation to commence the construction, development, replacement, improvement or expansion of a capital asset and ending on the earlier to occur of the date the capital asset commences commercial service and the date that it is abandoned or disposed of; 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 not repaid within twelve months after having been incurred, or repaid within such 12-month period with the proceeds of additional working capital borrowings.

 

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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, it includes a provision that will enable us, if we choose, to distribute as operating surplus up to $         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. In addition, the effect of including, as described above, certain cash distributions on equity interests in operating surplus will be to increase operating surplus by the amount of any such cash distributions. As a result, we may also distribute as operating surplus up to the amount of any such cash that we receive from non-operating sources.

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 twelve-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.

We define interim capital transactions as (1) 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 ordinary course of business) and sales of debt securities, (2) sales of equity securities, and (3) 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.

We define operating expenditures as all of our cash expenditures, including, but not limited to, taxes, reimbursements of expenses of our general partner and its affiliates, officer, director and employee compensation, debt service 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 expiration of its settlement or termination date specified therein will be included in operating expenditures in equal quarterly installments over the remaining scheduled life of such interest rate hedge contract or commodity hedge contract and amounts paid in connection with the initial purchase of a rate hedge contract or a commodity hedge contract will be amortized at the life of such rate hedge contract or commodity hedge 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 where such borrowings have previously been deemed to have been repaid (as described above);

 

 

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

 

 

expansion capital expenditures;

 

 

payment of transaction expenses (including taxes) relating to interim capital transactions;

 

 

distributions to our partners;

 

 

repurchases of partnership interests (excluding repurchases we make to satisfy obligations under employee benefit plans); or

 

 

any other expenditures or payments using the proceeds of this offering that are described in “Use of Proceeds.”

 

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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;

 

 

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; and

 

 

capital contributions received.

Characterization of cash distributions

All available cash distributed by us on any date from any source will be treated as distributed from operating surplus until the sum of all available cash distributed by us 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. We anticipate that distributions from operating surplus will generally not represent a return of capital. However, operating surplus, as defined in our partnership agreement, includes certain components, including a $         million cash basket, that represent non-operating sources of cash. Consequently, it is possible that all or a portion of specific distributions from operating surplus may represent a return of capital. Any available cash distributed by us in excess of our cumulative operating surplus will be deemed to be capital surplus under our partnership agreement. Our partnership agreement treats a distribution of capital surplus as the repayment of the initial unit price from this initial public offering and as a return of capital. We do not anticipate that we will make any distributions from capital surplus.

Capital Expenditures

Maintenance capital expenditures are cash expenditures (including expenditures for the construction or development of new capital assets or the replacement, improvement or expansion of existing capital assets) made to maintain, over the long term, our operating capacity or operating income. Examples of maintenance capital expenditures are expenditures to repair, refurbish and replace pipelines and storage facilities, to maintain equipment reliability, integrity and safety and to address environmental laws and regulations.

Expansion capital expenditures are cash expenditures incurred for acquisitions or capital improvements that we expect will increase our operating capacity or operating income over the long term. Examples of expansion capital expenditures include the acquisition of equipment, or the construction, development or acquisition of additional pipeline or storage capacity, to the extent such capital expenditures are expected to expand our long-term operating capacity or operating income. Expansion capital expenditures include interest payments (and related fees) on debt incurred to finance all or a portion of expansion capital expenditures in respect of the period from the date that we enter into a binding obligation to commence the construction, development, replacement, improvement or expansion of a capital asset 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.

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

 

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Subordinated Units and 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 $         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 in the payment of the minimum quarterly distribution on the common units from prior quarters. Furthermore, no arrearages will accrue or be payable 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.

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 after                     , 2016, 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 annualized minimum quarterly distribution) 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 the 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                     , 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 $         (150% of the annualized minimum quarterly distribution), plus the related distributions on the incentive distribution rights, 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 (1) $         (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 (2) the corresponding distributions on the incentive distribution rights; and

 

 

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

 

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Expiration upon removal of the general partner

In addition, if the unitholders remove our general partner other than for cause:

 

 

the subordinated units held by any person will immediately and automatically convert into common units on a one-for-one basis, provided (1) neither such person nor any of its affiliates voted any of its units in favor of the removal and (2) such person is not an affiliate of the successor general partner;

 

 

if all of the subordinated units convert pursuant to the foregoing, all cumulative common unit arrearages on the common units will be extinguished and the subordination period will end; 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.

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 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% to the common unitholders, pro rata, and 2% 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% to the common unitholders, pro rata, and 2% 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% to the subordinated unitholders, pro rata, and 2% 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.

 

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The preceding discussion is based on the assumptions that our general partner maintains its 2% 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% to all unitholders, pro rata, and 2% 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% general partner interest and that we do not issue additional classes of equity securities.

General Partner Interest and Incentive Distribution Rights

Our partnership agreement provides that our general partner initially will be entitled to 2% 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% general partner interest if we issue additional units. Our general partner’s 2% interest, and the percentage of our cash distributions to which it is entitled from such 2% interest, will be proportionately reduced if we issue additional units in the future (other than the issuance of common units upon any exercise by the underwriters of their option to purchase additional common units in this offering, the issuance of common units upon conversion of outstanding subordinated units or the issuance of common units upon a reset of the incentive distribution rights) and our general partner does not contribute a proportionate amount of capital to us in order to maintain its 2% general partner interest. Our partnership agreement does not require that our general partner fund its capital contribution with cash. Our general partner 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%, 23% and 48%) 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 currently holds 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% general partner interest, 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 unitholders 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:

 

 

first, 98% to all unitholders, pro rata, and 2% to our general partner, until each unitholder receives a total of $             per unit for that quarter (the “first target distribution”);

 

 

second, 85% to all unitholders, pro rata, and 15% to our general partner, until each unitholder receives a total of $             per unit for that quarter (the “second target distribution”);

 

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third, 75% to all unitholders, pro rata, and 25% to our general partner, until each unitholder receives a total of $             per unit for that quarter (the “third target distribution”); and

 

 

thereafter, 50% to all unitholders, pro rata, and 50% to our general partner.

Percentage Allocations of Available Cash from Operating Surplus

The following table illustrates the percentage allocations of available cash from operating surplus between the 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 the 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% general partner interest and assume that our general partner has contributed any additional capital necessary to maintain its 2% 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

   $                  %             %   

First Target Distribution

     above $         up to $               %             %   

Second Target Distribution

     above $         up to $               %             %   

Third Target Distribution

     above $         up to $               %             %   

Thereafter

     above $                  %             %   

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, subject to certain conditions, 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 set. If our general partner transfers all or a portion of the 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, we have made cash distributions to the holders of the incentive distribution rights at the highest level of incentive distributions for each of the four consecutive fiscal quarters immediately preceding such time 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 the holder of the incentive distribution rights 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.

 

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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 of the average 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 cash distributions per common unit during that two-quarter period. In addition, our general partner will be issued the number of general partner units necessary to maintain our general partner’s interest in us immediately prior to the reset election.

The number of common units that our general partner (or the then-holder of the incentive distribution rights, if other than 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 aggregate amount of 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 aggregate amount of cash distributed per common unit during each of these two quarters.

Following a reset election, the minimum quarterly distribution amount will be reset to an amount equal to the average cash distribution amount 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% to all unitholders, pro rata, and 2% to our general partner, until each unitholder receives an amount equal to 115% of the reset minimum quarterly distribution for that quarter;

 

 

second, 85% to all unitholders, pro rata, and 15% to our general partner, until each unitholder receives an amount per unit equal to 125% of the reset minimum quarterly distribution for the quarter;

 

 

third, 75% to all unitholders, pro rata, and 25% to our general partner, until each unitholder receives an amount per unit equal to 150% of the reset minimum quarterly distribution for the quarter; and

 

 

thereafter, 50% to all unitholders, pro rata, and 50% to our general partner.

The following table illustrates the percentage allocations of available cash from operating surplus between the unitholders and our general partner at various cash distribution levels (1) pursuant to the cash distribution provisions of our partnership agreement in effect at the completion of this offering, as well as (2) 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 $            .

 

     Quarterly
distribution per unit
prior to reset
    Marginal percentage
interest in distributions
     Quarterly  distribution
per unit
following hypothetical reset
 
       Common
unitholders
    General
partner
interest
    Incentive
distribution
rights
    

Minimum Quarterly Distribution

   $            %        2%        —        $       

First Target Distribution

   above $          up to $             %        2%        —        above $        up to $         (1)   

Second Target Distribution

   above $          up to $             %        2%        13%       above $          (1)    up to $         (2)   

Third Target Distribution

   above $          up to $             %        2%        23%       above $          (2)    up to $         (3)   

Thereafter

   above $            %        2%        48%       above $          (3)   

 

(1) This amount is 115% of the hypothetical reset minimum quarterly distribution.
(2) This amount is 125% of the hypothetical reset minimum quarterly distribution.
(3) This amount is 150% of the hypothetical reset minimum quarterly distribution.

 

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The following table illustrates the total amount of available cash from operating surplus that would be distributed to the unitholders and our general partner, including in respect of incentive distribution rights, based on an average of the amounts distributed for the two quarters immediately prior to the reset. The table assumes that immediately prior to the reset there would be              common units outstanding, our general partner’s 2% interest has been maintained, and the average distribution to each common unit would be $         per quarter for the two consecutive non-overlapping quarters prior to the reset.

 

    Quarterly
distribution per
unit prior to reset
    Cash
distributions
to common
unitholders
prior to
reset
    Cash distribution to general
partner prior to reset
    Total
distributions
 
        Common
units
    2%
General
partner
interest
    Incentive
distribution
rights
    Total    

Minimum Quarterly Distribution

  $          $        $        $        $        $        $     

First Target Distribution

  above $          up to $                    

Second Target Distribution

  above $          up to $                    

Third Target Distribution

  above $          up to $                    

Thereafter

  above $          $        $        $        $        $        $     

The following table illustrates the total amount of available cash from operating surplus that would be distributed to the unitholders and the general partner, including in respect of incentive distribution rights, with respect to the quarter after the reset occurs. The table reflects that, as a result of the reset, there would be              common units outstanding, our general partner has maintained its 2% general partner interest, and that the average distribution to each common unit would be $            . The number of common units issued as a result of the reset was calculated by dividing (x)              as the average of the amounts received by the general partner in respect of its incentive distribution rights for the two consecutive non-overlapping quarters prior to the reset as shown in the table above, by (y) the average of the cash distributions made on each common unit per quarter for the two consecutive non-overlapping quarters prior to the reset as shown in the table above, or $            .

 

    Quarterly
distribution per
unit after reset
    Cash
distributions
to common
unitholders
after reset
    Cash distribution to general
partner after reset
    Total
distributions
 
      Common
units
    2%
General
partner
interest
    Incentive
distribution
rights
    Total    

Minimum Quarterly Distribution

  $          $        $        $        $        $        $     

First Target Distribution

  above $          up to $                    

Second Target Distribution

  above $          up to $                    

Third Target Distribution

  above $          up to $                    

Thereafter

  above $          $        $        $        $       $        $     

Our general partner will be entitled to cause the minimum quarterly distribution amount and the target distribution levels to be reset on more than one occasion, provided that it may not make a reset election except at a time when it has received incentive distributions for the immediately preceding four consecutive fiscal quarters based on the highest level of incentive distributions that it is entitled to receive under our partnership agreement.

 

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Distributions from Capital Surplus

How distributions from capital surplus will be made

We will make distributions of available cash from capital surplus, if any, in the following manner:

 

 

first, 98% to all unitholders, pro rata, and 2% to our general partner, until we distribute for each common unit that was issued in this offering, an amount of available cash from capital surplus equal to the initial public offering price in this offering;

 

 

second, 98% to all unitholders, pro rata, and 2% to our general partner, until we distribute for each common unit, an amount of available cash from capital surplus equal to any unpaid arrearages in payment of the minimum quarterly distribution on the outstanding common units; and

 

 

thereafter, as if they were from operating surplus.

The preceding discussion is based on the assumptions that our general partner maintains its 2% general partner interest and that we do not issue additional classes of equity securities.

Effect of a distribution from capital surplus

Our partnership agreement treats a distribution of capital surplus as the repayment of the initial unit price from this initial public offering, which is a return of capital. The initial public offering price less any distributions of capital surplus per unit is referred to as the “unrecovered initial unit price.” Each time a distribution of capital surplus is made, the minimum quarterly distribution and the target distribution levels will be reduced in the same proportion as the corresponding reduction in the unrecovered initial unit price. Because distributions of capital surplus will reduce the minimum quarterly distribution after any of these distributions are made, the effects of distributions of capital surplus may make it easier for our general partner to receive incentive distributions and for the subordinated units to convert into common units. However, any distribution of capital surplus before the unrecovered initial unit price is reduced to zero cannot be applied to the payment of the minimum quarterly distribution or any arrearages.

Once we distribute capital surplus on a unit issued in this offering in an amount equal to the initial unit price, we will reduce the minimum quarterly distribution and the target distribution levels to zero. Then, after distributing an amount of capital surplus for each common unit equal to any unpaid arrearages of the minimum quarterly distributions on outstanding common units, we will then make all future distributions from operating surplus, with 50% being paid to the unitholders, pro rata, and 2% to our general partner and 48% to the holder of our incentive distribution rights.

Adjustment to the Minimum Quarterly Distribution and Target Distribution Levels

In addition to adjusting the minimum quarterly distribution and target distribution levels to reflect a distribution of capital surplus, if we combine our units into fewer units or subdivide our units into a greater number of units, we will proportionately adjust:

 

 

the minimum quarterly distribution;

 

 

target distribution levels;

 

 

the unrecovered initial unit price;

 

 

the number of general partner units comprising the general partner interest; and

 

 

the arrearages per common unit in payment of the minimum quarterly distribution on the common units.

 

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For example, if a two-for-one split of the common units should occur, the minimum quarterly distribution, the target distribution levels and the unrecovered initial unit price would each be reduced to 50% of its initial level, and each subordinated unit and general partner unit would be split into two units. We will not make any adjustment by reason of the issuance of additional units for cash or property (including additional common units issued under any compensation or benefit plans).

In addition, if legislation is enacted or if the official interpretation of existing law is modified by a governmental authority, so that we become taxable as a corporation or otherwise subject to taxation as an entity for federal, state or local income tax purposes, our partnership agreement specifies that the minimum quarterly distribution and the target distribution levels for each quarter may be reduced by multiplying each distribution level by a fraction, the numerator of which is available cash for that quarter (reduced by the amount of the estimated tax liability for such quarter payable by reason of such legislation or interpretation) and the denominator of which is the sum of available cash for that quarter (reduced by the amount of the estimated tax liability for such quarter payable by reason of such legislation or interpretation) plus our general partner’s estimate of our aggregate liability for the quarter for such income taxes payable by reason of such legislation or interpretation. To the extent that the actual tax liability differs from the estimated tax liability for any quarter, the difference may be accounted for in subsequent quarters.

Distributions of Cash Upon Liquidation

General

If we dissolve in accordance with our partnership agreement, we will sell or otherwise dispose of our assets in a process called liquidation. We will first apply the proceeds of liquidation to the payment of our creditors. We will distribute any remaining proceeds to the unitholders and our general partner, in accordance with their capital account balances, as adjusted to reflect any gain or loss upon the sale or other disposition of our assets in liquidation.

The allocations of gain and loss upon liquidation are intended, to the extent possible, to entitle the holders of outstanding common units to a preference over the holders of outstanding subordinated units upon our liquidation, to the extent required to permit common unitholders to receive their unrecovered initial unit price plus the minimum quarterly distribution for the quarter during which liquidation occurs plus any unpaid arrearages in payment of the minimum quarterly distribution on the common units. However, there may not be sufficient gain upon our liquidation to enable the holders of common units to fully recover all of these amounts, even though there may be cash available for distribution to the holders of subordinated units. Any further net gain recognized upon liquidation will be allocated in a manner that takes into account the incentive distribution rights of our general partner.

Manner of adjustments for gain

The manner of the adjustment for gain is set forth in our partnership agreement. If our liquidation occurs before the end of the subordination period, we will allocate any gain to our partners in the following manner:

 

 

first, to our general partner to the extent of any negative balance in its capital account;

 

 

second, 98% to the common unitholders, pro rata, and 2% to our general partner, until the capital account for each common unit is equal to the sum of:

(1) the unrecovered initial unit price;

(2) the amount of the minimum quarterly distribution for the quarter during which our liquidation occurs; and

(3) any unpaid arrearages in payment of the minimum quarterly distribution;

 

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third, 98% to the subordinated unitholders, pro rata, and 2% to our general partner, until the capital account for each subordinated unit is equal to the sum of:

(1) the unrecovered initial unit price; and

(2) the amount of the minimum quarterly distribution for the quarter during which our liquidation occurs;

 

 

fourth, 98% to all unitholders, pro rata, and 2% to our general partner, until we allocate under this paragraph an amount per unit equal to:

(1) the sum of the excess of the first target distribution per unit over the minimum quarterly distribution per unit for each quarter of our existence; less

(2) the cumulative amount per unit of any distributions of available cash from operating surplus in excess of the minimum quarterly distribution per unit that we distributed 98% to the unitholders, pro rata, and 2% to our general partner, for each quarter of our existence;

 

 

fifth, 85% to all unitholders, pro rata, and 15% to our general partner, until we allocate under this paragraph an amount per unit equal to:

(1) the sum of the excess of the second target distribution per unit over the first target distribution per unit for each quarter of our existence; less

(2) the cumulative amount per unit of any distributions of available cash from operating surplus in excess of the first target distribution per unit that we distributed 85% to the unitholders, pro rata, and 15% to our general partner for each quarter of our existence;

 

 

sixth, 75% to all unitholders, pro rata, and 25% to our general partner, until we allocate under this paragraph an amount per unit equal to:

(1) the sum of the excess of the third target distribution per unit over the second target distribution per unit for each quarter of our existence; less

(2) the cumulative amount per unit of any distributions of available cash from operating surplus in excess of the second target distribution per unit that we distributed 75% to the unitholders, pro rata, and 25% to our general partner for each quarter of our existence; and

 

 

thereafter, 50% to all unitholders, pro rata, and 50% to our general partner.

The percentages set forth above are based on the assumption that our general partner maintains its 2% general partner interest and has not transferred its incentive distribution rights and that we do not issue additional classes of equity securities.

If the liquidation occurs after the end of the subordination period, the distinction between common units and subordinated units will disappear, so that clause (3) of the second bullet point above and all of the fourth bullet point above will no longer be applicable.

 

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Manner of adjustments for losses

If our liquidation occurs before the end of the subordination period, after making allocations of loss to the general partner and the unitholders in a manner intended to offset in reverse order the allocations of gains that have previously been allocated, we will generally allocate any loss to our general partner and unitholders in the following manner:

 

 

first, 98% to the holders of subordinated units in proportion to the positive balances in their capital accounts and 2% to our general partner, until the capital accounts of the subordinated unitholders have been reduced to zero;

 

 

second, 98% to the holders of common units in proportion to the positive balances in their capital accounts and 2% to our general partner, until the capital accounts of the common unitholders have been reduced to zero; and

 

 

thereafter, 100% to our general partner.

The percentages set forth above are based on the assumption that our general partner maintains its 2% general partner interest and has not transferred its incentive distribution rights and that we do not issue additional classes of equity securities.

If the liquidation occurs after the end of the subordination period, the distinction between common units and subordinated units will disappear, so that all of the first bullet point above will no longer be applicable.

Adjustments to capital accounts

Our partnership agreement requires that we make adjustments to capital accounts upon the issuance of additional units. In this regard, our partnership agreement specifies that we allocate any unrealized and, for tax purposes, unrecognized gain resulting from the adjustments to the unitholders and the general partner in the same manner as we allocate gain upon liquidation. In the event that we make positive adjustments to the capital accounts upon the issuance of additional units, our partnership agreement requires that we generally allocate any later negative adjustments to the capital accounts resulting from the issuance of additional units or upon our liquidation in a manner that results, to the extent possible, in the partners’ capital account balances equaling the amount that they would have been if no earlier positive adjustments to the capital accounts had been made. In contrast to the allocations of gain, and except as provided above, we generally will allocate any unrealized and unrecognized loss resulting from the adjustments to capital accounts upon the issuance of additional units to the unitholders and our general partner based on their respective percentage ownership of us. In this manner, prior to the end of the subordination period, we generally will allocate any such loss equally with respect to our common and subordinated units. If we make negative adjustments to the capital accounts as a result of such loss, future positive adjustments resulting from the issuance of additional units will be allocated in a manner designed to reverse the prior negative adjustments, and special allocations will be made upon liquidation in a manner that results, to the extent possible, in our unitholders’ capital account balances equaling the amounts they would have been if no earlier adjustments for loss had been made.

 

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SELECTED HISTORICAL AND PRO FORMA COMBINED FINANCIAL DATA

The following table shows selected historical combined financial data of our Predecessor for accounting purposes, and selected unaudited pro forma combined financial statements of Phillips 66 Partners LP for the periods and as of the dates indicated. The selected historical combined financial statements of our Predecessor for the years ended December 31, 2012 and 2011, are derived from audited combined financial statements of our Predecessor. The following table should be read together with, and is qualified in its entirety by reference to, the 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.”

The selected unaudited pro forma combined financial statements presented in the following table as of, and for the year ended, December 31, 2012, are derived from the unaudited pro forma combined financial statements included elsewhere in this prospectus. The unaudited pro forma combined balance sheet assumes the offering and the related transactions occurred as of December 31, 2012, and the unaudited pro forma combined statement of income for the year ended December 31, 2012, assumes the offering and the related transactions occurred as of January 1, 2012. These transactions include, and the unaudited pro forma combined financial statements give effect to, the following:

 

 

Phillips 66’s contribution of all of our Predecessor’s assets to us;

 

 

our entry into a new $         million revolving credit facility, which we have assumed was not drawn during the pro forma period presented, estimated commitment fees that would have been paid had our revolving credit been in place during the pro forma period presented, and the amortization of estimated deferred issuance costs associated with the revolving credit facility;

 

 

our entry into multiple long-term commercial agreements with Phillips 66, our amendment of an existing commercial agreement with Phillips 66, and the recognition of transportation and terminaling revenue under those agreements at historical rates that were not recognized by our Predecessor;

 

 

our entry into an omnibus agreement with Phillips 66 and certain of its affiliates, including our general partner;

 

 

our entry into an operational services agreement with Phillips 66 Pipeline LLC;

 

 

the consummation of this offering and our issuance of              common units to the public,              general partner units and the incentive distribution rights to our general partner and              common units and              subordinated units to Phillips 66; and

 

 

the application of the net proceeds of this offering as described in “Use of Proceeds.”

The unaudited pro forma combined financial statements do not give effect to an estimated $3.6 million in incremental general and administrative expenses that we expect to incur annually as a result of being a separate publicly-traded partnership. In addition, while we have given pro forma effect to the costs we will incur under the omnibus agreement and operational services agreement that we will enter into with Phillips 66 as of the closing of this offering, those adjustments in the aggregate have yielded a similar result to the costs that our Predecessor incurred historically.

 

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The following table presents the non-GAAP financial measure of EBITDA, which we use in our business. For a definition of EBITDA and a reconciliation to our most directly comparable financial measures calculated and presented in accordance with GAAP, please read “—Non-GAAP Financial Measure.”

 

     Phillips 66 Partners LP
Predecessor historical
    Phillips 66
Partners
LP pro
forma
 
     Year ended December 31,  

(in millions, except unit amounts)

       2012             2011         2012  
                 (unaudited)  

Combined statements of income:

      

Revenue

      

Transportation and terminaling services—Phillips 66

   $ 79.7      $ 75.6      $ 108.8   

Transportation and terminaling services—third parties

     0.4        0.4        0.4   

Total revenue

     80.1        76.0        109.2   

Costs and expenses

      

Total costs and expenses

     38.7        37.2        46.6   

Net income

   $ 41.1      $ 38.5      $ 62.2   

Net income per limited partner unit (basic and diluted):

      

Common units

       $     

Subordinated units

       $     

Combined balance sheets (at period end):

      

Cash and cash equivalents

   $ —        $ —        $ 274.3   

Property, plant and equipment, net

     135.8        127.3        135.8   

Total assets

     144.9        134.7        421.5   

Total liabilities

     2.9        4.3        2.5   

Net investment

     142.0        130.4        —     

Partners’ capital

     —          —          419.0   

Total liabilities and net investment/partners’ capital

   $ 144.9      $ 134.7      $ 421.5   

Combined statements of cash flows:

      

Net cash provided by (used in):

      

Operating activities

   $ 44.5      $ 43.7      $     

Investing activities

     (15.0     (10.5  

Financing activities

     (29.5     (33.2  

Other financial data:

      

EBITDA(1)

   $ 48.0      $ 44.6      $ 71.2   

 

(1) For a definition of EBITDA and a reconciliation of EBITDA to our most directly comparable financial measures calculated and presented in accordance with GAAP, please read “—Non-GAAP Financial Measure.”

 

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Non-GAAP Financial Measure

We define EBITDA as net income (loss) before income taxes, net interest expense, depreciation and amortization. EBITDA is used as supplemental financial measures by management and by external users of our financial statements, such as investors and commercial banks, to assess:

 

 

our operating performance as compared to those of other companies in the midstream energy industry, without regard to financing methods, historical cost basis or capital structure;

 

 

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 EBITDA in this prospectus provides information useful to investors in assessing our financial condition and results of operations. The GAAP measures most directly comparable to EBITDA are net income and net cash provided by operating activities. EBITDA should not be considered an alternative to net income, net cash provided by (used in) operating activities or any other measure of financial performance or liquidity presented in accordance with GAAP. EBITDA excludes some, but not all, items that affect net income or net cash, and these measures may vary from those of other companies. As a result, EBITDA as presented below may not be comparable to similarly titled measures of other companies.

The following table presents a reconciliation of EBITDA to net income 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.

 

     Phillips 66 Partners LP
Predecessor

historical
     Phillips 66
Partners LP

pro forma
 
     Year ended December 31,  

(in millions)

       2012              2011          2012  

Reconciliation of EBITDA to net income:

        

Net income

   $ 41.1       $ 38.5       $ 62.2   

Add:

        

Depreciation expense

     6.6         5.8         6.6   

Income taxes

     0.3         0.3         0.4   

Amortization of deferred rentals

     —           —           0.2   

Interest expense, net

     —           —           1.8   
  

 

 

    

 

 

    

 

 

 

EBITDA

   $ 48.0       $ 44.6       $ 71.2   
  

 

 

    

 

 

    

 

 

 

Reconciliation of EBITDA to net cash provided by operating activities:

        

Net cash provided by operating activities

   $ 44.5       $ 43.7      

Change in assets and liabilities

     3.2         0.6      

Income taxes

     0.3         0.3      
  

 

 

    

 

 

    

EBITDA

   $ 48.0       $ 44.6      
  

 

 

    

 

 

    

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion of the financial condition and results of operations for Phillips 66 Partners LP in conjunction with the historical combined financial statements and notes of Phillips 66 Partners LP Predecessor, our predecessor for accounting purposes (our “Predecessor”) and our unaudited pro forma combined financial statements included elsewhere in this prospectus. Among other things, those historical and unaudited pro forma combined financial statements include more detailed information regarding the basis of presentation for the following information.

This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed below. Factors that could cause or contribute to such differences include, but are not limited to, those identified below and those discussed in the section entitled “Risk Factors” included elsewhere in this prospectus.

Overview

We are a growth-oriented, traditional master limited partnership recently formed by Phillips 66 to own, operate, develop and acquire primarily fee-based crude oil, refined petroleum product and NGL pipelines and terminals and other transportation and midstream assets. Our initial assets consist of crude oil and refined petroleum product pipeline, terminal and storage systems in the Central and Gulf Coast regions of the United States that are integral to the Phillips 66 refining and marketing operations they support.

Our initial assets consist of the following three systems:

 

 

Clifton Ridge crude system.    A crude oil pipeline, terminal and storage system located in Sulphur, Louisiana, that is the primary source for delivery of crude oil to Phillips 66’s Lake Charles refinery.

 

 

Sweeny to Pasadena products system.    A refined petroleum product pipeline, terminal and storage system extending from Phillips 66’s Sweeny refinery in Old Ocean, Texas, to our refined petroleum product terminal in Pasadena, Texas, and ultimately connecting to the Explorer and Colonial refined petroleum product pipeline systems and other third-party pipeline and terminal systems. This system is the sole distribution outlet for diesel and gasoline produced at Phillips 66’s Sweeny refinery.

 

 

Hartford Connector products system.    A refined petroleum product pipeline, terminal and storage system located in Hartford, Illinois, that distributes diesel and gasoline produced at the Wood River refinery (a refinery owned by a joint venture between Phillips 66 and Cenovus Energy Inc.) to third-party pipeline and terminal systems, including the Explorer refined petroleum product pipeline system.

How We Generate Revenue

We generate revenue primarily by charging tariffs and fees for transporting crude oil and refined petroleum products through our pipelines, and terminaling and storing crude oil and refined petroleum products at our terminals. We do not take ownership of the crude oil or refined petroleum products that we transport, terminal and store, and we do not engage in the trading of any commodities. At the closing of this offering, we will have multiple commercial agreements with Phillips 66 that will initially be the source of substantially all of our revenue. We believe these agreements, which will be long-term, fee-based agreements with minimum volume commitments and inflation escalators, will promote stable and predictable cash flows.

Most of our pipeline tariffs include a contractual loss allowance, which is calculated as a percentage of throughput volume multiplied by quoted market prices of the commodity being shipped. The amount of loss allowance recognized as revenue is independent of the actual volumetric loss/gain on the system (which we recognize as an increase or decrease in operating and maintenance expenses). This revenue, which accounted for 11% of total revenue in both 2012 and 2011, is subject to more volatility than our tariffs and terminaling fees, as it is directly dependent on commodity prices. As a result, the revenue we realize under our loss allowance provisions could increase or decrease as a result of changes in underlying commodity prices.

 

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Although Phillips 66 has not historically been subject to minimum throughput commitments with respect to most of our pipeline systems and storage facilities, we expect that Phillips 66 will ship volumes in excess of its minimum volume commitment under the commercial agreements we will have with Phillips 66 at the closing of this offering on most of our crude oil and refined product pipeline systems, and will terminal and store volumes in excess of its minimum volume commitments at most of our terminals and storage facilities. All of our transportation services agreements for our pipeline assets, other than our Hartford Connector throughput and deficiency agreement, will include a 10-year term, with Phillips 66 having an option to renew for up to two additional five-year terms. Our Hartford Connector throughput and deficiency agreement, which will be amended in connection with this offering, has a 23-year term (effective as of January 2008) and does not include any option to renew. Our terminaling services agreements for our terminals and storage assets include five-year terms, with Phillips 66 having an option to renew for up to two or three additional five-year terms, for a maximum term of 20 years.

These commercial agreements include provisions that permit Phillips 66 to suspend, reduce or terminate its obligations under the applicable agreement if certain events occur. These events include Phillips 66 deciding to permanently or indefinitely suspend refining operations at a refinery that our assets are integrated into for at least 12 consecutive months and certain force majeure events that would prevent us or Phillips 66 from performing required services under the applicable agreement.

For more information about our commercial agreements with Phillips 66, including Phillips 66’s minimum volume commitments under these agreements, please read “Cash Distribution Policy and Restrictions on Distributions—Significant Forecast Assumptions—Volumes” and “Business—Our Commercial Agreements with Phillips 66.”

How We Evaluate Our Operations

Our management intends to use a variety of financial and operating metrics to analyze our performance. These metrics are significant factors in assessing our operating results and profitability and include: (1) volumes (including pipeline throughput and storage terminal volumes); (2) operating and maintenance expenses; (3) EBITDA; and (4) distributable cash flow.

Volumes.    The amount of revenue we generate primarily depends on the volumes of crude oil and refined petroleum products that we handle with our pipeline and terminal assets. These volumes are primarily affected by the supply of, and demand for, crude oil and refined petroleum products in the markets served directly or indirectly by our assets. Although Phillips 66 has committed to minimum volumes under the new commercial agreements described above, our results of operations will be impacted by our ability to:

 

 

utilize the remaining uncommitted capacity on, or add additional capacity to, our pipeline systems;

 

 

increase throughput volumes at our terminals and provide additional ancillary services at those terminals, such as ethanol blending and additive injection; and

 

 

identify and execute organic expansion projects and capture incremental Phillips 66 and third-party volumes.

Operating and maintenance expenses.    Our management seeks to maximize the profitability of our operations by effectively managing operating and maintenance expenses. These expenses are comprised primarily of labor expenses (including contractor services), utility costs, and repairs and maintenance expenses. These expenses generally remain relatively stable across broad ranges of throughput volumes, but can fluctuate from period to period depending on the mix of activities, particularly maintenance activities, performed during that period. We will seek to manage our maintenance expenditures on our pipelines, terminals and storage facilities by scheduling maintenance over time to avoid significant variability in our maintenance expenditures and minimize their impact on our cash flow, without compromising our commitment to safety and environmental stewardship.

 

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Our operating and maintenance expenses will also be affected by volumetric imbalances resulting from variances in meter readings and other measurement methods, as well as volume fluctuations due to pressure and temperature changes. Under certain of our commercial agreements with Phillips 66, the value of any crude oil or refined petroleum product volumetric imbalance will be determined by reference to the monthly average reference price for the applicable commodity. Any gains and losses under these provisions will reduce or increase, respectively, our operating and maintenance expenses in the period in which they are realized. These contractual volumetric imbalance provisions could increase variability in our operating and maintenance expenses.

EBITDA and distributable cash flow.    We define EBITDA as net income before income taxes, net interest expense, depreciation and amortization. Although we have not quantified distributable cash flow on a historical basis, after the closing of this offering we intend to use distributable cash flow to analyze our performance. We define distributable cash flow as EBITDA less net interest paid, maintenance capital expenditures and income taxes paid, plus deferred revenue from minimum volume commitments. Distributable cash flow will not reflect changes in working capital balances. Distributable cash flow and EBITDA are not presentations made in accordance with GAAP.

EBITDA and distributable cash flow are non-GAAP supplemental financial measures that management and external users of our combined financial statements, such as industry analysts, investors, lenders and rating agencies, may use to assess:

 

 

our operating performance as compared to other publicly traded partnerships in the midstream energy industry, without regard to historical cost basis or, in the case of EBITDA, financing methods;

 

 

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

 

 

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 EBITDA in this prospectus provides useful information to investors in assessing our financial condition and results of operations. The GAAP measures most directly comparable to EBITDA are net income and net cash provided by operating activities. EBITDA should not be considered as an alternative to GAAP net income or net cash provided by operating activities. EBITDA has important limitations as an analytical tool because it excludes some but not all items that affect net income and net cash provided by operating activities. You should not consider EBITDA in isolation or as a substitute for analysis of our results as reported under GAAP. Additionally, because EBITDA may be defined differently by other companies in our industry, our definition of EBITDA may not be comparable to similarly titled measures of other companies, thereby diminishing its utility.

For a further discussion of the non-GAAP financial measures of EBITDA and distributable cash flow, and a reconciliation of EBITDA to its most comparable financial measures calculated and presented in accordance with GAAP, please read “Selected Historical and Pro Forma Combined Financial Data—Non-GAAP Financial Measure.”

Factors Affecting the Comparability of Our Financial Results

Our future results of operations may not be comparable to our historical results of operations for the reasons described below:

Revenue.    Following the closing of this offering, substantially all of our revenue will be generated from the commercial agreements that we will have amended or entered into with Phillips 66 in connection with this offering and under which Phillips 66 will agree to pay us tariffs for transporting crude oil and refined petroleum products on our pipeline systems and fees for providing terminaling and storage services at our terminals and

 

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storage facilities. These contracts contain minimum volume commitments and, in several cases, tariffs and fees that are higher than our historical rates. Accordingly, we expect a significant increase in revenue in 2013 and future years compared with our historical revenue as a result of these new agreements. Applying the new rates and fees to our historical 2012 volumes resulted in an approximate 39% increase in 2012 revenue. Historically, we did not have long-term transportation and terminaling arrangements with Phillips 66 at most of our facilities.

Expenses.    Our operating and maintenance and general and administrative expenses historically included direct charges for the management and operation of our assets and certain overhead and shared services expenses allocated by Phillips 66, as well as certain overhead expenses allocated by ConocoPhillips through April 30, 2012. Allocations for operating and maintenance services included such items as engineering and logistics support. Allocations for general and administrative services included such items as information technology, legal, human resources and other financial and administrative services. These expenses were charged or allocated to our Predecessor based on the nature of the expenses and our Predecessor’s proportionate share of (1) property, plant and equipment and equity-method investments or (2) pipeline miles. Following the closing of this offering, under our omnibus agreement and operational services agreements, Phillips 66 will continue to charge us a combination of direct and allocated charges for administrative and operational services, which are projected to be comparable in the near term to those charged to our Predecessor for 2012 and 2011. For more information about the new term fee and the services covered by it, please read “Certain Relationships and Related Party Transactions—Agreements Governing the Transactions—Omnibus Agreement.” We also expect to incur an additional $3.6 million of incremental annual general and administrative expenses as a result of being a separate publicly traded partnership, as well as approximately $5.6 million of incremental annual insurance costs.

Financing.    There are differences in the way we will finance our operations as compared to the way our Predecessor financed its operations. Historically, our Predecessor’s operations were financed as part of Phillips 66’s (and, prior to April 30, 2012, ConocoPhillips’) integrated operations and our Predecessor did not record any separate costs associated with financing its operations. Additionally, our Predecessor largely relied on internally generated cash flows and capital contributions from Phillips 66 to satisfy its capital expenditure requirements. Following the closing of this offering, we intend to make cash distributions to our unitholders at a minimum distribution rate of $         per unit per quarter ($         per unit on an annualized basis). Based on the terms of our cash distribution policy, we expect that we will distribute to our unitholders and our general partner most of the excess cash generated by our operations. We also expect that we will retain approximately $         million from the net proceeds of this offering for general partnership purposes, including to fund potential future expansion capital expenditures and potential future acquisitions from Phillips 66 and third parties. To the extent we do not fund expansion capital expenditures with proceeds from this offering, we expect to fund them primarily from external sources, including borrowings under our $        million revolving credit facility and future issuances of equity and debt securities.

Separation from ConocoPhillips.    Effective April 30, 2012, ConocoPhillips engaged in a separation of its downstream businesses into an independent, publicly traded company, Phillips 66, through the distribution of Phillips 66 common stock to the stockholders of ConocoPhillips. Phillips 66’s consolidated financial statements do not include all of the actual expenses that would have been incurred had Phillips 66 been a stand-alone company during periods prior to the separation and may not reflect Phillips 66’s consolidated results of operations, financial position and cash flows had Phillips 66 been a stand-alone company during those periods. Actual costs that would have been incurred if Phillips 66 had been a stand-alone company depend upon multiple factors, including organizational structure and strategic decisions made in various areas, including information technology and infrastructure. Subsequent to the separation, Phillips 66 began performing these functions using internal resources or services provided by third parties, certain of which were provided by ConocoPhillips during a transition period pursuant to a transition services agreement. As a result, our Predecessor’s historical financial statements for periods prior to the separation do not include all of the actual expenses that would have been allocated to our Predecessor had Phillips 66 been a stand-alone company during periods prior to the separation.

 

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Factors Affecting Our Business

Supply and demand for crude oil and products.    We expect to initially generate substantially all of our revenue under fee-based contracts with Phillips 66. These contracts are intended to promote cash flow stability and minimize our direct exposure to commodity price fluctuations. Since we do not take ownership of the crude oil or products that we transport and store for our customers, and we do not engage in the trading of any commodities, our direct exposure to commodity price fluctuations is limited to the loss allowance provisions in our tariffs and commercial agreements with Phillips 66. We also have indirect exposure to commodity price fluctuations to the extent such fluctuations affect the shipping patterns of Phillips 66 or our other future customers. Our throughput volumes depend primarily on the volume of crude oil processed and refined petroleum products produced at Phillips 66’s refineries with which our assets are integrated, which in turn is primarily dependent on Phillips 66’s refining margins. Refining margins depend on the cost of crude oil or other feedstocks and the price of refined petroleum products. These prices are affected by numerous factors beyond our or Phillips 66’s control, including the domestic and global supply of and demand for crude oil and refined petroleum products. While we believe we have substantially mitigated our indirect exposure to commodity price fluctuations through the minimum volume commitments in our commercial agreements with Phillips 66 during the respective terms of those agreements, our ability to execute our growth strategy in our areas of operation will depend, in part, on the availability of attractively priced crude oil in the areas served by our crude oil pipelines, as well as demand for refined petroleum products in the markets served by our refined petroleum products, pipelines and terminals.

The “crack spread” is a measure of the difference between market prices for refined petroleum products and crude oil, and it is used within the downstream industry as an indicator for refining margins. Both domestic and international industry average crack spreads increased from 2010 to 2011 and again from 2011 to 2012. The improvements were consistent with improved global demand for refined products resulting from worldwide economic recovery along with limited net increases in global refining capacity. Crack spreads in the Midcontinent region of the United States were especially strong, which can be attributed to the region’s crude feedstock price advantage. In addition, U.S. crude oil production continued to increase, and limited infrastructure for takeaway options resulted in low crude oil prices for U.S. refiners with access to attractively priced crude oil, particularly in the Midcontinent region. Increasing pressure on inventories in the Midcontinent continued to cause WTI crude oil to trade at a significant discount relative to crude oils such as LLS and Brent. Refineries capable of processing WTI crude oil and crude oils that price relative to WTI, primarily the Midcontinent and Gulf Coast refineries, benefited from these lower regional feedstock prices.

NGL prices improved in both 2010 and 2011 along with crude oil prices, but decreased in 2012 while crude oil prices stayed relatively stable. The NGL price decrease in 2012 was primarily due to growing NGL production from liquids-rich shale plays, while a corresponding demand increase from the petrochemical industry has not yet materialized as projects remain under development. Growing NGL production is driving industry investment in transportation and logistics to transport NGL from the shale basins to the NGL market hubs, such as Mont Belvieu, Texas, and Conway, Kansas.

Acquisition opportunities.    We plan to pursue acquisitions of complementary assets from Phillips 66 as well as third parties. In addition to our right of first offer to acquire Phillips 66’s one-third equity interest in each of Sand Hills and Southern Hills, we believe Phillips 66 will offer us the opportunity to purchase additional transportation and midstream assets that it currently owns or may acquire or develop in the future, and that Phillips 66 will prioritize assets that it acquires or develops in the future over assets that it currently owns with respect to any such future opportunity. We also may pursue acquisitions jointly with Phillips 66. We will focus our acquisition strategy on transportation and midstream assets within the crude, refined petroleum product and NGL sectors. We believe that we will be well positioned to acquire midstream assets from Phillips 66 and third parties should such opportunities arise, and identifying and executing acquisitions will be a key part of our strategy. However, if we do not make acquisitions on economically acceptable terms, our future growth will be limited, and the acquisitions we do make may reduce, rather than increase, our cash available for distribution.

 

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Results of Operations

Year ended December 31, 2012 compared to year ended December 31, 2011

 

      Year ended December 31,  

(in millions)

       2012              2011      

Revenue

     

Transportation and terminaling services—Phillips 66

   $ 79.7       $ 75.6   

Transportation and terminaling services—third parties

     0.4         0.4   
  

 

 

    

 

 

 

Total revenue and other income

     80.1         76.0   
  

 

 

    

 

 

 

Costs and Expenses

     

Operating and maintenance expenses

     22.9         24.5   

Depreciation

     6.6         5.8   

General and administrative expenses

     7.8         5.6   

Taxes other than income taxes

     1.4         1.3   
  

 

 

    

 

 

 

Total costs and expenses

     38.7         37.2   
  

 

 

    

 

 

 

Income before income taxes

     41.4         38.8   

Provision for income taxes

     0.3         0.3   
  

 

 

    

 

 

 

Net Income

   $ 41.1       $ 38.5   
  

 

 

    

 

 

 

EBITDA(1)

   $ 48.0       $ 44.6   
  

 

 

    

 

 

 

 

(1) For a definition of EBITDA and a reconciliation to its most directly comparable financial measure calculated and presented in accordance with GAAP, please read “Selected Historical and Pro Forma Combined Financial Data—Non-GAAP Financial Measure.”

Pipeline, Terminal and Storage Volumes

 

     Year ended December 31,  
     2012      2011  

Pipelines(MBD)(1)

     

Crude oil throughput

     240         237   

Refined product throughput

     278         241   
  

 

 

    

 

 

 

Total

     518         478   
  

 

 

    

 

 

 

Terminals(MBD)

     

Crude oil

     

Storage volumes

     193         196   

Terminaling throughput

     174         182   

Refined products

     

Terminaling throughput

     252         237   
  

 

 

    

 

 

 

Total

     619         615   
  

 

 

    

 

 

 

 

(1) Represents the sum of volumes transported through each separately tariffed pipeline segment.

 

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Revenue increased $4.1 million, or 5%, in 2012, compared with 2011. The increase was primarily attributable to:

 

 

Increased pipeline tariffs in 2012, compared with 2011, particularly on our Sweeny to Pasadena pipeline, which had a 7% tariff increase, and the Hartford Connector pipeline, which had a 5% tariff increase.

 

 

Increased terminaling and storage fees in 2012, compared with 2011, particularly at our Hartford terminal, which had higher storage and barge loading rates, as well as the Pasadena terminal, which had higher diesel and gasoline rack rates.

 

 

Higher throughput volumes in 2012, compared with 2011, on our Hartford Connector pipeline, primarily reflecting the completion of a coker and refinery expansion project at the Wood River refinery in late 2011, which increased refined petroleum product yield, including diesel transported on our Hartford Connector pipeline.

These increases were partially offset by lower terminaling and storage fees at our Clifton Ridge terminal. In 2012 and 2011, Clifton Ridge terminal fees were based on a cost-plus-margin arrangement. Our Clifton Ridge terminal experienced lower operating and maintenance expenses in 2012, which led to lower revenue under the cost-plus arrangement. Effective January 1, 2013, our Clifton Ridge terminal replaced its cost-plus arrangement with a fixed-fee, volume-based structure.

Operating and maintenance expenses decreased $1.6 million, or 7%, in 2012, compared with 2011. The decrease was primarily attributable to lower maintenance costs at our Clifton Ridge terminal, as well as the timing of maintenance activities at other facilities. Volume imbalances decreased operating and maintenance expense by $1.0 million and $1.7 million in 2012 and 2011, respectively.

Depreciation increased $0.8 million, or 14%, in 2012, compared with 2011. The increase was primarily due to higher depreciation at the Hartford terminal, reflecting the installation and startup of two new tanks in April 2011, and on the Sweeny to Pasadena pipeline, due to the retirement of a replaced control system.

General and administrative expenses increased $2.2 million, or 39%, in 2012, compared with 2011. The increase primarily reflected higher allocations from Phillips 66 due to Phillips 66’s increased costs associated with being a stand-alone company during the last eight months of 2012. In addition, Phillips 66 allocations related to compensation and benefit costs increased during 2012.

Capital Resources and Liquidity

Historically, our sources of liquidity included cash generated from operations and funding from Phillips 66. We participated in Phillips 66’s centralized cash management system; therefore our cash receipts were deposited in Phillips 66’s or its affiliates’ bank accounts, all cash disbursements were made from those accounts, and we maintained no bank accounts dedicated solely to our assets. Thus, historically our financial statements have reflected no cash balances.

Following this offering, we will have established separate bank accounts, but Phillips 66 will continue to provide treasury services on our general partner’s behalf under our omnibus agreement. In addition to the retention of a portion of the net proceeds from this offering for working capital needs, we expect our ongoing sources of liquidity following this offering to include cash generated from operations, borrowings under our revolving credit facility and issuances of additional debt and equity securities. We believe that cash generated from these sources will be sufficient to meet our short-term working capital requirements and long-term capital expenditure requirements and to make quarterly cash distributions.

We intend to pay a minimum quarterly distribution of $         per unit per quarter, which equates to $         million per quarter, or $         million per year in the aggregate, based on the number of common, subordinated and general partner units to be outstanding immediately after completion of this offering (or $         million per quarter, or $         million per year in the aggregate, if the underwriters exercise in full their option to purchase additional common units from us). We do not have a legal obligation to pay this distribution. Please read “Cash Distribution Policy and Restrictions on Distributions.”

 

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Revolving credit facility

To provide additional liquidity following the offering, we anticipate entering into a revolving credit facility. At the closing of this offering, we expect this new credit facility to be undrawn and initially have a borrowing capacity of approximately $         million. The credit facility is expected to provide for customary covenants for comparable commercial borrowers and contain customary events of default, such as nonpayment of principal when due; nonpayment of interest, fees or other amounts; violation of covenants; cross-payment default and cross-acceleration (in each case, to indebtedness in excess of a threshold amount). Indebtedness under this facility will likely bear interest at LIBOR plus a margin, depending on our credit rating and market conditions. This facility would also include customary fees, including administrative agent fees, commitment fees, underwriting fees and other fees. The new credit facility will be subject to definitive documentation, closing requirements and certain other conditions. Accordingly, no assurance can be given that this facility will be executed on the terms described above (including the amount available to be borrowed). While this facility may provide some additional liquidity, we may pursue other sources of liquidity, such as bilateral letters of credit.

Cash flows from operations

Our operations generated $44.5 million in cash from operations in 2012, compared with $43.7 million in 2011. An increase in revenue due to higher tariffs and volumes, along with lower maintenance costs during 2012 was mostly offset by negative working capital impacts. Working capital impacts primarily reflected timing of accounts payable balances between year-end 2012 and 2011.

Capital expenditures

Our operations can be capital intensive, requiring investments to expand, upgrade or enhance existing operations and to meet environmental and operational regulations. Our capital requirements will consist of maintenance capital expenditures and expansion capital expenditures. Following the closing of this offering, we will be required to distinguish between maintenance capital expenditures and expansion capital expenditures in accordance with our partnership agreement, even though historically we did not make a distinction between maintenance capital expenditures and expansion capital expenditures in exactly the same way as will be required under our partnership agreement. 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 new systems or facilities.

Our capital expenditures for the years ended December 31, 2012 and 2011, were $15.0 million and $10.5 million, respectively. These expenditures were primarily directed toward the following activities during the two-year period:

 

 

installation of biodiesel tanks and associated equipment at our Hartford and Pasadena terminals;

 

 

an upgrade of remote monitoring equipment at our Clifton Ridge terminal;

 

 

installation of a new tank at our Clifton Ridge terminal; and

 

 

capacity expansion work at our Hartford terminal.

We have budgeted maintenance capital expenditures of approximately $5.4 million for the twelve months ending December 31, 2013. Included in our planned 2013 maintenance capital expenditures is spending on our Clifton Ridge crude system, including the replacement of buried piping with above ground piping, installation of dredge piping and installation of enhanced measurement and monitoring equipment. We do not currently expect any material expansion capital expenditures during 2013.

 

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We anticipate that these planned maintenance capital expenditures will be funded primarily with cash from operations and, if necessary, borrowings under our revolving credit facility. Following this offering, we expect that we will initially rely primarily upon proceeds retained from this offering to fund any significant future expansion capital expenditures. Thereafter, we expect to rely primarily upon external financing sources, including borrowings under our revolving credit facility and the issuance of debt and equity securities, to fund any significant future capital expenditures.

Contractual obligations

A summary of our contractual obligations, as of December 31, 2012, is shown in the table below.

 

(in millions)

   Total      Up to
1 year
     Years
1-3
     Years
3-5
     After
5 years
 

Purchase obligations

   $ 1.4       $ 1.4       $ —         $ —         $ —     

Other long-term liabilities:

              

Asset retirement obligations

     0.3         —           —           —           0.3   

Accrued environmental costs

     0.3         0.1         0.1         0.1         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 2.0       $ 1.5       $ 0.1       $ 0.1       $ 0.3   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Off-Balance Sheet Arrangements

We have not entered into any transactions, agreements or other contractual arrangements that would result in off-balance sheet liabilities.

Regulatory Matters

Our interstate common carrier crude oil and refined petroleum products pipeline operations are subject to rate regulation by the Federal Energy Regulatory Commission under the Interstate Commerce Act and Energy Policy Act of 1992. Our pipelines and terminal operations are also subject to safety regulations adopted by the DOT, as well as to state regulations. For more information on federal and state regulations affecting our business, please read “Business—Rate and Other Regulation.”

Environmental matters and compliance costs

We are subject to extensive federal, state and local environmental laws and regulations. These laws, which change frequently, regulate the discharge of materials into the environment or otherwise relate to protection of the environment. Compliance with these laws and regulations may require us to remediate environmental damage from any discharge of petroleum or chemical substances from our facilities or require us to install additional pollution control equipment on our equipment and facilities. Our failure to comply with these or any other environmental or safety-related regulations could result in the assessment of administrative, civil, or criminal penalties, the imposition of investigatory and remedial liabilities, and the issuance of injunctions that may subject us to additional operational constraints.

Future expenditures may be required to comply with the Clean Air Act and other federal, state and local requirements for our various sites, including our pipelines and storage assets. The impact of these legislative and regulatory developments, if enacted or adopted, could result in increased compliance costs and additional operating restrictions on our business, each of which could have an adverse impact on our financial position, results of operations and liquidity. Phillips 66 will indemnify us for certain of these costs under our omnibus agreement. For a further description about future expenditures that may be required to comply with these requirements, or Phillips 66’s obligation to indemnify us for certain of these costs, please read “Business—Air Emissions and Climate Change” and “Certain Relationships and Related Party Transactions—Agreements Governing the Transactions—Omnibus Agreement.”

 

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If these expenditures, as with all costs, are not ultimately reflected in the tariffs and other fees we receive for our services, our operating results will be adversely affected. We believe that substantially all of our competitors must comply with similar environmental laws and regulations. However, the specific impact on each competitor may vary depending on a number of factors, including, but not limited to, the age and location of its operating facilities.

We accrue for environmental remediation activities when the responsibility to remediate is probable and the amount of associated costs can be reasonably estimated. As environmental remediation matters proceed toward ultimate resolution or as additional remediation obligations arise, charges in excess of those previously accrued may be required. New or expanded environmental requirements, which could increase our environmental costs, may arise in the future. We believe we comply with all legal requirements regarding the environment, but since not all of them are fixed or presently determinable (even under existing legislation) and may be affected by future legislation or regulations, it is not possible to predict all of the ultimate costs of compliance, including remediation costs that may be incurred and penalties that may be imposed.

Accrued liabilities for estimated site remediation costs to be incurred in the future at our facilities and properties have been included in our Predecessor historical combined financial statements. As of December 31, 2012 and 2011, environmental liabilities of $0.3 million and $0.4 million, respectively, were accrued for historical releases of refined petroleum products at our Hartford terminal.

Critical Accounting Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management to select appropriate accounting policies and to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses. See Note 2—Summary of Significant Accounting Policies, in the Predecessor Combined Financial Statements, for descriptions of our major accounting policies. Certain of these accounting policies involve judgments and uncertainties to such an extent that there is a reasonable likelihood that materially different amounts would have been reported under different conditions, or if different assumptions had been used. The following discussions of critical accounting estimates, including any related discussion of contingencies, address all important accounting areas where the nature of accounting estimates or assumptions could be material due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change.

As a company with less than $1 billion in revenue during its last fiscal year, we qualify as an “emerging growth company” as defined in the Jumpstart Our Business Startups Act of 2012, or the JOBS Act. As an emerging growth company, we have elected to opt out of the exemption that allows emerging growth companies to extend the transition period for complying with new or revised financial accounting standards. This election is irrevocable.

Depreciation

We calculate depreciation expense using the straight-line method over the estimated useful lives of our property, plant and equipment. Because of the expected long useful lives of the property and equipment, we depreciate our property, plant and equipment over periods ranging from three years to 45 years. Changes in the estimated useful lives of the property and equipment could have a material adverse effect on our results of operations.

Impairments

Long-lived assets used in operations are assessed for impairment whenever changes in facts and circumstances indicate a possible significant deterioration in future cash flows expected to be generated by an asset group. If, upon review, the sum of the undiscounted pretax cash flows is less than the carrying value of the asset group, the carrying value is written down to estimated fair value. Individual assets are grouped for impairment purposes

 

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based on a judgmental assessment of the lowest level for which there are identifiable cash flows that are largely independent of the cash flows of other groups of assets; generally at a pipeline system or terminal level. Because there usually is a lack of quoted market prices for long-lived assets, the fair value of impaired assets is typically determined based on the present values of expected future cash flows using discount rates believed to be consistent with those used by principal market participants, or based on a multiple of operating cash flow validated with historical market transactions of similar assets where possible. The expected future cash flows used for impairment reviews and related fair value calculations are based on judgmental assessments of future tariffs, volumes, operating costs, and capital project decisions, considering all available information at the date of review.

Asset retirement obligations

Under various contracts, permits and regulations, we have legal obligations to remove tangible equipment and restore the land at the end of operations at certain operational sites. Our largest asset removal obligations involve the abandonment or removal of pipeline. Estimating the future asset removal costs necessary for this accounting calculation is difficult. Most of these removal obligations are many years, or decades, in the future and the contracts and regulations often have vague descriptions of what removal practices and criteria must be met when the removal event actually occurs. Asset removal technologies and costs, regulatory and other compliance considerations, expenditure timing, and other inputs into valuation of the obligation, including discount and inflation rates, are also subject to change.

Environmental costs

In addition to asset retirement obligations discussed above, under the above or similar contracts, permits and regulations, we have certain obligations to complete environmental-related projects. These obligations are primarily related to historical releases of refined petroleum products. Future environmental remediation costs are difficult to estimate because they are subject to change due to such factors as the uncertain magnitude of cleanup costs, the unknown time and extent of such remedial actions that may be required, and the determination of our liability in proportion to that of other responsible parties.

Goodwill

At December 31, 2012, we had $2.5 million of goodwill recorded in conjunction with past business combinations. Under the accounting rules for goodwill, this intangible asset is not amortized. Instead, goodwill is subject to annual reviews for impairment at a reporting unit level. The reporting unit or units used to evaluate and measure goodwill for impairment are determined primarily from the manner in which the business is managed. A reporting unit is an operating segment or a component that is one level below an operating segment. We have determined we have one reporting unit for goodwill impairment testing purposes. Because quoted market prices for our reporting unit are not available, management must apply its judgment in determining the estimated fair value of our reporting unit for purposes of performing the periodic goodwill impairment test.

Management uses all available information to make this fair value determination, including the present values of expected future cash flows using discount rates commensurate with the risks involved in the assets and observed market multiples of operating cash flows and net income. In addition, if the estimated fair value of the reporting unit is less than the book value (including the goodwill), further management judgment must be applied in determining the fair values of individual assets and liabilities for purposes of the hypothetical purchase price allocation. At year-end 2012, the estimated fair value of our reporting unit was higher than recorded net book values (including goodwill) of the reporting unit. However, a lower fair value estimate in the future could result in an impairment. After the offering, our unit price and associated total company market capitalization will also be considered in the determination of reporting unit fair value. A prolonged or significant decline in our unit price could provide evidence of a need to record a material impairment of goodwill.

 

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Qualitative and Quantitative Disclosures About Market Risk

Market risk is the risk of loss arising from adverse changes in market rates and prices. As we do not take ownership of the crude oil or products that we transport and store for our customers, and we do not engage in the trading of any commodities, we have limited direct exposure to risks associated with fluctuating commodity prices. Certain of our pipeline tariffs include a contractual loss allowance, which is calculated as a percentage of throughput volume multiplied by quoted market prices of the commodity being shipped. This loss allowance revenue, which accounted for 11% of total revenue in both 2012 and 2011, is subject to more volatility than tariff and terminaling fee revenue, as it is directly dependent on commodity prices. As a result, the revenue we realize under our loss allowance provisions will increase or decrease as a result of changes in underlying commodity prices. Based on forecasted volumes and prices, as well as the new commercial agreements with Phillips 66 that we expect to enter into in connection with this offering, a $10 per barrel change in each applicable commodity price would change revenue by approximately $1.6 million for the twelve-month period ending March 31, 2014. We do not intend to enter into any hedging agreements to mitigate our exposure to decreases in commodity prices through our loss allowances.

Our commercial agreements with Phillips 66 are indexed to inflation to mitigate our exposure to increases in the cost of supplies used in our business.

Any debt that we incur under our revolving credit facility will bear interest at a variable rate and will expose us to interest rate risk.

 

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BUSINESS

Overview

We are a growth-oriented, traditional master limited partnership formed in February, 2013, by Phillips 66 to own, operate, develop and acquire primarily fee-based crude oil, refined petroleum product and NGL pipelines and terminals and other transportation and midstream assets. Our initial assets consist of crude oil and refined petroleum product pipeline, terminal and storage systems in the Central and Gulf Coast regions of the United States that are integral to the Phillips 66 refining and marketing operations they support.

We generate revenue primarily by charging tariffs and fees for transporting crude oil and refined petroleum products through our pipelines and terminaling and storing crude oil and refined petroleum products at our terminals. We do not take ownership of the crude oil or refined petroleum products that we transport, terminal and store, and we do not engage in the trading of any commodities. At the closing of this offering, we will have multiple commercial agreements with Phillips 66 that will initially be the source of substantially all of our revenue. These agreements will be long-term, fee-based agreements with minimum volume commitments and inflation escalators. We believe these agreements will promote stable and predictable cash flows. Please read “—Our Commercial Agreements with Phillips 66” below for a description of these agreements.

For the year ended December 31, 2012, on a pro forma basis, we had revenue of approximately $109.2 million, net income of approximately $62.2 million and EBITDA of approximately $71.2 million. Phillips 66 accounted for 99.6% of our pro forma revenue for that period. Please read “Selected Historical and Pro Forma Combined Financial Data” for the definition of the term EBITDA and a reconciliation of EBITDA to our most directly comparable financial measures calculated and presented in accordance with GAAP.

Our relationship with Phillips 66 is one of our principal strengths. Phillips 66 is a large, independent downstream energy company with an investment grade credit rating and refining and marketing, transportation, midstream and chemicals businesses with a key focus on safe and reliable operations. Phillips 66’s transportation and midstream assets and operations include crude oil, refined petroleum product, natural gas and NGL pipelines; crude oil, petroleum coke, refined petroleum product and liquefied petroleum gas terminals; truck and rail assets; NGL fractionators; a 50% equity interest in DCP Midstream, LLC; and a one-third equity interest in each of Sand Hills and Southern Hills.

Phillips 66 has stated that it intends to grow its transportation and midstream businesses and will use us as a primary vehicle for achieving that growth. In light of this strategy, we believe that Phillips 66 will offer us opportunities to purchase additional transportation and midstream assets that it may acquire or develop in the future or that it currently owns. For example, Phillips 66 has agreed that it will offer us the right to acquire its one-third equity interest in each of Sand Hills and Southern Hills before it sells any of those interests to any third party during the five-year period following the closing of this offering. Phillips 66 is under no obligation to offer to sell us additional assets (including our right of first offer assets, unless and until it otherwise intends to dispose of such assets), and we are under no obligation to buy any additional assets from Phillips 66. For a further description of our right of first offer assets, please read “—Our Asset Portfolio—Our Right of First Offer Assets.”

Business Strategies

Our primary business objectives are to generate stable and predictable cash flows and increase our quarterly cash distribution per unit over time. We intend to accomplish these objectives by executing the following strategies:

 

 

Maintain safe and reliable operations.    We are committed to maintaining and improving the safety, reliability and efficiency of our operations, which we believe to be key components in generating stable cash flows. We strive for operational excellence by utilizing Phillips 66’s existing programs to integrate health, occupational safety, process safety and environmental principles throughout our business with a

 

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commitment to continuous improvement. We will continue to employ Phillips 66’s rigorous training, integrity and audit programs to drive ongoing improvements in both personal and process safety as we strive for zero incidents. For example, we recently received the Occupational Safety and Health Administration’s Voluntary Protection Program (“VPP”) certification for our Clifton Ridge crude system.

 

 

Focus on fee-based businesses supported by contracts with minimum volume commitments and inflation escalators.    We are focused on generating stable and predictable cash flows by providing fee-based transportation and midstream services to Phillips 66 and third parties. At the closing of this offering, we will have multiple long-term, fee-based commercial agreements with Phillips 66 that include minimum volume commitments and inflation escalators. We believe these agreements will substantially mitigate volatility in our cash flows by reducing our direct exposure to commodity price fluctuations. In any new contracts, we will seek to negotiate commercial terms that are consistent with our focus on contracted fee-based revenue.

 

 

Grow through strategic acquisitions.    We plan to pursue strategic acquisitions of assets from Phillips 66 as well as third parties. In addition to our right of first offer assets, we believe Phillips 66 will offer us opportunities to purchase additional transportation and midstream assets that it may acquire or develop in the future or that it currently owns. We also may have opportunities to pursue the acquisition or development of additional assets jointly with Phillips 66. Although our initial assets are focused on transportation and storage assets that support Phillips 66’s refinery operations, we intend to expand our asset base into the broader midstream sector and seek acquisitions within the crude oil, refined petroleum product and NGL sectors.

 

 

Optimize existing assets and pursue organic growth opportunities.    We will seek to enhance the profitability of our existing assets by pursuing opportunities to increase throughput and storage volumes, as well as by managing costs and improving operating efficiencies. We also intend to consider opportunities to increase revenue on our pipeline, terminal and storage systems by evaluating and capitalizing on organic expansion projects that may arise in the markets we serve. For example, we have recently installed biodiesel blending equipment at our Pasadena and Hartford terminals in response to customer demand, implemented dyed diesel capabilities to sell additional refined petroleum products at our Hartford barge dock and expanded our truck offloading capacities for crude receipts at our Clifton Ridge terminal. We will evaluate organic growth projects within our geographic footprint, as well as in new areas, that provide attractive returns.

Competitive Strengths

We believe we are well positioned to execute our business strategies based on the following competitive strengths:

 

 

Strategic relationship with Phillips 66.    We have a strategic relationship with Phillips 66, a large, independent downstream energy company with an investment grade credit rating. Following this offering, Phillips 66 will own our general partner, a     % limited partner interest in us (or     % if the underwriters’ option to purchase additional common units is exercised in full) and all of our incentive distribution rights. In connection with this offering, Phillips 66 has granted us a right of first offer to acquire its one-third equity interest in each of Sand Hills and Southern Hills. We believe that our relationship with Phillips 66 is likely to provide us with attractive growth opportunities, as well as an investment grade commercial counterparty supporting substantially all of our revenue.

 

 

Stable and predictable cash flows.    Our assets consist of both common carrier and proprietary pipelines and terminal and storage facilities that generate stable revenue from tariffs and fees. We will initially generate substantially all of our revenue under tariffs and fees that are supported by long-term commercial agreements with Phillips 66 that include minimum volume commitments and inflation escalators. We believe these agreements will promote our cash flow stability and predictability. On a pro forma basis, Phillips 66’s minimum commitments under these agreements would have accounted for approximately 87% of our total revenue for the year ended December 31,