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New Source Energy Partners LP (NYSE:NSLP)

Q1 2013 Earnings Conference Call

May 15, 2013 11:00 am ET

Executives

Richard D. Finley – Chief Financial Officer and Treasurer

Kristian B. Kos – President and Chief Executive Officer

Analysts

Ethan H. Bellamy – Robert W. Baird & Co.

Daniel D. Guffey – Stifel, Nicolaus & Co., Inc.

Operator

Good morning and welcome to the New Source Energy Partners’ First Quarter 2013 Conference Call. Just a reminder, that today’s call is being recorded, and your participation implies consent to such recording. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation.

With that, I will turn the call over to Mr. Richard Finley, Chief Financial Officer of New Source Energy GP LLC. Thank you, sir. You may begin.

Richard D. Finley

Thank you. Good morning and I thank all of you for joining us today for the New Source Energy Partners first quarter earnings conference call. I am Richard Finley, Treasurer and Chief Financial Officer of New Source and with me today is Kristian Kos, our President and Chief Executive Officer.

Before we begin, I would like to remind all participants that our comments today may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act. These forward-looking statements are subject to risk and uncertainties that could cause the partnership’s actual results to differ materially from the anticipated results, or expectations expressed in these forward-looking statements. Those risks include among others, matters that we have described in our earnings release, as well as in our filings with the Securities and Exchange Commission, including our annual report on Form 10-K and our quarterly reports on Forms 10-Q. We disclaim any obligation to update these forward-looking statements.

During this call, we will also make reference to certain non-GAAP financial measures. Reconciliations of those non-GAAP financial measures to the applicable GAAP financial measures should be found in our earnings release. You can obtain a copy of our press release in the Investor Relations tab of our website at www.newsource.com.

And with that, I will hand the call over to Kristian.

Kristian B. Kos

Thank you, Richard. As our last call was just a month ago, our comments today will be brief. I will highlight a few financial and operational items from the quarter, and talk a bit about what we have in store for the future. Richard will then do a financial review of the quarter.

Since our IPO was completed on February 13th of the first quarter, you will see notes today in our tables for pro forma results and we will be referencing separately today both the period from February 13 when we became public through the end of March and the first quarter.

Our adjusted EBITDA during the period we were public in the first quarter was $4.6 million, which was in line with the quarterly forecast we filed in our IPO perspectives. While the natural gas prices we realized are up from a year ago, they are still historically low at an average of $3.34 per Mcf. In addition, NGL prices continued to remain low. Our average NGL price per barrel was roughly $35 versus the $40 we saw a year ago.

As a reminder, the majority of 2013 production is hedged at $3.66 per Mcf for gas and $36 per barrel for NGLs. While prices continued to fluctuate, our net daily production volumes continued to rise. Average net daily production for the three-month period ending March 31, 2013 was 3,141 BOE per day, including additional producing properties acquired by the partnership on March 29, 2013 as previously announced.

average daily production rates for the last three days of the quarter ended the quarter at a run rate of 3,764 barrels of oil equivalent per day. We continue to increase production and are on track to deliver estimates in line with our production guidance for the second quarter of 3,900 BOE to 4,100 BOE per day. We have a lot of potential to increase output beyond the range by the drillbit and that’s a large part of our focus. The New Source Group has grown to almost 250 gross wells in the Golden Lane field of the Hunton Formation since 1999.

As of March 31, 2013, the partnerships’ properties contained 121 gross proved undeveloped drilling locations including 66 gross infill locations. In addition, there is a vast amount of undeveloped acreage held at our parent level and by our Chairman that can be dropped into NSLP for further growth.

The Hunton is an ideal placement resource, because it continued to deliver liquids-rich long-lived reserves with a low decline rate. We announced on the April 1 that we completed an acquisition of oil and natural gas properties from New Source Energy Corporation, Scintilla, LLC and W.K. Chernicky LLC.

As a result of this transaction, we updated our second quarter guidance by 20% per production and we also recommended that our board increased our second quarter distribution to $0.55 per unit and our third quarter distribution to $0.575 per unit, which would represent $2.30 on an annualized basis or roughly 10% growth from the initial public offering.

Our current distribution coverage is roughly 1.2 times and with our guidance in place, we will be able to cover a higher distribution whilst keeping a conservative balance sheet. Our balance sheet is strong and as of March 31, 2013, we had $40 million of outstanding borrowings under our credit facility. We have, going forward, an estimated $2.6 million per quarter of maintenance CapEx spend and we continue to move forward on our growth plans. We recently added John Raber to our board. and John has a tremendous amount of experience in the sector and we are excited about having his expertise on our board.

With that, I’ll hand the call over to Richard to provide you with a financial review of the quarter. Richard?

Richard D. Finley

Thank you, Kristian. As we mentioned earlier, our IPO closed during the first quarter and you will note pro forma numbers in our release today. For the first quarter of 2013, we reported adjusted EBITDA of $4.6 million. This was in line with the forecast we published in our IPO perspectives in February. We had a net loss of $6.7 million or $0.99 per basic limited partner common unit for the period beginning February 13, and ending March 31, 2013.

We had a net loss of $1.4 million for the period beginning January 1 and ending March 31. The net loss was primarily due to $7.7 million of equity based compensation and derivative losses of $5.3 million recorded in the first quarter of 2013 partially offset by income tax benefit associated with a change in tax status of $12.1 million.

Average daily production for the last three days of the quarter ended March 31 was 3,764 BOE per day. average daily production for the three-month period ending March 31 was 3,141 barrels of oil equivalent per day. Average net daily production for the period from February 13 through March 31 was 196 barrels of oil per day. And for the period ending March 31 was 145 barrels per day. Production costs for the first quarter were $8.65 per BOE, which was up from the end of 2012 as more workovers were required during the quarter.

As Kristian said, we are in line to reach our second quarter production guidance of 3,900 to 4,100 barrels of oil equivalent per day as a result of the acquisition of the properties, which was announced on April 1. In addition, as a result of that acquisition, our reserves are anticipated to increase by nearly 4 million barrels. We are preparing to pay our first distribution that was declared on April 16 for a prorated $0.2741 per unit. The distribution will be paid on May 15 to all unit holders of record as of May 1.

As Kristian noted, we have recommended to our Board of Directors that they increase the second quarter distribution by 5% to $0.55 per unit or $2.20 per year on an annualized basis for all outstanding units, and our third quarter distribution to $.5750 per unit or $2.30 on an annualized basis for all outstanding units. We are in a great position for growth both from a financial perspective and from our growing portfolio.

With that, I would like to open the line for any questions if you may have. Operator?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question is coming from Ethan Bellamy of Robert W. Baird. Please proceed with your question.

Ethan H. Bellamy – Robert W. Baird & Co.

How much are you producing right now?

Kristian B. Kos

We are currently in the range, we believe, the guidance we’re providing for the second quarter, Ethan.

Ethan H. Bellamy – Robert W. Baird & Co.

Okay. You reiterated your distribution guidance, what kind of DCF coverage should we be looking for the full year assuming those distribution increases as guided?

Kristian B. Kos

We are anticipating subject to growth in terms of our strategy we’re laying out today. The planned distribution of $2.20 in the second quarter, $2.30 in the third quarter should put us in the range of our guided coverage ratio with the caveat that we have performed this increase to our distribution within the first in terms of outlining this distribution within the first 60 days of being public. And it is our aspiration and certainly our focus to try and move beyond that and grow the company beyond those points. So, in terms of where we stand today, the $2.20 and $2.30 for the second and third quarters, we believe we’re in the range of what we delivered in terms of expectations of coverage of the IPO and would anticipate that that will change if we’re successful in executing growth strategies and plans beyond what we have in our basket today.

Ethan H. Bellamy – Robert W. Baird & Co.

So one-two plus?

Kristian B. Kos

We would hope to be in the one-two plus range. That’s correct.

Ethan H. Bellamy – Robert W. Baird & Co.

Have you added any additional hedges?

Kristian B. Kos

We have not as of yet. We anticipate adding hedges for the acquisition performed. And as mentioned previously, we anticipate adding hedges on a quarterly basis and those will exclude puts, we will no longer be adding puts unless an acquisition we deem that it’s necessary for the purpose of an acquisition to give us the allocated time to get our arms around it as we did in the IPO and the drop down into NSLP.

Ethan H. Bellamy – Robert W. Baird & Co.

Okay. And then finally, could you talk about what John Raber brings to the table?

Kristian B. Kos

John Raber was the Operations President of ScissorTail upon its formation. ScissorTail is the gas plant that into which we deliver our wet stream and that gas plant was subsequently acquired by Copano Energy. He then became EVP of Copano Energy and Copano Energy was recently acquired by Kinder Morgan. So he has an exceptional understanding. he has been in this space for a long time. He understands all the product streams, all the hydrocarbon product streams with a very deep knowledge of the NGL product stream. He has a very deep understanding of our asset base and we feel that understanding how the processing works, how the midstream component works, given that we’re heavy in the infrastructure business is of exceptional value to our business model on a go-forward basis.

Ethan H. Bellamy – Robert W. Baird & Co.

Thanks a lot, Kristian.

Operator

Thank you. (Operator Instructions) Our next question is coming from Dan Guffey of Stifel. Please proceed with your question.

Daniel D. Guffey – Stifel, Nicolaus & Co., Inc.

Good morning, gentlemen. Can you talk about your expectations for run rates for per unit LOE production taxes and G&A?

Kristian B. Kos

Our run rate, what we look at on a cash basis, it’s very hard to assess probably what our G&A is on a BOE basis. But our assessment of G&A on a cash basis, we have the $2.27 roughly per barrel that we had given guidance for at our IPO. We have a portion of our cash that’s outside of the omnibus that relates to our third-party directors of the GP. We would envisage as we maintain a production in and around these levels that would be in the $2.30 to $2.60 handle depending on how we grow our volumes on a go forward basis. And we intend as mentioned previously to hold our firm on a go forward basis and generate the growth in terms of our G&A and the personnel that we hired inside New Source premise to base around our ability to grow production volumes. And then in terms of the taxes on the LOE basis, I believe, we’re in the, I think, it’s in the $1.60, but we could give you better clarity on this if you like to follow-up on the call afterwards. But there is a discrepancy in our tax base. I’ll let Richard talk about that for a brief moment. Richard?

Richard D. Finley

Thank you, Kristian. As you know, when we came out – when we had our IPO, we became a non-tax paying entity and as such, we were able to eliminate approximately $12 million deferred income tax liability coming out as (inaudible) that represents the credit to our income statement.

Daniel D. Guffey – Stifel, Nicolaus & Co., Inc.

Okay, great. And what about the per unit LOE, sorry, maybe I missed it.

Kristian B. Kos

Lease operating expense is still in the $4.50 handle, so we expect on an LOE going forward, we’re still in the same region of where we’ve been. So the discrepancy on our production cost versus our LOE is in the workover area and we’ve had a strategy and I believe that we did hopefully mentioned it – we mentioned it on the road show, we mentioned it to the analyst that we have a number of wells that we believe we could workover to increase our production volumes and it was part of our maintenance CapEx strategy and we’ve delivered on that and we’ll continue to delivery on that throughout the calendar year 2013.

So the discrepancy between the $6.50 handle, $5.50 handle in prior dates is that we are spending more on workover and that’s the benefit of the partnership by what it brings in terms of volumetric hydrocarbons. So what that really means on a net-net basis is, our LOE remains the same, consistent around the $4.50 and our workover just to maintain production or follow our natural decline maintains the same in the residual amount through the differential is based on our attempt, and current success in delivering production growth of the maintenance CapEx program through workovers.

Daniel D. Guffey – Stifel, Nicolaus & Co., Inc.

Okay, thanks. And Kristian, you’ve talked about in your prepared remarks the vast amounts of assets (inaudible) by your Chairman, can you try to give some color of when you think assets in that portfolio will be right for the drop down into NSLP?

Kristian B. Kos

We think that probably in the third quarter as we mentioned on our last conference call that we still believe that there are assets that are currently producing that will be appropriate for drop down probably or possibly in the third quarter or certainly by the end of the year. That would be another reservoir that utilizes the same strategy for production and that it’s an oilier type of assets and also it’s gassier, it’s less NGL as a product mix. And we think third quarter, possibly fourth quarter, that’s right.

as for the rest of it, we are looking on a day-to-day basis, it will be unfair to attempt to give guidance on something that we, as a management team, are trying to get our arms around and to see what’s most appropriate for the partnership. Really our focus would be to deliver our growth to the partnership and specifically to the unit holders, which we did in the first 60 days and we are giving guidance for those volumes. in Q2, we’re giving guidance for the distributions in Q2, Q3. and then we’re trying to give you, everyone a better perspective as to our ability to drop down more assets.

But more importantly for us now is to get our arms around to growth where we can consistently deliver that unit distribution growth over a long, long period of time and that today is more important to us than the $2.30 in the sense that we want to continuously deliver that growth on a quarter-on-quarter basis and now just have delivered for the first two to three quarters of being public. And from that perspective, we’re not prepared at present to give more guidance beyond our current volumes and we’ve given guidance on for Q2.

Daniel D. Guffey – Stifel, Nicolaus & Co., Inc.

Okay, sounds good. Can you talk a little bit about, I know on the road show, you talked about behind pipe formations at the parent level that potentially could be tested in 2013 and beyond. Can you talk about if there’s any test that will be taken place in any of these formations during 2013?

Kristian B. Kos

We will currently in one of the areas we did drop down some properties in what we call the Luther area of the Hunton formation that was part of the drop down that we performed in a (inaudible) effective date of March 1 of this year, the closing date is March 29. And in those properties, we believe that in that area, we will probably perform a test on another formation that would be a resource play and there are good analogies from other larger operators and we believe that if successful that it could be of large benefit or give us some room to add additional rig counts to our portfolio with an additional reservoir to have under our belt and that would probably occur in prior Q4 of this year, in terms of the testing we’ll be doing there.

Daniel D. Guffey – Stifel, Nicolaus & Co., Inc.

Okay. Thanks, guys.

Operator

Thank you. At this time, I would like to turn the floor back over to management for any additional or closing comments.

Kristian B. Kos

We very much appreciate everyone’s time and for taking the time out of your schedule to join us today on this call. We are very grateful for your support and look forward to continue both to deliver on expectations and also to exceed on these expectations. We will be at the NAPTP Conference up in Connecticut next week and look forward to seeing some of you there for your presence and we hope that you have a fantastic day and thank you again for your great support.

Operator

Ladies and gentlemen thank you for your participation. This does conclude today’s teleconference. You may disconnect your lines at this time and have a wonderful day.

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