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Summit Midstream Partners, LP (NYSE:SMLP)

Q4 2012 Earnings Call

March 14, 2013 11:30 a.m. ET

Executives

Marc Stratton – Head, IR and Treasurer

Steven Newby – CEO

Matt Harrison – CFO

Analysts

Ethan Bellamy - Robert W. Baird

Ted Durbin - Goldman Sachs

Helen Ryoo - Barclays

Operator

Good morning and welcome to the fourth quarter 2012 Summit Midstream Partners Earnings Conference Call. My name is John and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. Please note that this conference is being recorded. I would now turn the call over to Marc Stratton, Treasurer, Head of Investor Relations. You may begin, Marc.

Marc Stratton

Thanks, John, and good morning everyone. Thank you for joining us today as we discuss our financial and operating results for the fourth quarter and full year of 2012. If you do not already have a copy of our earnings release that was issued yesterday, please visit our website at www.summitmidstream.com, where you’ll find it in the news section. With me today are Steven Newby, our President and Chief Executive Officer, and Matt Harrison, our Chief Financial Officer.

Before we begin, I’d like to note that our discussion today may contain forward-looking statements. These statements may include but are not limited to our estimates of future volumes, operating expenses and capital expenditures. They may also include statements concerning anticipated cash flow, liquidity, business strategy and other plans and objectives for future operations. These statements are based on management’s believes and assumptions. Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can provide no assurance that such expectations will prove to be correct. Such statements are subject to certain risks, uncertainties and assumptions. If one or more of these risks materialize or should the underlying assumptions prove incorrect, actual results may vary materially from those expected. These risks are discussed in greater detail in our Form S-1 on file with the Securities and Exchange Commission.

Please also note that on this call we use the terms EBITDA, adjusted EBITDA, distributable cash flow and adjustable distributable cash flow. These are non-GAAP financial measures and we have provide reconciliations to the most directly comparable GAAP measures in our fourth quarter 2012 earnings release. And with that, I'll turn the call over to Steve Newby.

Steven Newby

Thanks, Marc, good morning everyone and thanks for joining us today. I will discuss our fourth quarter financial highlights, our business operations, then I will turn it over to Matt for more details on our financial results. I will then end the call with some key growth areas we are focused on for the balance of '13.

Yesterday we announced our financial and operating results for the fourth quarter of 2012. We had a very good fourth quarter with adjusted EBITDA of $28.6 million and adjusted distributable cash flow of $24.7 million. Both of these measures were up significantly over the fourth quarter of 2011. Adjusted EBITDA was up 44%, while adjusted distributable cash flow was up 22%. Please note however that the fourth quarter of '11 did not include a full quarter of results from our Grand River gathering subsidiary which we acquired at the end of October of 11.

Sequentially and what we think is a more appropriate comparison, adjusted EBITDA was up 23.8% over the third quarter of '12 while adjusted distributable cash flow was up 12.6% over the third quarter of '12. Total throughput volume in the fourth quarter averaged 933 million cubic feet per day. It was 2.6% lower than average daily volumes in the third quarter of 2012. All of the volume decreases experienced in the fourth quarter were related to our Grand River system and primarily came from our Mamm Creek and Orchard systems, which as we have stated in the past are supported by significant minimum volume commitments. Because of the minimum volume commitments or MVCs embedded in our gas gathering agreements, we recognized lower volume base gathering revenue and higher MVC shortfall payments essentially muting the impact of cash flows in the quarter. Matt will discuss our MVC mechanisms in greater detail later in the call.

You should also keep in mind that we tend to see the effect of wellhead production freeze offs at the Grand River during winter, and we believe they had an effect on total throughput volume as well. The DFW Midstream system recorded average daily volume throughput of 387 million cubic feet per day in the fourth quarter of '12 which helped to offset some of the volume declines at Grand River. This amount was up 1.7% over the third quarter of '12.

Fourth quarter volumes were impacted, however, by several days of downtime at our largest compressor station where we installed and began commissioning a new 6,000 horsepower compressor which we call our Unit 10 project. The Unit 10 project became operational in early January and increased system capacity from 410 to 450 million cubic feet per day. After adjusting for this downtime, DFW volumes averaged 394 million cubic feet per day or an increase of 3.7% over the third quarter of '12. Interestingly, and often interesting to note, DFWs volumes increased in the fourth quarter without having any new wells come online. The volume increases were solely related to volumes from existing connected well being increased by our producers.

Additionally, at the end of the fourth quarter, our customer still had approximately 20% of the total wells in our system shut in. This equates to 60 wells and when combined with wells waiting on us to connect we have close to 100 existing wells in inventory. We believe this supports that we have a large amount of additional gas behind our system that is insensitive to near-term drilling activity.

With that, I am going to turn it over to Matt to review the financial results in more detail.

Matt Harrison

Great. Thanks, Steve. I will cover the results of Summit Midstream Partners LP and Summit Midstream Partners LLC, the predecessor of Summit Midstream Partners LP or SMLP. SMLP completed initial public offering on October 3, 2012. Results prior to our IPO refer to our predecessor and results subsequent to our IPO refer to SMLP. Adjusted EBITDA for the three months ended December 31, 2012 was $28.6 million compared to $19.8 million for the three months ended December 31, 2011, an increase of 44%. The $8.8 million increase in adjusted EBITDA was primarily due to the October 2011 acquisition of the Grand River system.

Adjusted EBITDA for the fourth quarter of 2012 increased $5.5 million or 24% compared to the third quarter of 2012. This quarter-over-quarter increase was primarily the result of higher volume throughput on our DFW system, increased revenue from condensate sales on our Grand River system, and around $800,000 of future MVC shortfall payments. Also adjusted EBITDA in the third quarter of '12 included $2.7 million of non-recurring transaction cost and ad valorem tax expense.

Moving on to our MVC. We billed $7.2 million of MVC shortfall payments in the fourth quarter of 2012, primarily from our gas gathering agreements associated with our Grand River system. Approximately $4.8 million of these MVC shortfall payments were recognized as revenue on the income statement and the remaining $2.4 million were recognized as deferred revenue on our balance sheet. Adjusted EBITDA in the fourth quarter of 2012 included approximately $4.4 million due to the MVC mechanism in our gas gathering agreements including a $400,000 negative adjustment related to MVC shortfall payment. Additional tabular detail regarding MVC is included in our fourth quarter earnings release.

Adjusted distributable cash flow was $24.7 million in the fourth quarter of 2012. This implies a distribution coverage ratio of 1.21 times for fourth quarter distribution paid in February of 2013. CapEx for the fourth quarter 2012 was approximately $16 million of which approximately $2 million was classified as maintenance CapEx. With $199.2 million of debt outstanding under our revolving credit facility at 12/31/2012, the borrowing capacity on our $550 million facility is approximately $350 million.

Total leverage at December 31, 2012 was 1.8 times. As Steve mentioned, management is reiterating its adjusted EBITDA guidance for fiscal 2013 of $110 million to $120 million. We believe that the attainment of this target should facilitate distribution growth for our limited partners of 8% to 10% in 2013. CapEx for 2013 is anticipated to be between $35 million and $55 million, of which $6 million to $8 million of that relates to maintenance CapEx. All of this guidance excludes the effects of any potential asset drop downs from the owners of our general partner, Summit Investments.

Now I will turn the call back over to Steve.

Steven Newby

Thanks, Matt. I would like to now discuss our outlook for the rest of 2013 and what we believe will drive future growth at the MLP. First on our existing business, and I will reiterate what Matt said, we announced on our third quarter call we expect to increase our distribution per unit 8% to 10% this year and generate adjusted EBITDA of $110 million to $120 million. That 8% to 10% distribution growth is off of our $0.40 per unit Mcd, which we exceeded with our fourth quarter distribution of $0.41 per unit.

As Matt mentioned in his comments, we covered that fourth quarter distribution at 1.21 times which is in line with our full year target. It's important to note this guidance excludes the benefit of any potential dropdowns from the owner of our GP, Summit Investments. As we earlier today, we feel highly confident in achieving our previously issued guidance. Our core business is performing well. It's highly contracted with growing MVC and has very little direct commodity price exposure.

Specifically in the Barnett, we continue to see steady drilling activity and with the addition of compression capacity that came on in January, we have increased our ability to recognize growth on volumes we believe are already connected and ready to flow on our system. To date, we are pleased with the performance and utilization of the Unit 10 project. We are also currently connecting four pad sites that will come on in the first half of 2013, and each of those pad sites have existing drilled wells on.

At Grand River, as we discussed in the third quarter call, we expect volumes to slightly decline in 2013 relative to 2012. However, given our MVC contracts, we will see very little financial impact and in fact we actually expect cash flow to increase this year as our customers' MVC step-up into 2013. We continue to see steady drilling activity at Grand River from our largest customer Encana. Encana has a JV partner which enhances producers economics and helps sustain steady drilling activity in our area of operation. Overall, the core business is performing well, we continue to have highly contracted and steadily increasing cash flows while also maintaining significant upside to a gas price recovery, particularly in the Mancos and Niobrara which has gotten some good [press] from WPX's announcement of their first well.

Summit Investments, the owner of our GP has been very active over the past six months. Summit Investments now has a diversified business across gas gathering and processing, crude gathering and water gathering with a large foothold in the Uinta, DJ Niobrara and Bakken plays to be highest crude growth basins in North America. At 2013 at Summit Investments we will be installing over 200 miles of pipeline and bringing online two feed-based natural gas processing plants. As for as dropdown down timing goes, we expect that Summit Investments will offer its first asset to the MLP in the next three to six months. We anticipate the first asset to be offered will come from the recently completed Bear Tracker acquisition.

We view the acquired Bear Tracker assets which we have renamed Meadowlark Midstream, to consist of two to three asset packages that will be offered to the MLP over the next few years. As we stated in our first quarter call, we still expect that Summit Investments will offer some or all of its Red Rock assets to the MLP in the next nine to 12 months. In general, the integration of Red Rock is ahead of schedule, we are driving significant cost synergies out of the business, and the development projects we previously highlighted are going well.

So overall, if you take a step back, we have a large amount of inventories of midstream assets at Summit Investments that we expect to be offered to the MLP over the next few years. We believe these dropdowns will diversify the geographic areas in which we operate, the service offerings we provide to our customers, and significantly grow distributable cash flow. To facilitate the execution of this plan over the next several years, we have a strong and under-levered balance sheet, high existing distribution coverage, and significant liquidity.

So with that I will open it up for questions. John, do you want to open up the line?

Question-and-Answer Session

Operator

(Operator Instructions) And we do have a question from Ethan Bellamy from Baird. Please go ahead.

Ethan Bellamy - Robert W. Baird

Congrats on a solid quarter. Few questions for you. First, I would like to dig in a little bit more through the Mancos/Niobrara, obviously, those WPX results are pretty compelling. Is that a potential driver for the Orchard system or all three systems in the area and do you have any of your existing acreage dedication, how much of that might be prospective or was it contiguous acreage that would come from the new agreement.

Steven Newby

This is Steve. I think the WPX announcement, they have obviously been the most vocal on the Mancos/Niobrara. I would say Encana has been the most active though on drilling in Mancos/Niobrara but WPX put out some interesting results. For those who haven't seen, they announced the results of their first well, of a 7 to 10 Bcf well and they drilled it for to $5 million to $6 million of cost. So with that being the case, obviously it's a large well and very economic even at these prices. So we are very excited with that data point. To answer your question, I would tell you all of our Grand River systems is prospective to the Mancos/Niobrara.

We have a good slide in our posted deck on our website of announced and public wells that have been drilled in the Mancos/Niobrara. And those wells overlay our existing systems. So you can get a good idea of the acreage overlay from the Mancos/Niobrara. The well that WPX drilled is in just north of the River, so it's not flowing on our existing system. But the Orchard area, yes, the Orchard area is basically transporting today Mancos/Niobrara for production from Encana. And we would anticipate that that system growing as they come back in, Encana comes back in and drills more Mancos/Niobrara. That system is also, as we explained to folks in the past, that system is highly underpinned contractually.

Ethan Bellamy - Robert W. Baird

Okay. And just turning to the assets available for dropdown. Couple of questions on those. Can you give us ballpark, any idea of the amount of EBITDA that you could potentially drop in say the one that’s due in the next three to six months, and then maybe EBITDA in aggregate. And I understand, if not. And then also do you have the human capital and the operational bandwidth in place for those assets or do you need to build on to those over time.

Steven Newby

Let's talk about size a little bit. And you are right, I will talk about this in maybe relation to total amount. I would tell you, we believe we have somewhere in the neighborhood of $1 billion worth of assets at the MLP or, sorry, at Summit Investments or GP, to dropdown over the next several years, I would say. And we believe those dropdowns will occur in, call it, three to four different transaction. So you can probably look at size of that, that way. And I would tell you our anticipation is that they are all somewhat similar in size over the next couple of years.

As far as operational bandwidth, I would say, yes, we have a very large -- one of the things that has helped us tremendously with the Bear Tracker acquisition is we already had a very large operating presence in the Rockies. And so we have been able to move folks around very efficiently and put some of our highly skilled operating personal in the Bakken and I would tell you we are extremely excited about the growth prospects in those areas going forward.

Operator

Our next question is from Ted Durbin from Goldman Sachs. Please go ahead.

Ted Durbin - Goldman Sachs

I was just trying to understand a little bit of the commentary around the Grand River and realizing those MVCs there, but it was down pretty much sequentially every quarter in '12. Are you saying that it will be down again on an average '13 basis versus on average '12 basis, or do you think sort of, let's say we have hit the bottom here in fourth quarter and you kind of say we'd stay flat for here on volumes in Grand River?

Steven Newby

I think we are overall, and I would caution that Grand River is really three separate systems, Ted. And they are contracted separately. So I want to make that point because it definitely matters exactly where we are talking about. So let me give you a little more color. We actually think overall, Grand River volumes will be down. We are projecting to be down about 4% year-over-year. So average '13 to average '12. That’s what we anticipate sitting here today. A lot of those declines are coming, where we are seeing them come is in the Orchard area and that’s simply related to Encana's pull-back of drilling Mancos-Niobrara. And I would tell you we are insensitive to that from a cash flow perspective. That system is highly underpinned. It will get drilled eventually by them and it's just a price determination for them on natural gas.

So that's where we are seeing volumes. We are also seeing it from some other third party customers as well. But again those guys are under long-term and significant MVCs.

Ted Durbin - Goldman Sachs

That’s helpful. Thanks. Coming back to the dropdowns that you have talked about, which sounds like $1 billion? Should we assume that you will want to add some leverage as you go here? You said you are, I think south of 2 times levered now. You will maybe finance some of those dropdowns overtime more with debt than with equity, let's say?

Steven Newby

Yeah, I think -- look I think we have, and we did it on purpose coming out of the IPO, we have a very under levered balance sheet today particularly given the level of contracted cash flow we have. So we would anticipate -- yes, we would anticipate using some of that under levered capability with the dropdowns. We also have a very supportive GP, a very well capitalized GP as well too, or Summit Investments owner of our GP. So we have a lot of capability there to help the MLP execute the dropdown plan.

Matt Harrison

And Ted, this is Matt, in the past we have said and we are still there. From a long term perspective we are kind of a three to four times debt to EBITDA target for SMLP.

Ted Durbin - Goldman Sachs

Got it. And then last one from me is just on the distribution itself. You know you had the bump here right out of the gate, I guess. How you are thinking about, you know EBITDA guidance is kind of the same as it was when you -- that that you had in the prospective but you bumped kind of right out of the gate. I am just trying to think about the timing of -- are you thinking this is kind of a -- every quarter you are going to raise, did you see something better this quarter that’s sort of said, hey, let's come out strong on the very first one. I am trying to think about how you are thinking about that relative to the guidance on EBITDA at least being similar to what it was before.

Steven Newby

Yeah. Good question. And I think we would tell you we are more of a steady increments than lumpy. I think it is our plan. I don’t think you will see a significant amount of volatility in getting to that 8% to 10%. I think for coming out of the box higher, I'd tell you, as we have told people, it was a good quarter as you can see. And I think we were already at our target coverage in the first quarter and we felt very good about the balance of '13 so we decided to come out a little higher. So nothing, no other magic other than that.

Operator

(Operator Instructions) You have a question from Helen Ryoo from Barclays. Please go ahead.

Helen Ryoo - Barclays

I will start with a clarification question on your distribution guidance. Is the 8% to 10%, is that based on exit rate in 2013 or is that a full year '13 distribution versus I guess your annualized MTD?

Matt Harrison

Yeah, Helen, it's Matt. That’s the exit rate, so kind of fourth quarter compared to fourth quarter.

Helen Ryoo - Barclays

Okay, great. Thank you. And then just going back to the dropdown assets, could you talk about how much CapEx is being spent by Summit Investments in building out the Bakken assets at this point. And I think you said that’s going to come down in three to six months or at least that would be the first package of the transaction.

Steven Newby

Yeah. I think -- Helen, it's Steve. As I mentioned, we are putting in north of 200 miles of pipe and a couple of processing plants. So at Summit Investments overall, that not necessarily just in the Bakken. We are looking at -- if you look at the acquisitions over the last six months it's been north of $700 million. We will spend probably a couple of hundred million dollars this year up at Summit Investments.

Helen Ryoo - Barclays

Okay. So is that the level of spending that will take place before things get dropped down or maybe some of that you guys would have to sort of take on because -- I guess what I am trying to understand is, these projects, would they come to you as significant I guess organic investment opportunity?

Steven Newby

Our approach or view of that is, when the asset is offered to the MLP and in the MLP it still needs to have significant growth opportunities around it. What we are trying to do and doing at Summit Investment's level is really getting the assets in the big projects up and running and operating. So we would still anticipate, given these areas and given what's going on, they are still going to have, still going to have runways for growth, organic growth around them.

Helen Ryoo - Barclays

Okay. So I guess your organic CapEx budge would probably be much higher than the level you are spending right now. Given these assets are....

Steven Newby

Yeah. Let me clarify. The couple of hundred million dollars we were talking about is going to be -- that’s what will be anticipate being completed up at Summit Investments this year. So I just wanted to make the point that we still believe, even after being offered to and coming out of the MLP, there is still going to be growth, organic growth opportunities around the assets.

Helen Ryoo - Barclays

Okay, got it. And then just another clarification question regarding the MVC payment. So I guess you guys billed $7.2 million in the quarter and what flew through your EBITDA is $4.4 million so that essentially the rest will be received in first quarter.

Matt Harrison

Yeah, actually a little bit different then that Helen. So we have billed $7.2 million and of that $7.2 million the $4.8 million relates to MVC shortfall payments billed relative to Grand River. If you see in that table in our press release, $3.6 million of that had kind of been already recognized in adjusted EBITDA through the course of 2012. So of the $7.2 million, $4.8 million of that went right to revenue, but we had already recognized some of that -- $3.6 million of that in adjusted EBITDA over the course of the year. So the net impact of that 4.8 was 1.2 and then the total impact then would be 4.4 of the 7.2.

Helen Ryoo - Barclays

Okay. So essentially there is nothing spilling over into next year related to the MVC?

Matt Harrison

Yes. So the part that spills over would be, on here, the MVC shortfall payment adjustment - DFW. Those $800,000 of, and that’s a concept of kind of accruing for an anticipated MVC shortfall payment that would come next year.

Helen Ryoo - Barclays

Okay. And could you update us what was the MVC payment you are expecting for 2013, what's embedded in the guidance?

Matt Harrison

In the guidance it's close to $13 million.

Helen Ryoo - Barclays

Okay. And that’s essentially all coming from the Grand River side, you are not expecting anything to come from DFW?

Matt Harrison

Well, that $13 million is related to Grand River, actually, no, it will be more than that because of the (inaudible). So it would be around $20 million at Grand River and then like $1.5 million from DFW.

Helen Ryoo - Barclays

Okay. So in total $21.5 million of EBITDA coming from MVC, that’s in 2013 guidance?

Matt Harrison

That’s correct.

Operator

(Operator Instructions) And I am showing no further questions at this time.

Steven Newby

Great. We appreciate everybody joining. Obviously, if you have further questions you can follow up with us offline. Have a good afternoon.

Operator

Thank you ladies and gentlemen. This concludes today's call. Thank you for participating, you may now disconnect.

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