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RRMS > SEC Filings for RRMS > Form 10-Q on 9-Nov-2012All Recent SEC Filings

Show all filings for ROSE ROCK MIDSTREAM, L.P.

Form 10-Q for ROSE ROCK MIDSTREAM, L.P.


9-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the unaudited condensed consolidated interim financial statements and the notes thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q, and our Annual Report on Form 10-K for the year ended December 31, 2011, filed with the SEC. Overview of Business
We are a growth-oriented Delaware limited partnership formed in 2011 by SemGroup to own, operate, develop and acquire a diversified portfolio of midstream energy assets. We are engaged in the business of crude oil gathering, transportation, storage and marketing in Colorado, Kansas, Montana, North Dakota, Oklahoma and Texas. We serve areas that are experiencing strong production growth and drilling activity through our exposure to the Bakken Shale in North Dakota and Montana, the DJ Basin and the Niobrara Shale in the Rocky Mountain region, and the Granite Wash and the Mississippian oil trend in the Mid-Continent region. The majority of our assets are strategically located in, or connected to, the Cushing, Oklahoma crude oil marketing hub. Cushing is the designated point of delivery specified in all NYMEX crude oil futures contracts and is one of the largest crude oil marketing hubs in the United States. We believe that our connectivity in Cushing and our numerous interconnections with third-party pipelines, refineries and storage terminals provide our customers with the flexibility to access multiple points for the receipt and delivery of crude oil. We own and operate all of our assets, which at September 30, 2012 include:
7 million barrels of crude oil storage capacity in Cushing, Oklahoma;

          a 640-mile crude oil gathering and transportation pipeline system with
           over 660,000 barrels of associated storage capacity in Kansas and
           northern Oklahoma that is connected to several third-party pipelines
           and refineries and our storage terminal in Cushing;


          a crude oil gathering, storage, transportation and marketing business
           in the Bakken Shale in North Dakota and Montana in which we marketed
           an average of 6,500 barrels of crude oil per day for the three months
           ended September 30, 2012; and


          a modern, ten-lane crude oil truck unloading facility with 220,000
           barrels of associated storage capacity in Platteville, Colorado which
           connects to the origination point of SemGroup's White Cliffs Pipeline,
           with an additional six truck unloading lanes and 10,000 barrels of
           storage expected to be completed by the end of 2012.

For the three months and nine months ended September 30, 2012, approximately 79% and 78%, respectively, of our Adjusted gross margin was generated from fee-based services or fixed-margin transactions. For a definition of Adjusted gross margin and a reconciliation of Adjusted gross margin to operating income, its most directly comparable financial measure calculated and presented in accordance with generally accepted accounting principles ("GAAP"), please see "Non-GAAP Financial Measures".

How We Evaluate Our Operations
Our management uses a variety of financial and operational metrics to analyze our performance. We view these metrics as important factors in evaluating our profitability and review these measurements on at least a monthly basis for consistency and trend analysis. These metrics include financial measures, including Adjusted gross margin, operating expenses and Adjusted EBITDA, and operating data, including contracted storage capacity and transportation, marketing and unloading volumes.
Adjusted Gross Margin
We view Adjusted gross margin as an important performance measure of the core profitability of our operations, as well as our operating performance as compared to that of other companies in our industry, without regard to financing methods, historical cost basis, capital structure or the impact of fluctuating commodity prices. We define Adjusted gross margin as total revenues minus cost of products sold and unrealized gain (loss) on derivatives. Adjusted gross margin allows us to make a meaningful comparison of the operating results between our fee-based activities, which do not involve the purchase or sale of crude oil, and our fixed-margin and marketing operations, which do. In particular, Adjusted gross margin provides a way to compare the actual transportation fee received under fixed-fee contracts with the effective transportation fee realized through a fixed-margin transaction. In addition, Adjusted gross margin allows us to make a meaningful comparison of the results of our fixed-margin and marketing operations across different commodity price environments because it measures the spread between the product sales price and cost of products sold. See "Non-GAAP Financial Measures".

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Because Adjusted gross margin may be defined differently by other companies in our industry, our definition may not be comparable to similarly titled measures of other companies.

Operating Expenses
Our management seeks to maximize the profitability of our operations, in part, by minimizing operating expenses. These expenses are comprised of salary and wage expense, utility costs, insurance premiums, taxes and other operating costs, some of which are independent of the volumes we handle.
The current high levels of crude oil exploration, development and production activities are increasing competition for personnel and equipment. This increased competition is placing upward pressure on the prices we pay for labor, supplies and miscellaneous equipment. To the extent we are unable to procure necessary services or offset higher costs, our operating results will be negatively impacted.
Adjusted EBITDA
We define Adjusted EBITDA as net income (loss) before interest expense, income tax expense (benefit), depreciation and amortization and any non-cash adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities. We use Adjusted EBITDA as a supplemental performance and liquidity measure to assess:

          our operating performance as compared to that of other companies in
           our industry, without regard to financing methods, historical cost
           basis, capital structure or the impact of fluctuating commodity
           prices;


          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.

Contracted Storage Capacity and Transportation, Marketing and Unloading Volumes In our Cushing storage operations, we charge our customers a fee for storage capacity provided, regardless of actual usage. On our Kansas and Oklahoma system, we provide transportation services on a fee basis or pursuant to fixed-margin transactions, but in either case, the Adjusted gross margin we generate is dependent on the volume of crude oil transported (if on a fee basis) or purchased and sold (if pursuant to a fixed-margin transaction). We refer to these volumes, in the aggregate, as transportation volumes. Similarly, on our Kansas and Oklahoma system, and through our Bakken Shale operations, we conduct marketing activities involving the purchase and sale of crude oil or related derivative contracts. We refer to the crude oil volumes purchased and sold in our marketing operations as marketing volumes. Finally, at our Platteville truck unloading facility, we charge our customers a fee based on the volumes unloaded. We refer to these as unloading volumes.

How We Generate Adjusted Gross Margin
We generate Adjusted gross margin by providing fee-based services, by entering into fixed-margin transactions and through marketing activities. Revenues from our fee-based services are included in service revenue, and revenues from our fixed-margin and marketing activities are included in product revenue.

Fee-Based Services
We charge a capacity or volume-based fee for the unloading, transportation and storage of crude oil and related ancillary services. Our fee-based services include substantially all of our operations in Cushing, Oklahoma and Platteville, Colorado and a portion of the transportation services we provide on our Kansas and Oklahoma pipeline system. Some of our fee-based contracts are take-or-pay contracts whereby the customer is required to pay us a fixed minimum monthly fee regardless of usage. For the three months ended September 30, 2012 and 2011, approximately 58% and 61%, respectively, of our Adjusted gross margin was generated by providing fee-based services to customers. For both the nine months ended September 30, 2012 and 2011, our Adjusted gross margin generated by fee-based services to customers remained constant at 59%. Fixed-Margin Transactions
We purchase crude oil from a producer or supplier at a designated receipt point at an index price (less a transportation fee) and simultaneously sell an identical volume of crude oil at a designated delivery point to the same party at the same index price, thereby locking in a fixed margin that is, in effect, economically equivalent to a transportation fee. We refer to these arrangements as "fixed-margin" or "buy/sell" transactions. These fixed-margin transactions account for a portion of the Adjusted gross margin we generate on our Kansas and Oklahoma pipeline system and through our Bakken Shale operations. For the three months ended September 30, 2012 and 2011, approximately 21% and 12%, respectively, of our Adjusted gross

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margin was generated through fixed-margin transactions. For the nine months ended September 30, 2012 and 2011, approximately 19% and 14%, respectively, of our Adjusted gross margin was generated through fixed-margin transactions. Marketing Activities
We conduct marketing activities by purchasing crude oil for our own account from producers, aggregators and traders and selling crude oil to traders and refiners. Our marketing activities account for a portion of the Adjusted gross margin we generate on our Kansas and Oklahoma pipeline system and through our Bakken Shale operations. For the three months ended September 30, 2012 and 2011, approximately 21% and 27%, respectively, of our Adjusted gross margin was generated through marketing activities. For the nine months ended September 30, 2012 and 2011, approximately 22% and 27%, respectively, of our Adjusted gross margin was generated through marketing activities.
We mitigate the commodity price exposure of our crude oil marketing operations by limiting our net open positions through (i) the concurrent purchase and sale of like quantities of crude oil to create "back-to-back" transactions intended to lock in positive margins based on the timing, location or quality of the crude oil purchased and delivered or (ii) derivative contracts. All of our marketing activities are subject to our Comprehensive Risk Management Policy, which establishes limits to manage risk and mitigate financial exposure. More specifically, we utilize futures and swap contracts to manage our exposure to market changes in commodity prices to protect our Adjusted gross margin on our purchased crude oil. As we purchase crude oil from suppliers, we may establish a fixed or variable margin with future sales by selling a like quantity of crude oil for future physical delivery to create an effective back-to-back transaction; or entering into futures and swaps contracts on the NYMEX or over-the-counter markets.
Adjusted Gross Margin
The following table shows Adjusted gross margin generated by product revenue and service revenue for the three months and nine months ended September 30, 2012 and 2011 (in thousands):

                                     Three Months Ended September
                                                 30,                     Nine Months Ended September 30,
                                         2012            2011              2012                   2011
Revenues:
Product                              $   120,358     $   95,430     $        435,814       $        271,824
Service                                   11,196          9,142               32,932                 27,077
Other                                          -             44                  (59 )                  220
Total Revenues                           131,554        104,616              468,687                299,121
Less: Costs of products sold,
exclusive of depreciation and
amortization                             111,790         90,660              412,847                252,804
Less: Unrealized gain (loss) on
derivatives                                  554         (1,190 )                432                    334
Adjusted gross margin                $    19,210     $   15,146     $         55,408       $         45,983

The following tables show the Adjusted gross margin generated by our storage, transportation and marketing activities for the three months ended September 30, 2012 and September 30, 2011 (in thousands):

Three Months Ended                                                   Marketing
September 30, 2012               Storage        Transportation       Activities       Other  (1)        Total
Revenues                      $     8,367     $          4,768     $    116,318     $      2,101     $  131,554
Less: Costs of products
sold, exclusive of
depreciation and
amortization                            -                    -          111,790                -        111,790
Less: Unrealized gain
(loss) on derivatives                   -                    -              554                -            554
Adjusted gross margin         $     8,367     $          4,768     $      3,974     $      2,101     $   19,210

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Three Months Ended Marketing September 30, 2011 Storage Transportation Activities Other (1) Total Revenues $ 6,108 $ 3,365 $ 93,591 $ 1,552 $ 104,616 Less: Costs of products
sold, exclusive of
depreciation and
amortization - - 90,660 - 90,660 Less: Unrealized gain
(loss) on derivatives - - (1,190 ) - (1,190 ) Adjusted gross margin $ 6,108 $ 3,365 $ 4,121 $ 1,552 $ 15,146

(1) This category includes fee-based services such as unloading and ancillary storage terminal services.

The following tables show the Adjusted gross margin generated by our storage, transportation and marketing activities for the nine months ended September 30, 2012 and September 30, 2011 (in thousands):

Nine Months Ended September                                        Marketing
30, 2012                        Storage       Transportation       Activities       Other (1)        Total
Revenues                      $   24,205     $        13,425     $    425,439     $     5,618     $  468,687
Less: Costs of products
sold, exclusive of
depreciation and
amortization                           -                   -          412,847               -        412,847
Less: Unrealized gain
(loss) on derivatives                  -                   -              432               -            432
Adjusted gross margin         $   24,205     $        13,425     $     12,160     $     5,618     $   55,408



Nine Months Ended September                                        Marketing
30, 2011                        Storage       Transportation       Activities       Other (1)        Total
Revenues                      $   18,123     $        11,181     $    265,449     $     4,368     $  299,121
Less: Costs of products
sold, exclusive of
depreciation and
amortization                           -                   -          252,804               -        252,804
Less: Unrealized gain
(loss) on derivatives                  -                   -              334               -            334
Adjusted gross margin         $   18,123     $        11,181     $     12,311     $     4,368     $   45,983

(1) This category includes fee-based services such as unloading and ancillary storage terminal services.

Selected Consolidated Financial and Operating Data The following table provides selected historical condensed consolidated financial operating data as of and for the periods shown. The statement of income data for the three months and nine months ended September 30, 2012 and 2011 have been derived from our unaudited financial statements for those periods. The selected financial data provided below should be read in conjunction with our condensed consolidated financial statements and related notes included in this Form 10-Q.
The following table presents the non-GAAP financial measures of Adjusted gross margin and Adjusted EBITDA, which we use in our business and view as important supplemental measures of our performance and, in the case of Adjusted EBITDA, our liquidity. Adjusted gross margin and Adjusted EBITDA are not calculated or presented in accordance with GAAP. For definitions of Adjusted gross margin and Adjusted EBITDA and a reconciliation of operating income to Adjusted gross margin, of net income to Adjusted EBITDA and of net cash provided by (used in) operating activities to Adjusted EBITDA, their most directly comparable financial measures calculated and presented in accordance with GAAP, please see "Non-GAAP Financial Measures" below.

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Three Months Ended Three Months Ended Nine Months Ended Nine Months Ended
September 30, 2012 September 30, 2011 September 30, 2012 September 30, 2011
(in thousands, except per unit and operating data)

Statement of income data:
Total revenues $ 131,554 $ 104,616 $ 468,687 $ 299,121 Operating income $ 6,919 $ 4,264 $ 20,832 $ 17,610 Net income $ 6,469 $ 3,830 $ 19,353 $ 16,407 Net income per common unit (basic
and diluted) $ 0.38 $ 1.13 Net income per subordinated unit
(basic and diluted) $ 0.38 $ 1.13 Distributions paid per unit $ 0.3825 N/A $ 0.8220 N/A Statement of cash flows data:
Net cash provided by (used in):
Operating activities $ 15,446 $ 20,913 $ 35,525 $ 47,637 Investing activities $ (8,161 ) $ (9,666 ) $ (17,407 ) $ (25,542 ) Financing activities $ (6,742 ) $ (11,247 ) $ (14,329 ) $ (22,398 ) Other financial data:
Adjusted gross margin $ 19,210 $ 15,146 $ 55,408 $ 45,983 Adjusted EBITDA $ 9,510 $ 8,276 $ 29,634 $ 25,095 Capital expenditures $ 8,161 $ 9,666 $ 17,552 $ 25,545 Operating data:
Cushing storage capacity (MMBbls as
of period end) 7.000 5.050 7.000 5.050 Percent of Cushing capacity
contracted (as of end of period) 96 % 95 % 96 % 95 % Transportation volumes (average
Bbls/day) 48,500 32,000 47,500 30,000 Marketing volumes (average Bbls/day) 20,400 14,000 21,400 12,000 Platteville unloading volumes
(average Bbls/day) 51,500 33,200 46,100 31,600

Non-GAAP Financial Measures
We define Adjusted gross margin as total revenues minus cost of products sold and unrealized gain (loss) on derivatives. We define Adjusted EBITDA as net income (loss) before interest expense, income tax expense (benefit), depreciation and amortization and any non-cash adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities. Adjusted gross margin and Adjusted EBITDA are not financial measures presented in accordance with GAAP. We believe that the presentation of these non-GAAP financial measures provides useful information to investors in assessing our financial condition and results of operations.
Operating income (loss) is the GAAP measure most directly comparable to Adjusted gross margin, and net income (loss) and cash provided by (used in) operating activities are the GAAP measures most directly comparable to Adjusted EBITDA. Our non-GAAP financial measures should not be considered as alternatives to the most directly comparable GAAP financial measures. These non-GAAP financial measures have important limitations as analytical tools because they exclude some, but not all, items that affect the most directly comparable GAAP financial measures. You should not consider Adjusted gross margin and Adjusted EBITDA in isolation or as substitutes for analysis of our results as reported under GAAP. Because Adjusted gross margin and Adjusted EBITDA may be defined differently by other companies in our industry, our definitions of these non-GAAP financial measures may not be comparable to similarly titled measures of other companies, thereby diminishing their utility.
Management compensates for the limitation of Adjusted gross margin and Adjusted EBITDA as analytical tools by reviewing the comparable GAAP measures, understanding the differences between Adjusted gross margin and Adjusted EBITDA, on the one hand, and operating income (loss), net income (loss) and net cash provided by (used in) operating activities, on the other hand, and incorporating this knowledge into its decision-making processes. We believe that investors benefit from having access to the same financial measures that our management uses in evaluating our operating results.

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The following table presents a reconciliation of: (i) operating income to Adjusted gross margin, (ii) net income to Adjusted EBITDA, and (iii) net cash provided by operating activities to Adjusted EBITDA, the most directly comparable GAAP financial measures, for each of the periods indicated.

                                        Three Months Ended     Three Months Ended     Nine Months Ended      Nine Months Ended
                                        September 30, 2012     September 30, 2011     September 30, 2012     September 30, 2011
                                                                       (Unaudited; in thousands)
Reconciliation of operating income to
Adjusted gross margin:
Operating income                       $        6,919         $        4,264         $       20,832         $       17,610
Add:
Operating expense                               5,698                  4,530                 17,146                 13,695
General and administrative                      4,081                  2,040                  8,830                  6,507
Depreciation and amortization                   3,066                  3,122                  9,032                  8,505
Less:
Unrealized gain (loss) on derivatives,
net                                               554                 (1,190 )                  432                    334
Adjusted gross margin                  $       19,210         $       15,146         $       55,408         $       45,983
Reconciliation of net income to
Adjusted EBITDA:
Net income                             $        6,469         $        3,830         $       19,353         $       16,407
Add:
Interest expense                                  450                    434                  1,407                  1,405
Depreciation and amortization                   3,066                  3,122                  9,032                  8,505
Non-cash equity compensation                       79                      -                    218                      -
Loss on impairment or sale of assets                -                      -                     56                     12
Provision for (recovery of)
uncollectible accounts receivable                   -                   (300 )                    -                   (900 )
Less:
  Impact from derivative instruments:
Total gain (loss) on derivatives, net            (631 )                 (106 )                 (342 )                1,313
Total realized (gain) loss (cash
outflow) on derivatives, net                    1,185                 (1,084 )                  774                   (979 )
Non-cash unrealized gain (loss) on
derivatives, net                                  554                 (1,190 )                  432                    334
Adjusted EBITDA                        $        9,510         $        8,276         $       29,634         $       25,095
Reconciliation of net cash provided by
operating activities to Adjusted
EBITDA:
Net cash provided by operating
activities                             $       15,446         $       20,913         $       35,525         $       47,637
Less:
Changes in assets and liabilities               6,296                 13,071                  7,037                 23,947
Add:
Interest expense, excluding
amortization of debt issuance costs               360                    434                  1,146                  1,405
Adjusted EBITDA                        $        9,510         $        8,276         $       29,634         $       25,095

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Results of Operations


                                       Three Months       Three Months
                                     Ended September     Ended September    Nine Months Ended    Nine Months Ended
                                         30, 2012           30, 2011        September 30, 2012   September 30, 2011
                                                     (Unaudited, in thousands except per unit data)
Statement of income data:
Revenues, including revenues from
affiliates:
Product                              $      120,358     $        95,430     $     435,814        $     271,824
Service                                      11,196               9,142            32,932               27,077
. . .
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