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SEMG > SEC Filings for SEMG > Form 10-Q on 9-May-2014All Recent SEC Filings

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Form 10-Q for SEMGROUP CORP


9-May-2014

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, 2013, filed with the Securities and Exchange Commission (the "SEC").

Overview of Business
Our business is to 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.") and Canada. 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 between North American production and supply areas, including the Gulf Coast, Midwest, Rocky Mountain and Western Canadian regions. We also maintain and operate storage, terminal and marine facilities at Milford Haven in the United Kingdom (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, SemStreamฎ, SemCAMS, SemLogistics, SemMexico, and SemGasฎ.
Our Property, Plant and Equipment
Our assets include:

•          the 2% general partner interest and a 51.6% limited partner interest
           in Rose Rock Midstream, L.P. ("Rose Rock"), a publicly traded master
           limited partnership, which owns an approximately 570-mile crude oil
           pipeline network in Kansas and Oklahoma and a crude oil storage
           facility in Cushing, Oklahoma with a capacity of 7.6 million barrels,
           of which 7.1 million barrels of storage are leased to customers and
           0.5 million barrels are for used for crude oil operations;


•          a 51% ownership interest (17% directly and 34% indirectly, through our
           interest in 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;


•          a 50% interest in Glass Mountain Pipeline, LLC ("Glass Mountain"),
           which owns a 215-mile crude oil pipeline in western and north central
           Oklahoma. Construction of this pipeline was completed in January 2014.
           The pipeline is operated by Rose Rock;


•          9.1 million common units of NGL Energy Partners LP ("NGL Energy") and
           an 11.78% interest in NGL Energy Holdings LLC, the general partner of
           NGL Energy;


•          approximately 2,000 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, with
           an additional plant currently under construction, and one emulsion
           distribution terminal in Mexico;


•          majority interest in four natural gas processing plants in Alberta,
           Canada, with combined operating capacity of 695 million cubic feet per
           day;


•          four natural gas processing plants in the U.S., with 388 million cubic
           feet per day of capacity;


•          a modern, sixteen-lane crude oil truck unloading facility with 230,000
           barrels of associated storage capacity in Platteville, Colorado which
           connects to the origination point of the White Cliffs Pipeline;


•          a 37-mile crude oil gathering system with 210,000 barrels of
           operational storage connected to our Platteville, Colorado crude oil
           terminal and the origination point of the White Cliffs Pipeline;


•          a 12-mile crude oil pipeline that connects our Platteville, Colorado
           crude oil terminal to the Tampa, Colorado crude oil market; and

• a crude oil trucking fleet of over 130 transport trucks and 150 trailers.

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

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Recent Developments
Much of the crude oil produced from shale formations in the U.S. is sweet (i.e., low sulfur), with a relatively high specific gravity. This is not ideal for refineries which were designed to process crude oil that contains more sulfur and with lower specific gravity. We see an opportunity for potential profit by combining various crude oil types to produce a blended crude oil which is well suited to the refiners' preference. In order to acquire the tankage needed for such blending, we have arranged to take several tanks out of leased storage service beginning in May 2014.
Declining demand for sweet gas processing at our West Whitecourt plant threatens continued operations. Accordingly, the plant could be idled in the third quarter of 2014 and SemCAMS will evaluate its options.

Non-GAAP Financial Measures
We define Adjusted gross margin as total revenues minus cost of products sold and unrealized gain (loss) on derivatives. Adjusted gross margin is not a financial measure presented in accordance with GAAP. We believe that the presentation of this non-GAAP financial measure provides useful information to investors in assessing our financial condition and results of operations. Operating income is the GAAP measure most directly comparable to Adjusted gross margin. Our non-GAAP financial measure should not be considered as an alternative to the most directly comparable GAAP financial measure. This non-GAAP financial measure has important limitations as an analytical tool because it excludes some, but not all, items that affect the most directly comparable GAAP financial measure. You should not consider Adjusted gross margin as a substitute for analysis of our results as reported under GAAP. Because Adjusted gross margin may be defined differently by other companies in our industry, our definition of this non-GAAP financial measure may not be comparable to similarly titled measures of other companies, thereby diminishing its utility.
Management compensates for the limitation of Adjusted gross margin as an analytical tool by reviewing the comparable GAAP measure, understanding the difference between Adjusted gross margin on the one hand, and operating income 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 measure that our management uses in evaluating our operating results.

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Results of Operations
Consolidated Results of Operations

Three Months Ended March 31, (in thousands) 2014 2013 Revenue $ 498,883 $ 287,696 Expenses
Costs of products sold 385,113 212,369 Operating 50,778 40,771 General and administrative 18,736 17,037 Depreciation and amortization 23,637 12,636 Gain on disposal of long-lived assets, net (58 ) (162 ) Total expenses 478,206 282,651 Earnings from equity method investments 14,962 17,345 Gain on issuance of common units by equity method investee 8,127 - Operating income 43,766 22,390 Other expenses (income):
Interest expense 9,227 2,396 Other expense (income), net (1,730 ) 25,466 Total other expenses, net 7,497 27,862 Income (loss) from continuing operations before income taxes 36,269 (5,472 ) Income tax expense (benefit) 16,526 (54,006 ) Income from continuing operations 19,743 48,534 Income (loss) from discontinued operations, net of income taxes (5 ) 32 Net income $ 19,738 $ 48,566

Revenue and Expenses
Revenue and expenses are analyzed by operating segment below. General and administrative expense
A portion of general and administrative expenses of each corporate department is allocated to the segments based on criteria such as actual usage, headcount and estimates of effort or benefit. The method for allocating cost is based on the type of service being provided. For example, internal audit costs are based on an estimate of effort attributable to a segment. In contrast, accounting department costs are allocated based on the number of transactions processed for a given segment compared to the total number processed. Interest expense
Interest expense increased in the three months ended March 31, 2014 to $9.2 million from $2.4 million in the three months ended March 31, 2013. The increase in interest expense is due to the increase in the outstanding debt balance to $672.6 million at March 31, 2014 from $180.6 million at March 31, 2013. The increase in total outstanding debt is primarily attributable to the issuance of $300 million of 7.5% senior notes in the second quarter of 2013. Also contributing to the increase in total outstanding debt is an increase in the SemGroup revolver balance of $104.5 million and an increase in the revolver balance at Rose Rock of $92.0 million.
Other expense, net
Other income was $1.7 million for the three months ended March 31, 2014, compared to other expense of $25.5 million for the same period in 2013. Other expense for all periods presented was comprised primarily of gains or losses due to the change in the fair value of our outstanding warrants.

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Income tax expense (benefit)
The effective tax rate was 46% and 987% for the three months ended March 31, 2014 and 2013. The rate for the three months ended March 31, 2014 is impacted by $3.1 million Canadian withholding tax paid on remittances to the U.S. The rate for the three months ended March 31, 2013 is impacted by a discrete tax benefit of $50.9 million for the partial release of our valuation allowance. 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)                                          2014                2013
Revenue                                           $      292,514       $      171,232
Expenses
Costs of products sold                                   254,537              148,451
Operating                                                 15,139                5,738
General and administrative                                 3,942                3,850
Depreciation and amortization                             11,482                3,507
Loss (gain) on disposal of long-lived assets, net            (34 )                  -
Total expenses                                           285,066              161,546
Earnings from equity method investment                    11,371               10,429
Operating income                                  $       18,819       $       20,115

Three months ended March 31, 2014 versus three months ended March 31, 2013 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 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, (in thousands) 2014 2013 Reconciliation of operating income to Adjusted gross margin:
Operating income $ 18,819 $ 20,115 Add:
Operating expense 15,139 5,738 General and administrative expense 3,942 3,850 Depreciation and amortization expense 11,482 3,507 Loss (gain) on disposal of long-lived assets, net (34 ) - Less:
Unrealized gain (loss) on derivatives (606 ) 468 Earnings from equity method investment 11,371 10,429 Adjusted gross margin $ 38,583 $ 22,313

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, 2014 and 2013 (in thousands):

Three Months Ended March 31,                                               Marketing
2014                                Storage        Transportation (1)      Activities      Other (2)        Total
Revenues                          $    8,480     $             20,311     $  260,454     $     3,269     $ 292,514
Less: Costs of products sold,
exclusive of depreciation and
amortization                               -                        -        254,537               -       254,537
Less: Unrealized gain (loss) on
derivatives                                -                        -           (606 )             -          (606 )
Adjusted gross margin             $    8,480     $             20,311     $    6,523     $     3,269     $  38,583

(1) Transportation revenue is comprised of $3.0 million, $13.5 million and $3.8 million, related to pipeline transportation (fixed-fee), trucking (fixed-fee) and buy/sells (fixed margin), respectively.

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

Three Months Ended March 31,                                               Marketing
2013                                Storage       Transportation (1)       Activities       Other (2)        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 on
derivatives                                -                       -              468               -           468
Adjusted gross margin             $    8,367     $             5,776     $      4,897     $     3,273     $  22,313

(1) Transportation revenue is comprised of $0.9 million and $4.9 million, related to pipeline transportation (fixed-fee) and buy/sells (fixed margin), respectively.

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

Adjusted Gross Margin
Adjusted gross margin increased in the three months ended March 31, 2014, to
$38.6 million from $22.3 million in the three months ended March 31, 2013, due
to:
•          an increase in pipeline transportation volumes of approximately 3.4
           million barrels, resulting in a $1.1 million increase in Adjusted
           gross margin during the three months ended March 31, 2014, compared to
           the same period in 2013 due to a higher concentration of short-haul
           activity;


•          truck transportation volumes of 3.8 million barrels generating an
           additional $13.5 million in Adjusted gross margin;


•          a decrease in pumpover activity at Cushing, resulting in a $0.2
           million decrease in Adjusted gross margin during the three months
           ended March 31, 2014, compared to the same period in 2013;

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• an increase in unloading volumes from our Platteville operations of approximately 0.1 million barrels, contributing an additional $0.1 million Adjusted gross margin, during the three months ended March 31, 2014, compared to the same period in 2013;

• an increase in marketing volume of approximately 2.3 million barrels in the three months ended March 31, 2014, over the same period in 2013, offset by a lower spread between the purchase and sale price for volumes of crude oil sold, as the excess of our average sales price per barrel over our average purchase cost per barrel decreased to approximately $1.74 for the three months ended March 31, 2014, from approximately $2.26 for the three months ended March 31, 2013. This resulted in a $1.6 million increase in Adjusted gross margin during the three months ended March 31, 2014, compared to the same period in 2013; and

• an increase in the average Cushing storage capacity to 7.6 million barrels for the three months ended March 31, 2014, from 7.25 million barrels for the three months ended March 31, 2013, contributing an additional $0.2 million Adjusted gross margin.

Operating expense
Operating expense increased to $15.1 million in the three months ended March 31, 2014, from $5.7 million for the three months ended March 31, 2013. Approximately $10.5 million of the increase is attributable to the newly acquired trucking fleet, offset with reductions in employee expense, field expense and outside services, of approximately $0.6 million, $0.3 million and $0.2 million, respectively, exclusive of amounts related to trucking. General and administrative
General and administrative expense remained flat at $3.9 million in the three months ended March 31, 2014 and 2013.
Depreciation and amortization expense
Depreciation and amortization expense increased to $11.5 million in the three months ended March 31, 2014, from $3.5 million in the three months ended March 31, 2013. Approximately $5.4 million of the depreciation expense increase is due to a revision of the estimated useful life relating to a 62-mile section of the Kansas and Oklahoma pipeline system. An additional $1.8 million in depreciation expense is due to project completions and the acquisition of the crude oil trucking fleet. Amortization expense increased $0.8 million due to a contract acquired as part of the crude oil trucking fleet acquisition in 2013. Earnings from equity method investment
Crude's equity method investments are in White Cliffs and Glass Mountain. Earnings from White Cliffs increased in the three months ended March 31, 2014, to $11.1 million from $10.4 million in the three months ended March 31, 2013. This increase is due to increased volume transported by White Cliffs. As a result of the January 2014 start-up, earnings from Glass Mountain Pipeline increased in the three months ended March 31, 2014 to $0.3 million from zero in the three months ended March 31, 2013.

SemStream
On November 1, 2011, we contributed the primary operating assets of our SemStream segment to NGL Energy in exchange for a limited partnership interest and a general partnership interest in NGL Energy and cash. The results of operations shown below reflect 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. In addition, our limited partnership interest was diluted as a result of NGL Energy's public equity offering and acquisition during the fourth quarter of 2013. Accordingly, we recorded a non-cash gain of $8.1 million in the first quarter of 2014.
For additional information about NGL Energy's results for the quarter ended December 31, 2013, see the NGL Energy Form 10-Q for such period filed with the SEC.

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Three Months Ended March 31, (in thousands) 2014 2013 Revenue $ - $ - Expenses
Costs of products sold - - Operating - 1 General and administrative 113 156 Depreciation and amortization - - Loss on disposal of long-lived assets, net - 6 Total expenses 113 163 Earnings from equity method investment 3,591 6,916 Gain on issuance of common units by equity method investee 8,127 - Operating income $ 11,605 $ 6,753

SemLogistics
Three Months Ended March 31, (in thousands) 2014 2013 Revenue $ 4,790 $ 3,035 Expenses
Costs of products sold 350 - Operating 2,080 1,839 General and administrative 1,422 1,120 Depreciation and amortization 2,495 2,340 Total expenses 6,347 5,299 Operating loss $ (1,557 ) $ (2,264 )

Three months ended March 31, 2014 versus three months ended March 31, 2013 Revenue
Revenue in the three months ended March 31, 2014, increased to $4.8 million from $3.0 million for the three months ended March 31, 2013. The increase is due primarily to increased storage revenue as a result of improvement in both volume stored and rates.
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 throughout 2014. 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
In every category of expense, the amounts for the first quarter of 2014 are roughly equivalent to those of the first quarter of 2013.

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SemCAMS
Three Months Ended March 31, (in thousands) 2014 2013 Revenue $ 39,283 $ 35,781 Expenses
Costs of products sold 67 183 Operating 23,666 26,884 General and administrative 3,980 4,145 Depreciation and amortization 2,829 2,656 Total expenses 30,542 33,868 Operating income $ 8,741 $ 1,913

Three months ended March 31, 2014 versus three months ended March 31, 2013 Revenue
Revenue in the three months ended March 31, 2014, increased to $39.3 million from $35.8 million for the three months ended March 31, 2013. This increase is primarily due to increased fees of $6.6 million and operating cost recoveries of $2.6 million, offset in part by foreign exchange loss of $3.7 million. In . . .

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