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SEMG > SEC Filings for SEMG > Form 10-Q on 9-May-2013All Recent SEC Filings

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Form 10-Q for SEMGROUP CORP


9-May-2013

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, 2012, filed with the SEC.

Overview of Business
We provide gathering, transportation, storage, distribution, marketing and other midstream services primarily to independent producers, refiners of petroleum products and other market participants located in the Midwest and Rocky Mountain regions of the United States of America (the "U.S."), Canada and the west coast of the United Kingdom (the "U.K."). We, or our significant equity method investees, have an asset base consisting of pipelines, gathering systems, storage facilities, terminals, processing plants and other distribution assets located in North American production and supply areas, including the Gulf Coast, Midwest, Rocky Mountain and Western Canadian regions. We maintain and operate storage, terminal and marine facilities at Milford Haven in the U.K. that enable customers to supply petroleum products to markets in the Atlantic Basin. We also operate a network of liquid asphalt cement terminals throughout Mexico. Our operations are conducted directly and indirectly through our six primary business segments - Crude, SemStream®, SemCAMS, SemLogistics, SemMexico, and SemGas®.
Our Assets
Our assets include:

•          a 51% ownership interest (34% directly and 17% indirectly, through our
           interest in Rose Rock Midstream, L.P. ("Rose Rock")) in White Cliffs
           Pipeline, L.L.C. ("White Cliffs"), which owns a 527-mile crude oil
           pipeline running from Platteville, Colorado to Cushing, Oklahoma (the
           "White Cliffs Pipeline"), that Crude operates;


•          the 2% general partner interest and 58.2% of the limited partner
           interests in Rose Rock, which owns an approximately 640-mile crude oil
           pipeline network in Kansas and Oklahoma and a crude oil storage
           facility in Cushing, Oklahoma with a capacity of 7.25 million barrels
           and an additional 0.35 million barrels currently under construction,
           and a 17% ownership interest in White Cliffs;


•          9.1 million common units of NGL Energy Partners LP ("NGL Energy") and
           a 6.42% interest in NGL Energy Holdings LLC, the general partner of
           NGL Energy;


•          approximately 1,600 miles of natural gas and NGL transportation,
           gathering and distribution pipelines in Kansas, Oklahoma, Texas and
           Alberta, Canada;


•          8.7 million  barrels of owned multi-product storage capacity located
           in the U.K.;


•          12 liquid asphalt cement terminals and modification facilities and two
           emulsion distribution terminals in Mexico;


•          majority ownership interests in four natural gas processing plants in
           Alberta, Canada, with combined operating capacity of 694 million cubic
           feet per day; and


•          three natural gas processing plants in the U.S., with 98 million cubic
           feet per day of capacity.

We believe that the variety of our petroleum product assets creates opportunities for us and our customers that avoid seasonal fluctuations of less diverse business.

Recent Developments
On April 30, 2013, we executed a definitive agreement to acquire the equity interests of Mid-America Midstream Gas Services, L.L.C., a wholly owned subsidiary of Chesapeake Energy Corporation, which is the owner of gas gathering and processing assets in the Mississippi Lime play for $300 million in cash. The transaction is expected to close by the third quarter of 2013 and is subject to certain regulatory approvals and closing conditions. The acquisition includes:
• 200 miles of gathering pipeline;

•        Rose Valley I plant: 200 million cubic feet per day cryogenic processing
         plant, expected to be operational first quarter 2014;


•        Rose Valley II plant: 200 million cubic feet per day cryogenic
         processing plant, expected to be operational first quarter 2016;

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• Approximately 540,000 net acre dedication in the core of the Mississippi Lime play, supported by a recently announced joint venture between Chesapeake Energy Corporation and Sinopec International Petroleum Exploration and Production Corporation; and

• Chesapeake Energy Corporation has committed to a 20-year, 100% fee-based, gas gathering and processing agreement.

Rose Valley plants I and II require approximately $125 million of additional capital expenditures for completion, as well as additional capital related to future well connects. SemGroup will fund the acquisition under existing committed credit facilities.
On April 22, 2013, the SemGroup corporate credit agreement was amended to (i) permit the increase of the facility by up to an additional $300 million subject to certain conditions, (ii) remove the restriction limiting unsecured senior or subordinated indebtedness to $200 million, while establishing certain requirements for obtaining unsecured senior or subordinated indebtedness of $200 million or more and (iii) establish less restrictive leverage covenants. On May 3, 2013, we elected to increase the credit facility capacity to $200 million, for a total capacity of $500 million. The facility can be increased by an additional $100 million. In connection, with the increase, we recorded $2.2 million of capitalized loan fees which will be amortized over the remaining life of the facility.
On May 8, 2013, we declared a dividend of $0.19 per share payable on May 30, 2013 to shareholders of record on May 20, 2013.

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Results of Operations
Consolidated Results of Operations

Three Months Ended March 31, (in thousands) 2013 2012 Revenue $ 287,696 $ 312,031 Expenses
Costs of products sold 212,369 241,521 Operating 40,771 37,991 General and administrative 17,037 19,830 Depreciation and amortization 12,636 11,725 Gain on disposal of long-lived assets, net (162 ) - Total expenses 282,651 311,067 Earnings from equity method investments 17,345 7,498 Operating income 22,390 8,462 Other expense (income)
Interest expense 2,396 3,659 Other expense, net 25,466 3,957 Total other expenses, net 27,862 7,616 Income (loss) from continuing operations before income taxes (5,472 ) 846 Income tax benefit (54,006 ) (1,012 ) Income from continuing operations 48,534 1,858 Income from discontinued operations, net of income taxes 32 252 Net income $ 48,566 $ 2,110

Revenue and Expenses
Revenue and expenses before intercompany eliminations leading to operating income are analyzed by operating segment below. Interest expense
Interest expense decreased in the three months ended March 31, 2013 to $2.4 million from $3.7 million in the three months ended March 31, 2012. Although the outstanding debt balance increased to $180.6 million at March 31, 2013 from $123.7 million at March 31, 2012, interest expense decreased due to an $0.8 million increase in interest capitalized to the cost of new construction projects in 2013 combined with the write-off of $0.3 million in capitalized loan fees in January 2012 related to a reduction in the overall revolver capacity. Other expense (income), net
Other expense was $25.5 million for the three months ended March 31, 2013, compared to other expense of $4.0 million for the same period in 2012. Other expense for all periods presented was comprised primarily of gains and losses due to the change in the fair value of our warrants.

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Income tax expense (benefit)
The effective tax rate was 987% for the three months ended March 31, 2013, and
(120)% for the three months ended March 31, 2012. Due to our emergence from bankruptcy and overall restructuring, we have recorded a full valuation allowance on all U.S. federal and state deferred tax assets in prior periods. For the three months ended March 31, 2013, we recorded a discrete tax benefit of $50.9 million for the release of the valuation allowance on certain U.S. federal and state deferred tax assets. Refer to Note 7 for further information regarding our valuation allowance assessment. Significant items that impacted the effective tax rate for each period, as compared to the U.S. federal statutory rate of 35%, include earnings in foreign jurisdictions taxed at lower rates, a noncontrolling interest in Rose Rock for which taxes are not provided, warrant expense which is not deductible for tax purposes and the impact of the valuation allowance or release recorded against our deferred tax assets. Further, the foreign earnings are taxed in foreign jurisdictions as well as in the U.S., since they are disregarded entities for U.S. federal income tax purposes. Deferred tax liabilities, with the exception of those related to certain long-lived assets, have been considered as a source of future taxable income in establishing the amount of the valuation allowance. These combined factors, and the magnitude of permanent items impacting the tax rate relative to income from continuing operations before income taxes, result in rates that are not comparable between the periods.

Results of Operations by Reporting Segment

Crude
                                      Three Months Ended March 31,
(in thousands)                             2013                  2012
Revenue                         $       171,232               $ 179,715
Expenses
Costs of products sold                  148,451                 160,508
Operating                                 5,738                   5,454
General and administrative                3,850                   2,718
Depreciation and amortization             3,507                   2,967
Total expenses                          161,546                 171,647
Equity earnings in White Cliffs          10,429                   6,571
Operating income                $        20,115               $  14,639

Three months ended March 31, 2013 versus three months ended March 31, 2012 Revenue
Revenue decreased in the three months ended March 31, 2013 to $171 million from $180 million in the three months ended March 31, 2012, as shown in the following table:

                                               Three Months Ended March 31,
                                                 2013                 2012
                                                      (in thousands)
Gross product revenue                      $      630,446       $      501,479
ASC 845-10-15                                    (472,186 )           (331,947 )
Unrealized gain (loss) on derivatives, net            468                 (146 )
Product revenue                                   158,728              169,386
Service revenue                                    12,504               10,334
Other                                                   -                   (5 )
Total revenue                              $      171,232       $      179,715

Gross product revenue increased in the three months ended March 31, 2013 to $630 million from $501 million in the three months ended March 31, 2012. The increase was primarily a result of an increase in sales volumes to 6.8 million barrels for the three months ended March 31, 2013 from 5.0 million barrels for the same period in 2012, offset by a decrease in the average sales price of crude oil to $93 per barrel for the three months ended March 31, 2013 from $101 per barrel for the same period in 2012.

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ASC 845-10-15, "Nonmonetary Transactions," requires certain transactions - those where inventory is purchased from a customer then resold to the same customer - to be presented in the income statement on a net basis, resulting in a reduction of revenue and costs of products sold by the same amount, but has no effect on operating income. However, changes in the level of such purchase and sale activity between periods can have an effect on the comparison between those periods. Gross product revenue was reduced by $472 million and $332 million during the three months ended March 31, 2013 and 2012, respectively, in accordance with ASC 845-10-15.
Service revenue increased in the three months ended March 31, 2013 to $13 million from $10 million for the three months ended March 31, 2012, due to additional storage capacity and pumpover activity at Cushing, OK and additional truck unloading at Platteville, CO.
Costs of products sold
Costs of products sold decreased in the three months ended March 31, 2013 to $148 million from $161 million for the same period in 2012. Costs of products sold were reduced by $472 million and $332 million in the three months ended March 31, 2013 and 2012, respectively, in accordance with ASC 845-10-15. Costs of products sold decreased in the three months ended March 31, 2013, primarily as a combined result of an increase in the volume sold, offset by a decrease in the average cost of crude oil per barrel to $91 from $98 per barrel, and a higher proportion of transactions subject to ASC 845-10-15 for the same period in 2012.
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 costs 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 petroleum products, and our fixed-margin and marketing operations, which do. 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 costs of products sold.
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.
The following table shows the Adjusted gross margin generated by our fee-based services, our fixed-margin transactions and our marketing activities for the three months ended March 31, 2013 and 2012 (in thousands):

Three Months Ended March 31,                                            Marketing
2013                                Storage        Transportation       Activities       Other(1)        Total
Revenues                          $    8,367     $          5,776     $    153,816     $    3,273     $ 171,232
Less: Costs of products sold,
exclusive of depreciation and
amortization                               -                    -          148,451              -       148,451
Less: Unrealized gain (loss) on
derivatives                                -                    -              468              -           468
Adjusted gross margin             $    8,367     $          5,776     $      4,897     $    3,273     $  22,313



Three Months Ended March 31,                                       Marketing
2012                               Storage      Transportation    Activities     Other(1)      Total
Revenues                             7,410              4,357       166,175        1,773      179,715
Less: Costs of products sold,
exclusive of depreciation and
amortization                                                        160,508                   160,508
Less: Unrealized gain (loss) on
derivatives                                                            (146 )                    (146 )
Adjusted gross margin                7,410              4,357         5,813        1,773       19,353

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

The following table presents a reconciliation of operating income to Adjusted gross margin, the most directly comparable GAAP financial measure for each of the periods indicated.

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Three Months Ended March 31,
2013 2012
(in thousands)

Reconciliation of operating income to Adjusted gross margin:
Operating income $ 20,115 $ 14,639 Add:
Operating expense 5,738 5,454 General and administrative expense 3,850 2,718 Depreciation and amortization expense 3,507 2,967 Less:
Unrealized gain (loss) on derivatives 468 (146 ) Earnings from equity method investment 10,429 6,571 Adjusted gross margin $ 22,313 $ 19,353

Operating expense
Operating expense increased in the three months ended March 31, 2013, to $6 million from $5 million for the three months ended March 31, 2012. This increase is due primarily to increased field expense and outside services. General and administrative
General and administrative expense increased in the three months ended March 31, 2013, to $4 million from $3 million for the three months ended March 31, 2012. This increase is primarily the result of financial and legal advisors' costs associated with the drop down of SemGroup's one-third interest in SemCrude Pipeline, LLC.
Earnings from equity method investment
Crude's equity method investments are in White Cliffs and Glass Mountain Pipeline. Earnings from White Cliffs increased in the three months ended March 31, 2013 to $10 million from $7 million in the three months ended March 31, 2012. This increase is due primarily to a 45% increase in the crude oil volume shipped from Platteville, CO to Cushing, OK. The Glass Mountain Pipeline is still under construction.

SemStream
On November 1, 2011, we contributed the primary operating assets of our SemStream segment to NGL Energy. We did not, however, contribute any of the assets or liabilities of SemStream's Arizona residential business to NGL Energy. On September 12, 2012, we entered into a definitive agreement to sell those assets and liabilities. This sale was subject to approval by the Arizona Corporation Commission and closed on December 31, 2012 after that approval was granted; therefore, 2012 results are reported as discontinued operations. The results of operations shown below for 2013 reflect only corporate overhead allocations, minor adjustments and the earnings from our equity method investment in NGL Energy. We include our share of NGL Energy's earnings on a one-quarter lag because we do not receive their financial statements in sufficient time to apply the equity method to the current period.

                                     Three Months Ended March 31,
(in thousands)                              2013                   2012
Revenue                       $              -                    $   6
Expenses
Costs of products sold                       -                       34
Operating                                    1                       (6 )
General and administrative                 156                       51
Depreciation and amortization                -                        -
Loss on disposal                             6                        -
Total expenses                             163                       79
Equity earnings in NGL Energy            6,916                      927
Operating income              $          6,753                    $ 854

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SemLogistics
Three Months Ended March 31, (in thousands) 2013 2012 Revenue $ 3,035 $ 3,784 Expenses
Costs of products sold - - Operating 1,839 1,454 General and administrative 1,120 1,811 Depreciation and amortization 2,340 2,318 Total expenses 5,299 5,583 Operating loss $ (2,264 ) $ (1,799 )

Three months ended March 31, 2013 versus three months ended March 31, 2012 Revenue
Revenue decreased in the three months ended March 31, 2013 to $3 million from $4 million in the three months ended March 31, 2012.
The decline in revenue is a result of a decline in the volume of storage leased and drop in storage rates. This decline was offset, in part, by an increase in fees for ancillary terminal services. High crude oil prices and backwardated market conditions (i.e., prices for future deliveries are lower than current prices) exist today and are forecast to continue through 2013. These factors have a negative effect on storage economics. As a result, the demand for storage is depressed and we have experienced difficulty securing contract renewals and replacement of long-term contracts.
We are uncertain when market conditions will improve. However, we believe that geographical imbalances between the production and consumption of crude oil and related refined products will require physical transportation and, as a result, bulk liquid storage must play a key role in the supply chain. This creates a demand for storage which is independent of current crude oil prices, forward price curves and the entire speculative trading environment.
Storage economics have been unfavorable for some time. We will continue to monitor this situation and recognize the possibility that an impairment of the long-lived assets may be required in the near term. General and administrative
General and administrative expense decreased in three months ended March 31, 2013 to $1 million from $2 million in the three months ended March 31, 2012. This reduction is due primarily to employee costs and intercompany allocations which decreased by approximately $440 thousand and $310 thousand, respectively. General
In every other category of expense, the amounts for the first quarter of 2013 are roughly equivalent to those of the first quarter of 2012.

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SemCAMS
Three Months Ended March 31, (in thousands) 2013 2012 Revenue $ 35,781 $ 35,165 Expenses
Costs of products sold 183 119 Operating 26,884 26,236 General and administrative 4,145 4,418 Depreciation and amortization 2,656 2,573 Total expenses 33,868 33,346 Operating income $ 1,913 $ 1,819

Three months ended March 31, 2013 versus three months ended March 31, 2012 Revenue
Revenue in the three months ended March 31, 2013 increased to $36 million from $35 million for the three months ended March 31, 2012. This increase is due to incremental fees of $1.8 million related to take or pay contracts, maintenance capital recovery fees of $0.9 million and $0.5 million in flow through expenses related to turnaround planning which were offset, in part, by reductions in revenue due to producer shut-ins and plant outages of $1.6 million and $0.9 million, respectively.
General
In every category of expense, the amounts for the three months ended March 31, 2013 are roughly equivalent to those of the three months ended March 31, 2012.

SemMexico
                                 Three Months Ended March 31,
(in thousands)                      2013               2012
Revenue                       $      42,994       $      62,651
Expenses
Costs of products sold               38,649              57,041
Operating                             2,165               2,000
General and administrative            2,222               2,688
Depreciation and amortization         1,480               1,561
Gain on disposal                       (166 )                 -
Total expenses                       44,350              63,290
Operating loss                $      (1,356 )     $        (639 )

Three months ended March 31, 2013 versus three months ended March 31, 2012 Revenue
Revenue decreased in the three months ended March 31, 2013 to $43 million from $63 million in the three months ended March 31, 2012. Lower volume (61,861 metric tons versus 89,525 metric tons) accounted for 98% of the decrease. The decline in volume is a result of a slowdown in federal government spending on infrastructure projects in Mexico.

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Costs of products sold
Costs of products sold decreased in the three months ended March 31, 2013 to $39 million from $57 million in the three months ended March 31, 2012. On a per unit basis, the cost of products sold decreased to $625 per metric ton from $637 per metric ton.

SemGas
                                  Three Months Ended March 31,
(in thousands)                      2013                2012
Revenue                       $       38,739       $       33,440
Expenses
. . .
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