ROSE ROCK MIDSTREAM, L.P. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

(Edgar Glimpses Via Acquire Media NewsEdge) 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".

Page 17-------------------------------------------------------------------------------- Table of Contents 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 investmentopportunities.

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 Page 18-------------------------------------------------------------------------------- Table of Contents 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 Page 19-------------------------------------------------------------------------------- Table of Contents 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.

Page 20-------------------------------------------------------------------------------- Table of Contents 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.

Page 21-------------------------------------------------------------------------------- Table of Contents 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 Page 22-------------------------------------------------------------------------------- Table of Contents 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 Other - 44 (59 ) 220 Total revenues 131,554 104,616 468,687 299,121 Expenses, including expenses from affiliates: Costs of products sold, exclusive of depreciation and amortization shown below 111,790 90,660 412,847 252,804 Operating 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 Total expenses 124,635 100,352 447,855 281,511 Operating income 6,919 4,264 20,832 17,610 Other expenses: Interest expense 450 434 1,407 1,405 Other expense (income) - - 72 (202 ) Total other expenses 450 434 1,479 1,203 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 Distribution paid per unit $ 0.3825 N/A $ 0.8220 N/A Adjusted gross margin (1) $ 19,210 $ 15,146 $ 55,408 $ 45,983 Adjusted EBITDA (1) $ 9,510 $ 8,276 $ 29,634 $ 25,095 (1) For a definition of Adjusted gross margin, Adjusted EBITDA and reconciliation to their most directly comparable financial measures calculated and presented in accordance with GAAP, please read "Non-GAAP Financial Measures." 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.

Three months ended September 30, 2012 vs. three months ended September 30, 2011 Revenue Revenue increased in the three months ended September 30, 2012, to $132 million from $105 million for the three months ended September 30, 2011, as shown in the following table: Page 23-------------------------------------------------------------------------------- Table of Contents Three Months Ended Three Months Ended September 30, 2012 September 30, 2011 (in thousands) Gross product revenue $ 565,595 $ 266,132 Nonmonetary transaction adjustment (ASC 845-10-15) (445,791 ) (169,512 ) Unrealized gain (loss) on derivatives, net 554 (1,190 ) Product revenue 120,358 95,430 Service revenue 11,196 9,142 Other - 44 Total revenue $ 131,554 $ 104,616 Gross product revenue increased in the three months ended September 30, 2012, to $566 million from $266 million in the three months ended September 30, 2011. The increase was primarily a result of an increase in sales volumes to 6.2 million barrels for the three months ended September 30, 2012 from 3.0 million barrels for the same period in 2011, and an increase in the average sales price of crude oil to $91 per barrel for the three months ended September 30, 2012 from $89 per barrel for the same period in 2011. The increase in volume relates primarily to increased buy/sell and marketing activity as a result of new crude oil production around our assets and directed efforts to maximize the use of those assets.

Service revenue increased in the three months ended September 30, 2012, to $11 million from $9 million for the three months ended September 30, 2011, due to fees earned on 1.950 million barrels additional storage capacity at Cushing, Oklahoma, brought on line during the first four months of 2012.

Costs of Products Sold Costs of products sold increased in the three months ended September 30, 2012, to $112 million from $91 million for the same period in 2011. Costs of products sold were reduced by $446 million and $170 million in the three months ended September 30, 2012 and 2011, respectively, in accordance with ASC 845-10-15.

Costs of products sold increased in the three months ended September 30, 2012, primarily as a result of an increase in the volume sold and an increase in the average cost of crude oil per barrel to $89 from $87 per barrel for the same period in 2011.

Adjusted Gross Margin We define Adjusted gross margin as total revenues minus costs of products sold and unrealized gain (loss) on derivatives. (See "Non-GAAP Financial Measures" for Adjusted gross margin tables.) Adjusted gross margin increased in the three months ended September 30, 2012, to $19 million from $15 million in the three months ended September 30, 2011, due to: • an increase in marketing volume (which is a subset of the total gross product revenue volume sold as shown above) of approximately 0.6 million barrels in the three months ended September 30,2012, over the same period in 2011, 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 $2 for the three months ended September 30, 2012, from approximately $3 for the three months ended September 30, 2011. This lower realized spread resulted in a $0.1 million reduction in Adjusted gross margin during the three months ended September 30, 2012, compared to the same period in 2011; • an increase in transportation volumes of approximately 1.5 million barrels, contributing an additional $1.4 million Adjusted gross margin during the three months ended September 30, 2012, compared to the same period in 2011; • an increase in unloading volumes from our Platteville operations of approximately 1.7 million barrels, contributing an additional $0.3 million Adjusted gross margin, during the three months ended September 30, 2012, compared to the same period in 2011; and • an increase from our storage operations of approximately 5.0 million barrels in storage capacity at September 30, 2011, to 7.0 million barrels at September 30, 2012, contributing an additional $2.3 million Adjusted gross margin.

Page 24-------------------------------------------------------------------------------- Table of Contents Operating Expense Operating expense increased in the three months ended September 30, 2012, to $6 million from $5 million in the three months ended September 30, 2011. This increase is due primarily to increased field expenses ($300 thousand), employment expense ($250 thousand) and maintenance expense ($175 thousand). In addition, we recorded a previously written off accounts receivable ($300 thousand) in the 2011 period.

General and administrative expense General and administrative expense increased in the three months ended September 30, 2012, to $4 million from $2 million for the three months ended September 30, 2011. This increase is primarily the result of giving year to date effect to a recently completed transfer pricing study which increased the allocation of SemGroup corporate costs to Rose Rock by approximately $1.8 million and costs associated with being an SEC registrant of approximately $200 thousand.

Nine months ended September 30, 2012 vs. nine months ended September 30, 2011 Revenue Revenue increased in the nine months ended September 30, 2012, to $469 million from $299 million for the nine months ended September 30, 2011, as shown in the following table: Nine Months Ended Nine Months Ended September 30, 2012 September 30, 2011 (in thousands) Gross product revenue $ 1,538,806 $ 748,121 Nonmonetary transaction adjustment (ASC 845-10-15) (1,103,424 ) (476,631 ) Unrealized gain (loss) on derivatives, net 432 334 Product revenue 435,814 271,824 Service revenue 32,932 27,077 Other (59 ) 220 Total revenue $ 468,687 $ 299,121 Gross product revenue increased in the nine months ended September 30, 2012, to $1.5 billion from $748 million in the nine months ended September 30, 2011. The increase was primarily a result of increased sales volumes to 16.4 million barrels for the nine months ended September 30, 2012, from 8.0 million barrels for the same period in 2011, and an increase in the average sales price of crude to $94 per barrel for the nine months ended September 30, 2012, from $93 per barrel for the same period in 2011. The increase in volume relates primarily to increased buy/sell and marketing activity as a result of new crude oil production around our assets and directed efforts to maximize the use of those assets.

Service revenue increased in the nine months ended September 30, 2012, to $33 million from $27 million for the nine months ended September 30, 2011, due to fees earned on 1.950 million barrels additional storage capacity at Cushing, Oklahoma, brought on line during the first four months of 2012.

Costs of Products Sold Costs of products sold increased in the nine months ended September 30, 2012, to $413 million from $253 million for the same period in 2011. Costs of products sold were reduced by $1.1 billion and $477 million in the nine months ended September 30, 2012 and 2011, respectively, in accordance with ASC 845-10-15.

Costs of products sold increased in the nine months ended September 30, 2012, as a result of increased volume of barrels sold and an increase in the average cost of crude oil per barrel to $93 from $91 per barrel for the same period in 2011.

Adjusted Gross Margin We define Adjusted gross margin as total revenues minus costs of products sold and unrealized gain (loss) on derivatives. (See "Non-GAAP Financial Measures" for Adjusted gross margin tables.) Adjusted gross margin increased in the nine months ended September 30, 2012, to $55 million from $46 million in the nine months ended September 30, 2011, due to: • an increase in marketing volume (which is a subset of the total gross product revenue volume sold as shown above) of approximately 2.6 million barrels, offset by a lower spread between the purchase and sale price for Page 25-------------------------------------------------------------------------------- Table of Contents 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 $2 from approximately $4. These offsetting factors resulted in a decrease of $0.2 million in Adjusted gross margin; • an increase in transportation volumes of approximately 4.8 million barrels, contributing an additional $2.0 million Adjusted gross margin; • an increase in unloading volumes from our Platteville operations of approximately 4.0 million barrels, contributing an additional $0.7 million Adjusted gross margin; and • an increase from our storage operations of approximately 5.0 million barrels in storage capacity to 7.0 million barrels, contributing an additional $6.1 million Adjusted gross margin.

Operating expense Operating expense increased in the nine months ended September 30, 2012, to $17 million from $14 million in the nine months ended September 30, 2011. This increase is due primarily to increased compensation expense ($1.2 million), field expense ($600 thousand) and maintenance expense ($350 thousand). In addition, we recovered a previously written off accounts receivable ($900 thousand) in the 2011 period.

General and administrative expense General and administrative expense increased in the nine months ended September 30, 2012, to $9 million from $7 million in the nine months ended September 30, 2011. This increase is primarily the result of giving year to date effect to a recently completed transfer pricing study which increased the allocation of SemGroup corporate costs to Rose Rock by approximately $1.8 million and costs associated with being an SEC registrant of approximately $800 thousand.

Liquidity and Capital Resources Our principal sources of short-term liquidity are cash generated from operations and borrowings under our revolving credit facility. Potential sources of long-term liquidity include the issuance of debt securities and common units.

Our primary cash requirements currently are operating expenses, capital expenditures and quarterly distributions to our unitholders and general partner.

In general, we expect to fund: • operating expenses, maintenance capital expenditures and cash distributions through existing cash and cash from operating activities; • expansion capital expenditures and working capital deficits through cash on hand and borrowings on our revolving credit facility; and • debt principal payments through cash from operating activities and refinancing when the credit facility becomes due.

Our ability to meet our financing requirements and fund our planned capital expenditures will depend on our future operating performance, which will be affected by prevailing economic conditions in our industry. In addition, we are subject to conditions in the debt and equity markets for debt securities and limited partner units. There can be no assurance we will be able or willing to access the public or private markets in the future. If we would be unable or unwilling to access those markets, we could be required to restrict future expansion capital expenditures and potential future acquisitions.

We believe our cash from operations and our remaining borrowing capacity allow us to manage our day-to-day cash requirements, distribute the minimum quarterly distribution on all our outstanding common, subordinated and general partner units, and meet our capital expenditure commitments for the coming year.

Cash Flows The following table summarizes our changes in cash for the periods presented: Page 26-------------------------------------------------------------------------------- Table of Contents Nine Months Ended September 30, 2012 2011 (in thousands) Cash flows provided by (used in): Operating activities $ 35,525 $ 47,637 Investing activities (17,407 ) (25,542 ) Financing activities (14,329 ) (22,398 ) Change in cash and cash equivalents 3,789 (303 ) Cash and cash equivalents at beginning of period 9,709 303 Cash and cash equivalents at end of period $ 13,498 $ - Operating Activities.

For the nine months ended September 30, 2012, we experienced operating cash inflows of $35.5 million. Net income of $19.4 million included $9.1 million of non-cash expenses, comprised primarily of depreciation and amortization. The primary changes to working capital included an increase to accounts receivable of $73.7 million, an increase in inventory of $7.6 million and a decrease in receivables from affiliates of $2.1 million, an increase in accounts payable and accrued liabilities of $83.4 million and an increase in payables to affiliates of $2.7 million. The increases to accounts receivable and accounts payable and accrued liabilities are primarily due to our ability to capture value related to market conditions and demand around our Kansas and Oklahoma system and Bakken Shale operations through marketing and buy/sell transactions. The impact to accounts receivable and accounts payable is subject to the timing of purchases and sales. The changes in affiliate receivables and payables are related to transactions with SemGroup, White Cliffs and NGL Energy.

For the nine months ended September 30, 2011, we experienced operating cash inflows of $47.6 million. Net income of $16.4 million included $7.3 million of non-cash expenses, comprised primarily of depreciation and amortization. The primary changes to working capital included a $34.9 million increase in accounts payable and accrued liabilities, a $12.3 million increase in accounts receivable and a $1.7 million decrease in margin deposits.

Investing Activities.

For the nine months ended September 30, 2012 and 2011, our cash outflows from investing activities related primarily to capital expenditures of $17.6 million and $25.5 million, respectively. These capital expenditures related primarily to the construction of storage tanks at our terminal in Cushing, Oklahoma. The decrease in capital expenditures for the nine months ended September 30, 2012, compared to the same period in 2011, is due to the majority of tank construction costs having been incurred in 2011, partially offset by expenditures for projects started in 2012.

Financing Activities.

Cash outflows from financing activities for the nine months ended September 30, 2012, consisted primarily of distributions to our unitholders and our general partner in the amount of $14.1 million. Cash outflows from financing activities for the nine months ended September 30, 2011, consisted primarily of distributions to SemGroup of $22.7 million.

Revolving Credit Facility At September 30, 2012, we had no outstanding borrowings under our $150 million revolving credit facility. We had $38.2 million in outstanding letters of credit, which are not reflected as borrowings on our balance sheet but they do reduce our borrowing capacity. We had $8.4 million outstanding in secured bilateral letters of credit which are external to the credit facility and do not reduce our borrowing capacity. In September 2012, we amended the credit agreement such that our borrowing capacity under this credit facility can be increased by $400 million, subject to commitments from new lenders or additional commitments from existing lenders. The previous agreement provided for an increase of up to $200 million. The credit facility is guaranteed by all of our material subsidiaries and is secured by a lien on substantially all of our property and assets, subject to customary exceptions. At September 30, 2012, we were in compliance with the terms of the credit facility. The credit facility matures on December 14, 2016. Borrowings under the credit facility bear interest at either an alternative base rate or an adjusted Eurodollar rate, in each case plus an applicable margin. The applicable margin varies based upon our Leverage Ratio, as defined in the credit facility. At September 30, 2012, had there been any borrowings under our revolving credit facility, the interest rate applicable to alternate base rate borrowings would have been 4.50% and the interest rate applicable to Eurodollar rate borrowings would have been the Eurodollar margin of 2.25% plus the applicable LIBOR rate.

Page 27-------------------------------------------------------------------------------- Table of Contents Fees are charged on any outstanding letters of credit at a rate that ranges from 2.25% to 3.25%, depending on a leverage ratio specified in the credit agreement.

In addition, a fronting fee of 0.25% is charged on outstanding letters of credit.

A commitment fee that ranges from 0.375% to 0.50%, depending on a leverage ratio specified in the credit agreement, is charged on any unused capacity of the revolving credit facility. In addition, we are charged an annual administrative fee of $0.1 million. The credit facility also allows for the use of secured bilateral letters of credit. At September 30, 2012, we had $8.4 million of bilateral letters of credit outstanding. The interest in effect was 1.75% on $2.7 million of the bilateral letters of credit and 2.00% on the remaining $5.7 million.

The credit facility contains representations and warranties and affirmative and negative covenants customary for transactions of this nature. The negative covenants limit or restrict our ability (as well as the ability of our Restricted Subsidiaries, as defined in the credit facility) to: • permit the ratio of our consolidated EBITDA to our consolidated cash interest expense at the end of any fiscal quarter, for theimmediately preceding four quarter period, to be less than 2.50 to 1:00; • permit the ratio of our consolidated net debt to our consolidated EBITDA at the end of any fiscal quarter, for the immediately preceding four quarter period to be greater than 4.50 to 1.00 (or 5.00 to 1.00 during a temporary period from the date of funding or thepurchase price of certain acquisitions (as described in the creditfacility) until the last day of the third fiscal quarter following such acquisitions); • incur additional debt, subject to customary carve outs for certain permitted additional debt, incur certain liens on assets,subject to customary carve outs for certain permitted liens, or enter into certain sale and leaseback transactions; • make investments in or make loans or advances to persons that are not Restricted Subsidiaries, subject to customary carve out for certain permitted investments, loans and advances; • make certain cash distributions, provided that we may make distributions of available cash so long as no default under the credit agreement then exists or would result therefrom; • dispose of assets in excess of an annual threshold amount; • make certain amendments, modifications or supplements to organization documents, our risk management policy, other material indebtedness documents and material contracts or enter into certain restrictive agreements or make certain payments on subordinated indebtedness; • engage in business activities other than our business as described herein, incidental or related thereto or a reasonable extension of the foregoing; • enter into hedging agreements, subject to a customary carve out for agreements entered into in the ordinary course of business for non-speculative purposes; • make changes to our fiscal year or other significant changes to our accounting treatment and reporting practices; • engage in certain mergers or consolidations and transfers of assets; and • enter into transactions with affiliates unless the terms are not less favorable, taken as a whole, than would be obtained in anarms-length transaction, subject to customary exceptions.

Working Capital Working capital is the amount by which current assets exceed current liabilities and is a measure of our ability to pay our liabilities as they become due. Our working capital was $22.5 million and $26.0 million at September 30, 2012 and December 31, 2011, respectively.

Capital Requirements The midstream energy business can be capital intensive, requiring significant investment for the maintenance of existing assets or acquisition or development of new systems and facilities. We categorize our capital expenditures as either: • maintenance capital expenditures, which are cash expenditures (incurred for the addition or improvement to, or the replacement of, our capital assets or for the acquisition of existing, or the construction or development of new, capital assets) made to maintain our long-term operating income or operating capacity; or • expansion capital expenditures, which are cash expenditures incurred for acquisitions or capital improvements that we expect will increase our operating income or operating capacity over the long-term.

Page 28-------------------------------------------------------------------------------- Table of Contents We budgeted $37.4 million in capital expenditures for the year ending December 31, 2012, of which $33.7 million represents expansion capital expenditures related to the construction of 1.95 million barrels of storage capacity at our Cushing terminal, a truck unloading bay expansion at Platteville and other strategic growth projects. The $3.7 million balance represents maintenance capital expenditures, of which $0.9 million is related to truck replacements and $2.8 million is related primarily to increased pipeline integrity management expenses to comply with new regulations. We spent $17.6 million and $25.5 million in capital expenditures during the nine months ended September 30, 2012 and 2011, respectively.

In addition to our budgeted capital program, we anticipate that we will continue to make significant expansion capital expenditures in the future. Consequently, our ability to develop and maintain sources of funds to meet our capital requirements is critical to our ability to meet our growth objectives. We expect that our future expansion capital expenditures will be funded by borrowings under our credit facility and the issuance of debt and equity securities.

Distributions The cash distribution for the fourth quarter of 2011 was $0.0670 per unit. This prorated amount corresponds to the minimum quarterly cash distribution of $0.3625 per unit, or $1.45 per unit on an annualized basis. The proration period began on December 15, 2011, immediately after the closing date of our initial public offering, and continued through December 31, 2011. The distribution was paid on February 13, 2012 to all unitholders of record as of February 3, 2012.

The cash distribution for the first quarter of 2012 was $0.3725 per unit, or $1.49 per unit on an annualized basis. This represented a 2.8% increase over the prior quarter. The distribution was paid on May 15, 2012 to all unitholders of record as of May 7, 2012.

The cash distribution for the second quarter of 2012 was $0.3825 per unit, or $1.53 per unit on an annualized basis. This represented a 2.7% increase over the prior quarter. The distribution was paid on August 14, 2012 to all unitholders of record as of August 6, 2012.

The cash distribution for the third quarter of 2012 is $0.3925 per unit, or $1.57 per unit on an annualized basis. This represents a 2.6% increase over the prior quarter. The distribution will be paid on November 14, 2012, to all unitholders of record on November 5, 2012.

Credit Risk We are subject to risks of loss resulting from nonpayment or nonperformance by our customers. We examine the creditworthiness of third party customers to whom we extend credit and manage our exposure to credit risk through credit analysis, credit approval, credit limits and monitoring procedures, and for certain transactions, we may request letters of credit, prepayments or guarantees.

Customer Concentration Gavilon, LLC, Phillips 66, Tesoro Refining and Marketing Company, Vitol S.A. and BP Oil Supply Company, each accounted for more than 10% of our total revenue for the three months ended September 30, 2012, at approximately 14%, 13%, 13%, 12% and 11%, respectively. Shell Trading (US) Company, 4K Fuel Supply, LLC, Vitol S.A. and Phillips 66, each accounted for more than 10% of our total revenue for the nine months ended September 30, 2012, at approximately 15%, 14%, 14% and 10%, respectively. Although we have contracts with customers of varying durations, if one or more of our major customers were to default on their contract, or if we were unable to renew our contract with one or more of these customers on favorable terms, we might not be able to replace any of these customers in a timely fashion, on favorable terms or at all. In any of these situations, our revenues and our ability to make cash distributions to our unitholders may be adversely affected. We expect our exposure to risk of non-payment or non-performance to continue as long as we remain substantially dependent on a relatively small number of customers for a substantial portion of our Adjusted gross margin.

Purchase and Sale Commitments For information regarding purchase and sales commitments, see the discussion under the caption "Purchase and sale commitments" in Note 4 of our condensed consolidated financial statements on page 12 of this Form 10-Q, which information is incorporated by reference into this Item 2.

Letters of Credit In connection with our purchasing activities, we provide certain suppliers and transporters with irrevocable standby and performance letters of credit to secure our obligation for the purchase of crude oil. Our liabilities with respect to these purchase obligations are recorded as accounts payable on our balance sheet in the month the crude oil is purchased. Generally, these Page 29-------------------------------------------------------------------------------- Table of Contents letters of credit are issued for 50- to 70-day periods (with a maximum of a 364-day period) and are terminated upon completion of each transaction. At September 30, 2012 and December 31, 2011, we had outstanding letters of credit of approximately $38.2 million and $39.6 million, respectively.

Off-Balance Sheet Arrangements We do not use any off-balance sheet arrangements to enhance our liquidity and capital resources, or for any other purpose.

Critical Accounting Policies and Estimates For disclosure regarding our critical accounting policies and estimates, see the discussion under the caption "Critical Accounting Policies and Estimates" in Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2011.

Recent Accounting Pronouncements See Note 1 to our condensed consolidated financial statements.

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