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Blueknight Energy Partners L.P. (NASDAQ:BKEP)

Q4 2013 Earnings Conference Call

March 12, 2014 3:00 PM ET

Executives

Brent Gooden - IR

Alex Stallings - CFO and Secretary

Mark Hurley - CEO

Analysts

Theresa Chen - Barclays Capital

Michael Peterson - MLV & Company

Michael Tanzer - DG Capital Management

Operator

Good day and welcome to the Blueknight Energy Partners’ Fourth Quarter and Full Year 2013 Financial Results Conference Call. All participants will be in listen-only mode. (Operator Instructions) After today’s presentation there will be an opportunity to ask questions (Operator Instructions).

I would now like to turn the conference over to Brent Gooden. Please go ahead.

Brent Gooden

Thank you very much and good afternoon everyone. It is my pleasure to welcome you to today’s conference call where will discuss Blueknight’s financial and operating results for the fourth quarter ended December 31, 2013. Alex Stallings, our Chief Financial Officer will discuss the financial results for the three and 12 months ended December 31, 2013. Mark Hurley, our Chief Executive Officer will update you on our strategies, projects and opportunities, as well as external factors influencing our business. After prepared comments, Mark and Alex will be glad to take your questions.

Before we begin, I would like to remind everyone that information on this call may contain certain forward-looking statements that are subject to risk and uncertainties that could cause the actual results to differ materially from those anticipated including uncertainties relating to Blueknight’s future cash flows and operations, future market conditions, current and future governmental regulations, and future taxation.

Please refer to the Blueknight’s SEC filings for a description of these and other risk and uncertainties that could affect our actual results. Blueknight undertakes no obligation to update you or revise any forward-looking statements contained in this call, whether as a result of new information, future events or otherwise.

Blueknight Energy Partners L.P. is a publicly traded master limited partnership with operations in 21 states. We provide integrated terminalling, storage, gathering, and transportation services for companies engaged in the production, distribution and marketing of crude oil, asphalt and other petroleum products. We manage our operations through four operating segments. Crude oil, terminalling and storage services, crude oil pipeline services, crude oil trucking and producer field services, and asphalt services.

Now, I’m pleased to turn the call over to CFO, Alex Stallings. Alex?

Alex Stallings

Thanks Brent. As we announced Tuesday evening, we reported adjusted EBITDA of $14.4 million for the fourth quarter 2013 as compared to adjusted $13 million for the same period in 2012 which is an increase of $1.3 million or about 10%. Adjusted EBITDA for the 12 months ended December 31, 2013 was $68.7 million as compared to adjusted EBITDA of $61.4 million in December 31, 2012, an increase of $7.3 million or approximately 12%.

Partnership reported net income of $5.3 million on total revenues from continuing operations of $49.8 million for the three months ended December 31, 2013 compared to net income of $5.5 million on total revenues from continuing operations of $46.2 million for the three months ended December 31, 2012. For the 12 months ended December 31, 2013 the Partnership reported net income of $28 million on total revenue in continuing operations of 194.7 million as compared to net income of $31.6 million on total revenues from continuing operations of $178.8 million.

Net income for the 12 months ended December 31, 2013 does include an asset impairment charge of $6.4 million related to discontinued operations. Partnership previously announced a fourth quarter 2013 cash distribution of $0.1265 per common unit, a 3.3% increase over the previous quarter’s distribution and a 10% increase over the fourth quarter of 2012, and a $0.17875 distribution per preferred unit which were both paid on February 14, 2014.

A few highlights from each of the segments; crude oil terminalling and storage. For the year ended December 31, 2013 we reported operating margin of $27.1 million excluding depreciation and amortization which is a decrease of $4.8 million or 15% for the year ended December 31, 2013 as compared to 2012. Reason for this decrease as mentioned throughout the year is due to market conditions at Cushing that resulted in lower renegotiated rates for our Cushing Oklahoma storage as compared to prior years.

As of March 2014 we had approximately 5.6 million barrels of crude oil storage under service contracts with remaining terms remaining from month-to-month to 22 months including 4.1 million barrels under contract to Vitol. The crude oil pipeline we reported operating margin of $6.9 million for 2013 excluding depreciation and amortization which is an increase of $4.1 million as compared to 2012.

In trucking and producer field services, we reported operating margin of $10.1 million exclusive of depreciation and amortization which is an increase of $2.4 million or 31.2% for the year ended December 31, 2013 as compared to the year ended December 31, 2012. Increase in operating margin is driven primarily by 13% year-over-year increase in volumes transported as well as efficiency gains in our fleet.

In asphalt services we reported operating margin of $41.0 million exclusive of depreciation and amortization which is an increase of $4.4 million or 12% for the year ended December 31, 2013 as compared to the year ended December 31, 2012. The increase in operating margin is due to increased throughput on our facilities, incremental short-term storage service agreements at certain of our facilities and annual rate escalations on a number of our contracts.

G&A; reported G&A expenses of $17.5 million for the year ended December 31, 2013 which was a decrease of $2.3 million or 11.6% as compared to the year ended December 31, 2012. Couple of other items that I just wanted to note, we had a gain on sale of assets of $1.1 million for the 12 months ended 2013 compared to $7.3 million for the 12 months ended December 31, 2012. And we also had a net loss of $3.4 million that was recorded on certain discontinued operations in 2013 which was comparable to income of $1.9 million in 2012.

2013 net loss was comprised of an impairment expense of $6.4 million which was recorded on an East Texas Pipeline System as well as the north number one asphalt facility, which was also partially offset by the reimbursement of certain capital expenditures and operating income from the assets. From a liquidity perspective, our leverage ratio at December 31 of 2013 was 3.6 times and at March 10th we had aggregate unused commitments under our revolving credit facility of approximately $122.5 million which is subject to financial covenant limits.

From a capital investment perspective, as we have discussed in prior quarters we anticipated a significant ramp-up in our 2013 capital spend as a result expansion capital expenditures including our investment in Advantage Pipeline were almost $70 million in 2013 as compared to approximately $18 million in 2012. Significant majority of the expenditures relates to the Arbuckle pipeline project and to our investment in Advantage Pipeline which both commenced operations late in 2013.

Maintenance capital expenditures for the 12 months ended December 31, 2013 totaled $9.3 million which is net of $2.7 million of reimbursable capital expenditures and a $4.2 million line fill purchase which was associated with our Midcontinent Pipeline System.

Now with that I will now turn it over to Mark Hurley.

Mark Hurley

Thank you very much Alex. I am going to spend a few minutes recapping our accomplishments in 2013 as I believe last year was a real turning point for the Partnership. First and foremost, we developed and implemented a concise, focused, simplifying business strategy that has three key elements. First of these elements was to improve the cost structure of our trucking business and then begin to expand it. We have invested significant resources and technology and employee development in our trucking business. This investment coupled with the current crude oil market which places a premium on transporting barrels from the field to market as rapidly as possible, led to an increase in 2013 as compared to 2012 of 13% and operating margin of 31% on top of a 17% increase in volumes in 2012. We are significantly growing our business and with the efficiency gains achieved, we have been able to increase volumes without adding to the size of our fleet.

The second key element of our strategy was to grow our crude transportation business with a particular focus on developing pipeline projects in the shale production areas. The Southern Oklahoma Arbuckle pipeline system became operational in the third quarter of 2013 and we continue to see increased volumes on the system. We expect Arbuckle and Oklahoma mainline volumes to further increase in 2014. The West Texas Pecos River Pipeline of which we are operator and 30% owner also went operational in the third quarter. We continue to see volumes increase on this systems as well and expect more significant increases in 2014. We continue to believe the Pecos River Pipeline will be a great platform for future growth, most significant of which will be extension of this pipeline north possibly into the New Mexico where a number of E&P companies are expanding their footprint.

The extension would consist of 110 mile pipeline tied to our existing Pecos River Pipeline it would serve in emerging production area in Far West Texas and Southern New Mexico. I am pleased to report a positive response to this project from prospective users of the system. We are also continuing to move forward on our East Texas project to build a pipeline from the Woodbine and EagleBine area to the Houston market. This would be 125 mile to 150 mile pipeline backed by shipper commitments and 100% constructed, owned and operated by Blueknight. We are now refining the route, design and specifications of this system and continue to work with counterparties to execute commitments. We are targeting potential start-up for this system in mid to late 2014.

The third element of our strategy is to grow our asphalt business by focusing on growth with existing key customers as well as searching for acquisition opportunities. We enjoy very good relationships with our key asphalt customers and this is reflected in our strong operating results this past year. We continue to search for strategic acquisitions or doing projects with our customers as we see additional opportunities to grow this important sector of our business.

Another area of accomplishment has been our emphasis on growth and business development. In 2013 we made several strategic investments to strengthen our business development team. Specifically, we added five business development managers and analysts, as you can appreciate the addition of these experienced managers and analysts have significantly increased the number of relevant new business opportunities being evaluated by the Partnership. And furthermore I want to comment on the strengthening of our senior management team through the hiring of Chris Paul our General Counsel and Brian Melton our Vice President of Pipeline Marketing and Business Development.

These are notable additions to our management team, Chris and Brian add additional experience and significant capabilities that allow Partnership to more effectively evaluate and execute on both organic projects and acquisitions. I would add that since Brian came on-board this past December, we have already evaluated a number of acquisition opportunities. Brian brings significant experience in the M&A area and we intend to be much more active in the midstream marketplace.

Another accomplishment of which we were very proud is the improvement in our liquidity. In June 2013 we were able to successfully replace our previous $295 million credit facility with a new five year term $400 million credit facility at much more favorable terms. We believe this facility and our strong lineup of banks gives us access to additional capital as we grow the Partnership and it also gives us flexibility to pursue selected opportunities to grow our business through expansion and acquisition.

Along with this we have been able to increase our unitholder value over the past 18 months. Since the completion of the capital and debt restructuring at the end of 2011, our unit prices increased more than 50% from approximately $5.50 a unit to a current price of approximately $9. We have been able to increase our common unit distribution now for six consecutive quarters. A common unit cash distribution which commenced during the fourth quarter of 2011 have increased from $0.11 a unit to $0.1265 per unit, an increase of 15%. Distributions for 2013 totaled $0.4865 per unit as compared to a distribution of $0.4475 per unit for 2012, which is an increase of 8.7%.

And last but not least we have had a renewed emphasis on environmental, health and safety performance. Blueknight has a history of strong EH&S performance, however this is one area where you can never let your guard down and there will always be new regulations and new challenges. I’m happy to say we recently added Chuck First as our new EH&S Director. Chuck brings with him over 20 years of EH&S experience and is a recognized leader in the field.

Looking forward our plans for 2014 are to continue to capitalize on the momentum we have established in 2013. We will continue to remain intensely focused on project growth as we pursue and develop opportunities that are in line with our strategy. Our stated goal is to invest at least $100 million in expanded capital in 2014. The first half of 2014 is expected to be mostly in line with results of 2013, as we expect to see transportation volumes to begin to increase on the Oklahoma mainline, inclusive of the Arbuckle system as a result of the new Southern Oklahoma production beginning to increase.

We also expect volume increases on the West Texas Pecos River system as production increases in phase 2 was completed. We do anticipate that the terminalling and storage business will continue to be challenged in 2014 due to the current backwardated market for West Texas intermediate crude, increased Cushing storage capacity, the reversal of the Seaway pipeline and significant production increases in Kansas, Oklahoma and Texas. These trends have impacted demand for crude oil storage and have created downward pressure on storage rates. The current market environment places more importance on services and connectivity and as a result we are investing approximately $8 million in capital expansion projects in Cushing in 2014 to enhance our connectivity and blending, and we are aggressively marketing our services and top notch operations team.

Those are our prepared comments. So Chad I will turn it back over to you and open the call up for questions.

Question-and-Answer Session

Operator

Certainly, we will begin the question-and-answer session. (Operator Instructions) Our first question comes today from Theresa Chen with Barclays Capital. Please go ahead.

Theresa Chen - Barclays Capital

Good afternoon.

Mark Hurley

Hi Theresa.

Theresa Chen - Barclays Capital

Hi. A question of -- following up on your comments about the expansion CapEx, in that $100 million number, could you provide us with some color on what the breakdown is between the projects that you have announced? I know you mentioned $8 million spending in Cushing, but in relation to the other bigger projects and roughly what are your expectations for return on that?

Mark Hurley

Yes, sure we would be happy to Theresa. We mentioned, as you said, the Cushing expansion, or the Cushing connectivity projects for 8 million, and the balance of that 100 million capital will really be focused on the other two major projects that I talked about which is the East Texas Woodbine project which is very far along in this development and we anticipate over the next several weeks that we’ll get all of the commercial contracts done and in place. And then coming behind that the West Texas Pecos River Pipeline extension and so those two will consume most of the rest of that capital with the Woodbine project coming first, now we don’t give out specific economics on project on individual projects but the Woodbine project is in the neighborhood of $200 million to $250 million, it’s 100% Blueknight project and like all of our projects we target about a 15% rate of return.

We would expect to start spending money on that project in the last third quarter or early fourth quarter this year. In fact we’ve already started some predevelopment work and so we see that ramping up over the course of the year. The West Texas Pecos River Pipeline extension we think has another three to six months of negotiations and we think there would be some capital spent on that prior to the end of the year assuming we get sufficient shipper commitments to go forward again targeting about a 15% rate of return.

Theresa Chen - Barclays Capital

Thank you. And on the Woodbine project is the in-service date still expected to mid 2015?

Mark Hurley

Probably, third quarter, last third quarter or early fourth quarter something like that something in that...

Theresa Chen - Barclays Capital

Understood and then on maintenance CapEx do you have an idea of what that might look like for 2014?

Mark Hurley

As I would probably keep I mean typically what we’re going to say Theresa on that is to think about it in the 12 million range should be a little bit higher than what we spent kind of last year on a net basis.

Theresa Chen - Barclays Capital

Okay and then lastly on the Arbuckle pipeline project and you gave indication about volumes ramping up, do you have a timeline of when you expect that pipeline should reach for EBITDA contribution of which I believe is about 5 million annually but please correct me if I’m wrong?

Mark Hurley

Well it’s, you’re right. Important to note that, that pipeline has backing yet of 15 year commitment from a producer, those volumes peak in about 2017 to 2018 so that’s when we hit kind of maximum EBITDA. But the important thing to keep in mind is that even though the volumes committed by that particular shipper will continue to ramp-up overtime. We do work very hard to fill that system up with what we call walk-up volume month-to-month kind of volume. And so I think that which is done at a different tariff, but nevertheless gives us the additional revenue. And so we think most of the year in 2014 that system will be running at or for near capacity.

Theresa Chen - Barclays Capital

Great thank you very much.

Mark Hurley

Thank you.

Operator

(Operator Instructions) Our next question is from Michael Peterson with MLV & Company.

Michael Peterson - MLV & Company

Good afternoon gentlemen. Couple of questions this afternoon, I would like to start with third-party revenues which were down both sequentially and year-over-year, can you give us a sense as to how much of this weakness was transitory and how you see 2014 shaping up?

Mark Hurley

Yes I really don’t think it’s a very strong signal to tell you the truth. I think a lot of its reflection in just really Vitol’s marketing program taking off and I think a lot of our transportation volumes have been done with a lot of growth has come out of Vitol, but at the same time when I would tell is we look at ’14, I think you will see third-party volumes ramp-up I think with some of the ways that we’ve thought about restructuring our trucking business. I think we’ve really focused our efforts around a handful or more of really key customer relationships which are include Vitol, but all of the other ones obviously are third-party. So I think as we look at ’14, I think you’ll see that number start trending back the other direction.

Michael Peterson - MLV & Company

Any chance that Alex I can pin you down on a year-over-year range of growth, you mentioned a little higher than ’13 thinking your visibility is probably better than ours in terms of what you might expect?

Alex Stallings

From third-parties?

Michael Peterson - MLV & Company

Yes, yes.

Alex Stallings

I don’t even I mean if I would have to I don’t even know if I can gander a guess on that, it’s all depends -- we also expect Vitol’s volumes to grow as well. So it’s going to be -- that one is a very hard question for me to answer with that much specificity.

Michael Peterson - MLV & Company

Understood just thought I would ask just in case you were willing to venture that. Next if I can shift to G&A expenses which were down again sequentially and year-over-year will we see a little bit rebound in the first quarter or have you done some things that will capture those efficiencies going forward?

Mark Hurley

I think that in the G&A or you got two things going on primarily one is that there were some expenses at the executive level both in transitioning from the old team to the new team. And so those are kind of one-time events and behind us anything we do that significantly have helped our G&A expenses is bringing an in-house counsel to replace our outside reliance on accounts on the past. And so that will continue to be a I think a positive for us as we will see outside legal expenses down from last year. We also have gotten a lot of previous litigation behind us and so I think that will be benefit to us as well. And so I would expect those to be about flat maybe slightly up from last year but pretty much in line with last year.

Michael Peterson - MLV & Company

Okay thank you Mark. Last from me would be kind of an open ended question with regard to the asphalt market I think there are a lot of folks that have been cautiously optimistic or maybe even a little bit critical of that market kind of given federal and state budgets and even local spending. I wanted to get your sense as to how you see ’14 unfolding and if you see more or less seasonality than we’ve seen in times past?

Mark Hurley

I think you’ll continue to see the seasonality I think that’s just a very fundamental part of the way that business is operated where most of the inventory build is done in winter months and most of the paving in the market is done in second and third quarter, so the seasonality will certainly be there. We spend a lot of time talking to our customers about their views on the market and they see it getting better and I think unanimously they will tell you that we have seen the bottom of the market and we see gradual improvement there. I think the pace of growth is the thing that they will debate and that’s highly related to the economy and the condition of state budgets and that sort of thing. And so there are different degrees, there are different opinions on how fast the rebound but I think we’ve all seen the bottom. We certainly saw a better market last year that we expected and we see no signs so far this year that would create a lot of pessimism for us.

Michael Peterson - MLV & Company

That’s helpful, that’s all I have for this afternoon and I appreciate your help guys. Thank you.

Alex Stallings

Hey Michael I just want to make a little one follow up comment I mean and looking kind of back to the earnings release I mean our third-party revenue was actually up sequentially as well as year-over-year I mean the related…

Michael Peterson - MLV & Company

Affiliate, my apologies Alex affiliate is how I should have phrased the question.

Alex Stallings

Okay, okay yes I mean the revenue from Vitol was actually down a little bit quarter-over-quarter but for the most part our growth is coming out of third-party revenue.

Michael Peterson - MLV & Company

I appreciate the clarification. Thank you very much.

Operator

Our next question comes from Michael Tanzer with DG Capital Management.

Michael Tanzer - DG Capital Management

Hey Mark, hey Alex, how are you?

Alex Stallings

Good.

Mark Hurley

Hi Michael.

Michael Tanzer - DG Capital Management

Just a quick question with regard to the current joint venture income at Pecos so from my understanding Pecos phase 2 within the Advantage Pipeline the revenue should I guess be ramping up now and when you gave EBITDA guidance for sort of flat EBITDA year-over-year 2014 from 2013. Does that EBITDA measure include the benefit of the equity income you’ve received from the Advantage JV and if not or in any case I guess what would be your expectation of that benefit through 2014?

Alex Stallings

Yes really Michael we don’t expect to really see any real equity earnings probably until the second half of 2014 so -- but that’s partly why Mark made the comment that he made because phase 2 really won’t be online until the second quarter of this year. And right now the only thing that’s operating is phase 1 which is on a much lesser scale than what we’re expecting whenever phase 2 goes online which again would be some time in 2Q.

Michael Tanzer - DG Capital Management

I am sorry just a follow-up on that point and aside from equity earnings what’s the expected I guess distribution once that ramps up?

Alex Stallings

Well again I don’t think we’ve given specific guidance on that particular project but I think what we’ve stated before Michael is that it’s at least in -- what we expected to at least meet our kind of 15% threshold for return on that $20 million investment.

Michael Tanzer - DG Capital Management

Okay, understood. Thank you. And then I guess when you think about -- I enjoyed your positive commentary surrounding the Woodbine and it sounds like you’ve a very high level of confidence in the project getting done when it comes to $100 million plus expansion capital that you are planning to spend this year is that going to be funded off of your $122 million capacity or is there plans to raise equity and would you raise the distribution ahead of that or just feel free to expend?

Alex Stallings

I think we have kind of mentioned previously is that it’s probably going to take a combination of financing options probably including some equity and debt. So, I mean I think all of it’s just a really timing question. We’re not going to go out and get in front of that project by any means of the imagination. So, what we’re going to try to do is raise the capital or raise the financing when it makes sense to do so. But it will be a combination of variety of financing options and will consist of some equity and debt.

Michael Tanzer - DG Capital Management

Got you. And I’m sorry, just one more last question. I think you previously mentioned that there are a couple of opportunities on the asphalt side to do some sort of tack on acquisitions. Are you seeing any of this in the pipeline and for a magnitude or has this just taking a backseat to the interesting projects you are doing in Woodbine in West Texas?

Alex Stallings

Well, definitely those make a backseat, I mean those two projects are getting more attention now because those are the ones that are furthest along and they have -- and make a significant difference to us but we continually explore asphalt acquisitions and we’ve looked at two or three over the last 12 months and we are looking at some right now, just waiting for the right terms to fall in place. But we do think there will be something out there it’s just the matter of continuing to farm for these things and get something that fits.

Michael Tanzer - DG Capital Management

Okay. Well, thanks for the update and look forward to your progress. Thanks.

Alex Stallings

Thank you, Michael.

Operator

It appears to me no further questions at this time. I’d like to turn the conference back over to management for any closing remarks.

Mark Hurley

As always we really appreciate everyone’s attention and focus on Blueknight and thank you for joining us today. And look forward to any follow-up questions that you might have and please don’t hesitate to contact any of us. So with that I think we’ll sign off.

Operator

Thank you very much. The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect your line.

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