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

Q1 2014 Earnings Conference Call

May 7, 2014 3:00 PM ET

Executives

Brent Gooden – IR

Alex Stallings – CFO and Secretary

Mark Hurley – CEO

Analysts

Theresa Chen – Barclays Capital

Michael Tanzer – DG Capital Management

Operator

Good day and welcome to the Blueknight Energy Partners First Quarter 2014 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. Please note this event is being recorded. I would now like to turn the conference over to Brent Gooden, Blueknight Media Relations. Please go ahead.

Brent Gooden

Thank you and good afternoon. It is my pleasure to welcome you to today’s conference call where we will discuss Blueknight’s financial and operating results for the first quarter ended March 31, 2014. Alex Stallings our Chief Financial Officer will discuss our results for the three months ended March 31, 2014. Mark Hurley, our Chief Executive Officer will update you on our operational performance, projects and opportunities as well as several factors influencing our business.

After prepared remarks, Mark and Alex will 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 risks and uncertainties that could cause actual results to differ materially from those anticipated including uncertainties relating to Blueknight’s future cash flow 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 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 $12.6 million for the first quarter of 2014 which compares to $14.9 million for the same period in 2013 which is a decrease of $2.3 million.

Partnership reported net income of $3.9 million on total revenues of $46.4 million for the three months ended March 31, 2014 compared to net income of $6 million on total revenues, $44.5 million for the three months ended March 31, 2013. The partnership previously announced a first quarter cash distribution of $0.13 per common unit, a 2.8% increase over the previous quarter’s distribution and a 10.6% increase over the first quarter of 2013 as well as 17.875 cent distribution per preferred unit, both of which will be paid on May the 15th of 2014.

A few highlights from each of the segments; first crude oil terminalling and storage. For the quarter ended March 31, 2014 we reported operating margin of $6.4 million which is a decrease of $1.1 million or 15% for the quarter ended March 31st of 2014 as compared to the first quarter of 2013. Reason for the decrease is due to the current backwardated conditions at Cushing, which has led to a decrease in renegotiated storage rates as compared to the same period prior year. However we have been able to keep our Cushing facility fully contracted during the down market.

As of May 2, we have approximately 5.2 million barrels of crude oil storage under service contracts with remaining terms ranging from month to month to 20 months. Second crude oil pipeline, we reported operating margin of $0.6 million of 2014 excluding depreciation and amortization which is a decrease of $0.2 million as compared to 2013, decrease is primarily related to the timing of repair and maintenance expenses associated with our systems as well as refinery turnaround on Eagle North pipeline system which impacted our February revenues. The refinery is now back on line and we expect volumes to continue at prior year levels.

Third is trucking and producer field services business. We reported operating margin of $2.4 million which is an increase of $0.3 million or 15% for the quarter ended March 31st of 2014 as compared to the quarter ended March 31st of 2013. Increase in operating margin is driven primarily by the 23% increase in volumes transported and efficiency gains in our fleet. We continue to experience solid growth in this segment as a result of a current backwardated crude oil market which drives a premium for transporting volumes to market as soon as possible.

And lastly, Asphalt services segment. We reported operating margin of $7.9 million which is a decrease of $0.5 million or 6% for the quarter ended March 31st of 2014 as compared to the prior year. Decrease in our operating margin is due primarily to the timing of schedule type inspection and maintenance expenses.

G&A really remained flat quarter-over-quarter, we were $4.5 million for the 2014 first quarter which was a decrease of about $0.2 million of what it was in the previous year first quarter. We also had a gain on sale of asset to $0.4 million for the three months ended March 31 of 2014 as compared to a loss on the sale of assets of $0.2 million for the three months ended March 31 of 2013.

From a liquidity perspective our leverage ratio is at 3.95 times and as of May 2nd we had aggregated unused commitments under our revolving credit facility of approximately $118.5 million subject to financial covenant limits.

From a capital investment perspective, expansion capital for the first quarter of 2014 totaled $5.8 million as compared to $10.2 million in the first quarter of 2013. We are currently estimating expansion capital expenditures of $20 million to $25 million for 2014 which is prior to the execution of any of the projects Mark will be discussing next. We are still targeting to spend up to $100 million on expansion capital in 2014 assuming we are successful on one or more of the projects.

Maintenance capital expenditures for the three months ended March 31 of 2014 totaled $1 million which is net of $1.1 million of reimbursable expenditures. We expect maintenance capital of expenditures to be in the $12 million to $14 million range which will be net of any reimbursable expenditures in 2014.

With that I’ll now turn it over to Mark Hurley. Mark?

Mark Hurley

Thank you very much Alex. I am going to spend a few minutes discussing our quarterly results from operations and then focus on updating you on our plan going forward.

Overall, our first quarter of 2014 was in line with our expectations. Our revenues were up in the first quarter of 2014 as compared to the first quarter of 2013 in spite of the downward pressure on Cushing storage rates. This revenue increase confirms the growth we are experiencing across our businesses.

It was a however, a quarter where we had a heavily load of routine plant maintenance and our costs were up as a result. This will moderate over the rest of the year as we get as this earlier maintenance schedule. As we have discussed in previous quarters, rates for Cushing crude storage are down as compared to prior year as a result of the current supply demand situation in Cushing, largely due to the backwardated crude oil market. Even in the challenge market we still look to capture value of our Cushing storage facility.

The key to achieving this is to focus on services mainly blending and blending capability and connectivity. As such last year we embarked on $8 million of multiple phase program that will add additional connectivity and capabilities to our terminal, it has been very well received by our customers. We believe that when coupled with our experienced operational employees our terminal will be more competitive in buying for customers that will be seeking to new contracts in the couple of years as we believe there are a number of companies that will be in the market renegotiating deals.

These customers will be more focused on service offerings than they have been previously because of the backwardated market. We believe we quickly identified this trend and will be poised to capture additional customers as they look to renew contracts and take advantage of our service capabilities. Otherwise our three point strategy remains the same. That is one, improve the efficiency of our trucking business and then grow it. Two, expand our pipeline business in the fast growing shale areas and three, grow our Asphalt business through acquisitions.

Now, let me say a few words about the progress we are making on each element of our strategy. In our trucking operation we made excellent program in improving the efficiency of our business. As Alex mentioned earlier, our volumes increased 23% in the first quarter of 2014 as compared to the first quarter of 2013. Remarkably with the efficiency range we have achieved we have been able to increase volumes without adding to the size of our fleet.

In addition, we have actually decreased the number of driver over the past couple of years as we have been able to attract and retain drivers in the key areas we serve. Since our drivers are hauling additional crude and doing it more efficiently they are able to put more money in their pockets, as a result our drug turnover is down considerably.

And while the volumes are up, we actually decreased a number of overall customer surge and concentrated on those key customers that put a value on high touch service. We have made investments in new hardware and software and are now building systems that allow us to be very responsive to our customers.

Our average turnaround from the time that the crude lease is called in for transport to the time it is delivered to an injection point is regularly less than 24 hours, the industry average is about 2.5 days.

In addition, we have a dedicated customer service team and they react quickly with feedback received from our customers. We believe this is a step change for the industry and we believe it will set us apart from our competition.

We are also making progress on the second key element of our strategy which is to develop crude pipeline projects in the high growth shale areas. In Southern Oklahoma Arbuckle pipeline expansion project became operational in the third quarter of last year. The system is running at near capacity and we continue to get interest on peers [Inaudible] to bring additional volume.

In West Texas the first phase of the Pecos River pipeline started up in the fourth quarter of 2013 and we expect the second phase of the project to be operational in the third quarter of 2014.

Volumes have steadily increased on the systems and start-up and we are now working on numerous opportunities around this pipeline to install truck stations and bring additional volume. We are also working two deals to connect gathering system to this pipeline. We feel very good about the future of this project.

The Pecos River pipeline will be a great platform for further growth opportunities and more significant of which will be an extension of this line North possibly in to New Mexico where a number of the E&P companies are expanding their footprint.

The extension will consist of a 110 mile pipeline tied into our existing Pecos River pipeline, it was serve an emerging production area in Far West Texas and Southern New Mexico. This project continues to gain traction and we will be actively soliciting shipper commitments and factually as we speak.

Building on the success of these projects, we continue to develop the East Texas Wood Bind pipeline project. This is a potential project to construct the 140 mile pipeline originating just north of Madisonville, Texas and terminating near Houston.

The pipeline will be backed by shipper commitments and will be 100% constructed our own and operated by [Inaudible] We’ve been working on this project for some time as you all know and we are now in the refining the well design and specifications of the system. We continue to get strong interest and we feel very good about the project. We are targeting a startup of this project in late 2015 or early 2016.

Finally, the third element of our strategy is to grow our asphalt business most likely by way of acquisition. We have explored a number of fossil acquisitions and continue to do so. These discussions are moving deliberately, but there are some possibilities and we continue to work on it.

Those are prepared comments, Andrew I will turn it back over to you to open the call up for questions.

Question-and-Answer Session

Operator

We will now begin the Question and Answer Session. (Operator Instructions). The first question comes from Theresa Chen with Barclays Capital. Please go ahead.

Theresa Chen – Barclays Capital

Good afternoon. Question on the announced potential projects as the north expansion on the Pecos river pipeline and the gathering systems; what magnitude are we talking about here? And where are you currently in the evaluation process or when would you feel more comfortable in sharing something more quantitative?

Mark Hurley

The evaluation process as usual starts with scoping out the project Theresa and then talking to potential shippers and we have made already a couple of rounds of discussions with potential shippers and gotten their feedback and we are now going back to them with more specifics on pipeline round late.

A potential construction strategy is always whether will be build all of our – phases or having those discussions today as a matter of fact with the some of the major producers and shippers in the area. We always want these things to move along quickly and they always take longer than you think they’re going to.

But the key is already making progress and yes we are. We think the project it we build all the way to loving New Mexico would be on the order of about $175 million something in that plus or minus $25 million depending on exactly what we build, the size line putting that sort of thing. I would love to tell you we’ll have something doing next month. It will probably be more like third quarter so far in that.

Theresa Chen – Barclays Capital

Hey that’s very helpful thank you. And on the Arbuckle pipeline, you’d mentioned that is currently running a near capacity. Are you comfortable that the walk up volumes will be sustainable going forward above what’s committed on the minimum.

Mark Hurley

Yes I mean based what we see with the level of interest that we are seeing from shippers to putting new pumps they can do truck and what we see happening on the production front down in Southern Oklahoma. Yes, we feel very comfortable about that and we think that if anything the area needs more capacity built out and so we talk about possibilities to do that.

Theresa Chen – Barclays Capital

Great and then the last one from me. What is your outlook for trucking volumes for the rest of the year given the strong results this quarter?

Mark Hurley

Yes we currently move about 65 to 70 something like that depending on the monsoon production schedule and that sort of thing. And so we see those going up. We even occasionally have looked at acquisitions of trucking fleets and we will continue to do so and maybe get more serious about that. Obviously those volumes increasing, we feel really good about what type business is now.

Theresa Chen – Barclays Capital

Thank you very much.

Mark Hurley

Thank you Theresa.

Operator

(Operator Instructions). The next question comes from Michael Tanzer of DG Capital. Please go ahead.

Michael Tanzer – DG Capital Management

Hey guys, thanks for let me ask some questions. So my first question is when you think about the run-rate of earnings and the ramp up of Pecos phase 2. It seems to me that as we discuss before it should roughly a $70 million EBITDA run rate. Do you think that’s going to be the case by Q3 once you see that phase 2 construction complete?

Mark Hurley

We definitely see the $70 EBITDA in our future. Mike whether it’s third quarter or fourth quarter late early. It really depends on how producers are what their production schedules are and they fluctuate quite a bit. And then how quickly we can get additional truck stations built and gathering systems built and that sort of thing. We obviously push those things fast as possible, but the producers and the shippers they have a role to play there as well.

And so it really depends on those things. I can tell you that the fundamentals around that pipeline are just strong and or even stronger than we thought they were going into the project. We went into that because number one the result that we saw a lot of production coming on in the area and number two there was just very limited pipeline infrastructure. And we thought we would attract the volume once we built the line and that is absolutely what is happening.

Michael Tanzer – DG Capital Management

Okay. And then as a follow up to that point I guess. It seems like you’re much more optimistic about the Pecos extension and just for clarification you mentioned Q3, was the Q3 signing some sort of deal with a large shipper or you, can you provide more key color as you are working with the single shipper or multiple shippers and will there be some sort of like contract or final investments decisions in that Q3 or is that [Inaudible] construction or any sort of color you could provide would be helpful.

Mark Hurley

Yes sure. As the Q3 reference was around getting commercial agreements in place with a shipper or shippers and getting a final investment decisions. And of course, construction or the engineering phase of project build out would start soon after that. And we’re talking to the all these buyers out there those who have large production areas. And so whether it’s multiple shipped with multiple smaller shippers or fewer shippers on the back of a larger shipper will be determined by the negotiations that we have and their interest in the production schedules.

Michael Tanzer – DG Capital Management

Okay understood. And then on the Woodbine East Texas project, it seems like timeline for construction has perhaps been pushed out a little bit. Is there, can you provide any details on in terms of any contractual disagreements or hurdles that you’re currently going through. Did I miss or is this just sort of the way things work when you are working with the counter party that move slowly?

Mark Hurley

Yes, let me think back to first part of your question there. You asked about construction timeline, the actual construction timeline hasn’t changed at all. We’ve always anticipate that it would be roughly 18 months or 20 months kind of schedule, once we get commercial agreements done the critical path right now is getting the commercial agreements done and it just takes some time because there are multiple agreements being worked at the same time and it just takes longer than you said you are likely to, I would say, the positive coming out of this is that, we, it is all about how we design the system and how big we make the system and that’s the good news.

We are talking all of our bigger project than we were talking about six months ago. And in spite of the fact that it can take six or eight months to do one of these deals, it feels like six or eight years, but you can usually take six or eight months to put something like this together once it’s a major investment and that’s playing out.

Michael Tanzer – DG Capital Management

And with regard to the expanded size, could you perhaps maybe update the capital requirements for such an expanded size?

Mark Hurley

Yeah we were thinking that it would be on the border of 225 to 250 earlier and we’re now thinking that will be more like 275 to 300 [Inaudible] and building up of 16 inch system as opposed to 12 inch system.

Michael Tanzer – DG Capital Management

Got you. So that would be roughly I guess $450 million in capital projects that you can see in the next two years?

Mark Hurley

Yeah on an [Inaudible] basis that’s right and we have some smaller stuff.

Michael Tanzer – DG Capital Management

Okay and sorry to take up so much of your time, but one last question or maybe this is a request, when you send out your press release announcing your quarterly earnings, it would just be very helpful if you included just a brief table highlighting the segment information, so it allows more people to ask more informed questions on the call and being prepared ahead of time that’s just my sense, but I’m sorry.

Mark Hurley

Well thank you. I’ve the author of the announcement sitting next to me, so I’ll pass on to him, thank you Michael.

Operator

(Operator Instructions). The next question comes from Michael Blue of Wells Fargo. Please go ahead.

Unidentified Analyst

Hi good afternoon guys. I guess maybe I’ll ask towards so just a couple of questions and you threw out a lot of numbers, so I don’t know if I got them alright. But I just wanted to understand a little bit better on the trucking business, kind of the interplay between the volume and margins, it seems like you highlighted that your volumes were up by 22% but it doesn’t seem like you got commensurate increase in segment margins.

I’m just trying to figure out I’m not sure if that’s correct what I just said but if it is what’s the interplay there as we increase the volumes, what’s going on with the margin and how should we think about that longer term?

Alex Stallings

Yeah Michael this is Alex. One thing that in this particular quarter because the volume ramped up so quickly frankly we had to add some flexible capacity meaning that we basically had to use some contract third parties and typically when we contract with third parties at best that’s usually done on a breakeven and what we’re trying to do is just to secure the volume until we can actually move assets into the area.

So what we did then over the quarter if you really look at it if you were to break it down between kind of January through March is if you look at January and February the reliance on third parties was much more significant than it was finally in March and then I think going forward. So it’s just something that you probably don’t see where you look at actually the margin increase but I do think you will see improvements in that as we decrease the reliance now on those third parties because we’ve now moved assets into those areas.

Mark Hurley

The other thing that can happen Michael was that we report a volume but the revenue is actually made up of two components, it is the volume and also the distance that the loads are being hauled, and so you can move 10,000 barrels a day over a distance of 20 miles or 10,000 barrels a day over a distance of 50 miles and the revenue, resulting revenue and the resulting margin is going to be different, so you had to kind of dig little deeper to see what’s going on there.

Alex Stallings

Yeah one other quick thing I’ll add on that is, is over the quarter we did actually add a couple of new key customers and sometimes it just takes us a little bit of time to kind of adjust to kind of like what Mark said where that volume’s going to be. But I think the good news is we’ve struck a couple of new deals, a couple of new relationships over the quarter and hopefully going to continue to kind of expand on that and make it more efficient as we go into the – into latter half of the year.

Unidentified Analyst

Okay thanks, that’s helpful. The other question just want to ask about the storage rates, so you said you’ve got some contracts on month to month, some are 20 months just trying to guess as we go through the year should we expect more contracts on lower rates or due to settle at the bottom here and just trying to get a little more color on that?

Mark Hurley

From a contracting perspective I do think we have some rolling off as the year goes on it’s not a majority of the agreements mainly but you will see us in the market continuing to really negotiating rates.

I think from a rate perspective and particularly from a quarter-over-quarter comparison a lot of our rates changed middle of last year and so you’re seeing some of that impact because the rates were higher in Q1 of 2013 than they were lighter in 2013. So you’re kind of getting a what I think is probably a little bit more of a dramatic impact as you look at Q1 to Q1 comparison because a lot of those contracts renew mid to late year.

So, that’s kind of where they are, I think we will be out here and continuing to renegotiate rates that really depends on where the markets are at the time of negotiation as to what those look like going forward.

Alex Stallings

We have rolled over the large portion of our contracts we have somewhat to go the most of it has already rolled over and been renegotiated.

Unidentified Analyst

Okay thank you.

Operator

This concludes our question and answer session. I would like to turn the conference back over to Mark Hurley, CEO for any closing remarks.

Mark Hurley

We just want to thank you for your time. We continue to feel very good about the Blueknight story. There’s a lot of news in what we’re seeing in terms of revenue increases and obviously the unit distribution increases and you should read a very positive message in that coming from all of us at Blueknight and so again, we thank you for your interest and wish you all the best, thanks.

Operator

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.

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