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Atlas Pipeline Partners, LP (NYSE:APL)

Q2 2012 Earnings Conference Call

August 2, 2012, 9:00 am ET

Executives

Matthew Skelly – Head of Investor Relations

Eugene Dubay - President, Chief Executive Officer, Managing Board Member

Patrick McDonie – COO, Senior Vice President

Trey Karlovich – CFO

Analysts

Derek Walker – Bank of America

(Patrick Lee) – Wells Fargo

(Justin Campo – Kane Anderson)

Sharon Lui – Wells Fargo

Operator

Good day, ladies and gentlemen and welcome to the Q2 2012 Atlas Pipeline Partner earnings conference call. My name is Sue, and I will be your operator for today. At this time, all participants are in listen-only mode. We will conduct a question and answer session towards the end of the conference.

As a reminder, this call is being recorded for replay purposes. I would now like to turn the call over to Mr. Matthew Skelly, head of investor relations. Please proceed, sir.

Matthew Skelly

Thank you, Sue. Good morning, and thank you for joining us for today’s second quarter 2012 earnings call. Before the management team provides comments on our second quarter results, I’d like to remind everyone of the following safe harbor provisions.

During this conference call, we may make certain forward-looking statements, that is statements relating to future, not past events. In this context, forward-looking statements often address our expected future business and financial performance and financial conditions and often contain words such as expect, anticipate, intend, believe, and similar words or phrases.

Forward-looking statements by their nature address matters are, to different degrees, uncertain and subject to certain risks and uncertainties which could cause actual results to differ materially from those projected in the forward-looking statement. We discuss these risks in our quarterly report on form 10-Q and our annual report on form 10-K, particularly in item one. I would like to caution you not to place undue reliance on these forward-looking statements, which reflect management’s analysis only as of the date hereof.

The company undertakes no obligations to publicly update our forward-looking statements, or to publicly release the results of any revisions to forward-looking statements, which may be made to reflect events or circumstances after the date hereof, or to reflect the occurrence of unanticipated events.

Lastly, management’s discussion this morning includes references to items such as the EBITDA and distributable cash flow, which represent non-gap measures. Our reconciliation of these non-gap measures is provided in the financial table of our quarterly earnings release as well as our form 10-Q.

With that, I will turn the call over to our Chief Executive Officer, Eugene Dubay, for his remarks. Eugene?

Eugene Dubay

Thank you, Matt. Ladies and gentlemen, thank you for your participation today and your interest in Atlas Pipeline Partners. We are pleased to have you with us on our call.

In the second quarter, we continued to see significant producer activity in all of our operating areas. The growth and volumes across our systems has exceeded all of our expectations, and I believe that in most cases, they have exceeded producer expectations.

Our processed volume increased to an average of 682 million cubic feet per day in the second quarter, from an average volume of 632 million cubic feet per day, which we experience in the first quarter.

During this quarter, we completed the construction of our new 60 million cubic feet per day plant at Velma and that plant is already processing over 40 million cubic feet per day. All of our plants, with the exception of the new Velma plant, are full and we are bypassing the West Oak plants with approximately 115 million cubic feet per day.

Our financial results do not reflect this growth because we remain constrained on our liquids take away capacity in West Texas and western Oklahoma. However, despite having the fractionater down for a month in the quarter and being curtailed on our liquids production we have delivered the distributable cash flow to cover our distribution of $0.56.

This quarter, we expect to have our new plant at WESTOF completed, and we will add 200 million cubic feet per day of capacity to that system. Our new driver plant in West Texas should be complete in the first quarter of 2013 and we intend to utilize all 200 million cubic feet per day of capacity in that plant as quickly as possible.

In this quarter and the next, we will begin to receive incremental margins with the addition of these plants, but the significant increase in margin will not be realized until we can increase our liquids production in 2013.

By the end of the second quarter of 2013, we should have the capacity to maximize our liquids production and recognize the earnings impact attributable to our new plants.

We have continued to extend forward our hedge production to cover our liquids, our hedge protection, to cover our liquids production, and we remain exuberant with regard to our potential development opportunities.

This has been a difficult quarter, from an operating standpoint, because of the downstream problems caused by our fractionation and transportation suppliers. It has been significant in creating the foundation that we need to exploit the opportunities we have in the near term.

With the volume of gas that we have across our systems, the next couple of quarters will remain challenging to our operations, but our business fundamentals will continue to improve, and as we gain capacity for our liquids production in 2013, we will be in an enviable position, and the benefit to our investors should be substantial.

It is my pleasure now to introduce to you Pat McDonie, our new Chief Operating Officer. Pat has worked for producers for ten years. Two years as a production and reservoir engineer, and eight years managing the marketing of equity gas. He has spent the last 17 years in the gas-marketing arena, with his most recent role as President of Oneok Energy Services.

Pat brings to Atlas a very good knowledge of the energy business, strong producer relationships, excellent decision-making skills, and a great understanding of risk management and hedging strategies. We are pleased to have Pat with us, and I will now ask Pat to elaborate on my comments. Pat?

Patrick McDonie

Thanks, Gene, and good morning everyone. I am excited about being here and I do see a lot of additional opportunities in all of our core operating areas. As production volumes in each of these areas continues to outpace previously projected rates, we are very well positioned and poised to execute on these additional opportunities, so that we can continue to provide service and infrastructure to our producers and consequently, invest capital that will provide attractive returns to our unit holders.

Across all of our systems, gathered volumes in the second quarter increased 14% to 775 million cubic feet a day. And liquids production increased 2% as compared to the first quarter. The smaller increase in liquids production is primarily due to constrained liquids takeaway capacity, as a result of the continuing fractionater issue at Mont Bellevue, and due to the economic decision to begin ethane rejection at our West Oak facilities.

At Velma, we had 13 rigs working behind our system, and during the second quarter, we realized a 6% increase in gathered volumes. During the quarter, we connected five wells, but you need to remember that the well connect figure does not include volumes received behind existing central delivery points from which we receive a significant portion of our new production.

We have begun processing gas at our new 16 million a day cryofacility, which was built to accommodate the long-term fee-based agreement, with XTO Energy, a subsidiary of Exxon Mobil. As of the end of the second quarter, the new plant was processing just over 50% of its capacity, and is currently processing 45 million cubic feet a day. We expect the remaining capacity to be fully utilized by the end of the year, and we are currently evaluating additional growth opportunities at our Velma facilities.

At West Oak we have 39 rigs running behind the system, and during the second quarter we connected 115 wells, a 26% increase from the prior quarter. This increase in producer activity resulted in a 14% increase in gathered volumes over the previous quarter.

We continue to make progress on the installation of the new 200 million feet a day cryogenic plant at the Wenoka site, and expect operations to begin in the third quarter of this year. The addition of this plant will increase the West Oak nameplate processing capacity to approximately 458 million cubic feet a day. Until this plant is in operation, we will continue to utilize third party processing contracts and bypass a portion of our volumes to enable us to continue to provide reliable gathering services to our producers.

For the month of July, we have offloaded approximately 5 million cubic feet a day to third party processing plants and as Gene mentioned, we are bypassing approximately 115 million cubic feet a day. We continue to see significant growth in volume in this area, and the volume currently being bypassed represents 58% of the baseload capacity of the new 200 million cubic feet a day plant.

Beginning in late May, the West Oak system entered into ethane rejection, due to ethane processing economics. We remain in ethane rejection today. When the new plant comes online, we anticipate operating in partial ethane rejection, due to NGL takeaway limitations. At WestTX, we have 66 rigs dedicated to the system and during the second quarter connected 74 wells, a 48% increase from the prior quarter. This increase in producer activity resulted in a 9% increase in gathered volumes over the previous quarter. In addition, we continued to experience volume growth from existing delivery points as a result of producer infill drilling and re-completions

For the month of July, the WestTX system was utilizing 96% of the total 255 million cubic feet a day of (inaudible) capacity. With the expected continued increase in volumes, construction of the new driver plant is a priority. The first phase of construction of the driver plant, which will increase processing capacity by 100 million cubic feet a day, is progressing on schedule and is expected to be in service in the first quarter of 2013.

As discussed on previous calls, the second phase involving placement of additional compression and refrigeration equipment to increase the plant's capacity to 200 million cubic feet a day is currently expected to be operational by the first quarter of 2014.

Beginning in May, the WestTX system went into ethane rejection as a result of scheduled fractionator maintenance at Mont Belvieu. We continue to operate in partial ethane rejection as fractionator has yet to return to 100% of its volumetric capabilities. For the remainder of the year, we expect the WestTX facility will operate in partial ethane rejection due to transportation and fractionation limitations.

As third-party transportation and fractionation projects are completed in 2013, we expect to return to fully ethane recovery. With respect to our remaining facilities, we transported approximately 244,000 barrels per day on our West Texas pipeline and we gathered 8.3 million cubic feet per day on our Tennessee system

In the second quarter, we acquired the Mansfield Gathering System in the Barnett Shale. This acquisition was effective in June and during June, ATL Barnett gathered 24.4 million cubic feet per day under (fixed-V) arrangements.

That concludes my remarks and I will now turn the call over to Trey Karlovich.

Trey Karlovich

Thanks, Pat. It's great to have you on the team and I look forward to working with you as we continue to grow our business to the benefit of our stakeholders.

As Gene has mentioned, we are pleased with our financial results for this quarter. In spite of significant issues impacting the NGL industry including the downtime of fractionation, reduction in liquid allocations, and a significant decline in NGL uprising, our business continued to perform very well, as we anticipated it would, under the macro economic environment.

We recently announced our quarterly distribution of $0.56 per unit consistent with our expectations for this quarter and a 19% increase over our distribution in the same quarter last year.

While our distribution coverage is tighter than we would like at 1.10 times for the trailing 12 months and 1.01 times for the current quarter on a fully diluted basis, we expect our distribution and our coverage to increase once our new plants are fully operational and benefiting from incremental NGL takeaway in 2013.

I will continue to reiterate that we believe maintaining adequate distribution coverage is important for the long-term success of our business

Our quarterly results are in line with the guidance we issued for the year and reaffirmed in late June. As both Gene and Pat mentioned, our volumes and growth opportunities are exceeding our expectation. Our balance sheet remains very strong with leverage at 3.4 times and we believe we have an enviable risk management portfolio.

During the quarter, we completed an amendment to our revolving credit facility which increased our buying capacity to $600 million and it can be increased to $800 million with the accordion feature. We also lowered our interest costs and extended the term of the facility.

This amendment was another positive step in achieving our balance sheet and financing goals. As we perceive new opportunities to grow our business, we will continue to maintain a strong balance sheet and adequate liquidity.

Reviewing some of the financial highlights for the quarter, our adjusted EBITDA for the quarter was approximately $49.1 million, 13% better than the second quarter last year and distributable cash flow was $32.8 million, a 10% increase from last year.

As we have discussed, key factors in the current period include further increases in gathered and process volumes offset by the impact of the downtime at the (inaudible) fractionator and lower realized commodity prices, both of which resulted in our WestOK and WestTX facilities operating at ethane rejection during the quarter.

We had weighted average NGL prices during the quarter of $0.80 per gallon compared to prior quarter average price of $1.03. Our gross margin was about $60.8 million for the quarter compared to $69.1 million for the first quarter. However, our definition of gross margin does not include the realized impact of our hedging activities, which is an additional $2 million gain this quarter compared to a $2.5 million loss in the first quarter.

A summary of our volumes and prices was included in the earnings release that went out yesterday. Plant operating expenses remain in line with our expectations, which is commendable considering the significant increase in volumes on our systems. General administrative costs excluding non-cash (comp) were about $7.5 million for the quarter compared to $9 million in the first quarter, which is also consistent with our guidance.

Interest expense totaled $9.3 million this quarter and increased the prior quarter but also in line. Our maintenance capital expenditures totaled approximately $4 million this quarter, which is slightly lower than where we expected it for the quarter.

Looking at our balance sheet, we had total debt to capital of 36% and debt to adjusted EBITDA of 3.4 times, both well below our maximum thresholds. As we have continually communicated, we expect our leverage to stay below four times throughout our construction program and for it to be below 3.5 times soon after the projects come online and begin generating strong cash flows.

Our liquidity at the end of the quarter was approximately $270 million. We spent approximately $81 million this quarter on growth capital including paying for the acquisition in the Barnett Shale which services our affiliate company, Atlas Resource Partners.

We also funded significant amounts of our plant expansions at West Oak, WestTX, and Velma. We have incurred approximately $175 million of growth capital this year-to-date, which has funded a very compelling list of projects.

We have completed our new $60 million a day Velma plant, installed a significant amount of the major equipment of our new $200 million a day facility at West Oak, made down payments on key components and equipment of the $200 million a day driver plant at WestTX, expanded our West Oak gathering system including new compression and pipeline and an acquisition in Kansas, added new compression to our WestTX system, and purchased a gathering system in the Barnett Shale.

Needless to say, we have been busy growing and look forward to this growth continuing. We previously updated our gross capital spending guidance for the year to between $320 million and $350 million and based on the projects and acquisitions we have announced to date, we remain on track for that amount.

They mentioned we were very pleased with our risk management portfolio which was a benefit to us in the current quarter and was an asset addition of $67 million at June 30 and remains in a similar position today. I believe this is further evidence that we continue to focus on protecting the commodity price sensitivity of our business

We continue to layer in price protection to our portfolio during the quarter including putting out protection for natural gas and additional NGL and (inaudible) positions in 2013 and 2014.

Our projected margins and cash flow excluding ethane for the second half of 2012 are approximately 78% protected. We are 75% protected in 2013 as well as being approximately 24 protected in the first half of 2014.

As a reminder, our targeted risk management levels are up to 80% for 12 months out, up to 50% for 24 months out, and up to 25% for 36 months out, so we are right in line with our targets. We believe our portfolio and targets provide us with the protection we need, yet allow for potential upside should commodity prices increase. We expect to continue to add to our portfolio as we elongate our book.

In closing, the current quarter met our expectations financially and we weathered the impact of the NGL fractionation downtime and low price environment. Our volumes continue to increase and we are working diligently to increase our gathering and processing capacity on each of our systems.

We're comfortable with our current distribution in the short term and look forward to a meaningful increase in our distributable cash flow once all our new facilities are on line and NGL takeaway fractionation infrastructure is complete.

I will now turn the call back over to Gene for his closing remarks.

Gene Dubay

Thank, you Trey, and I wish to thank you as investors for your support for this management team and we look forward to continuing to work with you. We will now take questions.

Question-and-Answer Session

Operator

Thank you. (Operator instructions). Thank you, and your first audio question comes from Derek Walker, Bank of America.

Derek Walker – Bank of America

Hi, good morning, guys. Congratulations. Good quarter given the backdrop (and tack) and congratulations as well. Just a couple quick questions, you mentioned that maybe CapEx was a little lighter than you had expected. Any thing that we should be thinking about there and how should we think about that going forward in the back half of 2012?

Trey Karlovich

Derek, this is Trey. So our managed capital for the quarter was about $4 million. In first quarter it was a little bit closer to $5 million. $5 million is generally what our run rate is. I would expect about a $19 million to $20 million year-to-date number, which is what we kind of iterate in our guidance. So I would expect it to be in that $4 million to $5 million range for the rest of the year.

Derek Walker

OK, great. And then the – while the bolt-ons aren't a significant portion of the overall portfolio. Can you just give us a sense there? It sounds like you had to bring on additional fee-based revenues. Are there any other additional opportunities out there for bolt-ons as far as – especially in the kind of (Mississippian) mine as well as kind of branching out with ARP?

Gene Dubay

This is Gene. I think we'll continue to see opportunities as we go forward. But until we have something signed up, I hate to speculate on what exactly we might have for ourselves.

Derek Walker

OK, thanks guys, appreciate it.

Operator

Thank you. And your next question comes from (James Tripe) – Wells Fargo. Your line is open. Please go ahead.

(Patrick Lee) – Wells Fargo

Yes, this is (Patrick Lee) calling in for (James Biser). I’m just wondering, your revolver borrowings are kind of increasing right now and I’m just wondering how much (inaudible) do you think you need under the revolver to feel comfortable?

Trey Karlovich

(Patrick), this is Trey. What – kind of where our liquidity number is is about $100 million. We don't really want to go under that from a liquidity standpoint. Remember, too, our revolver has a $200 million accordion feature.

And as we discussed previously we will not ride our revolver for an extended period of time with our growth projects. We'll fund our growth capital projects under the revolver and then look at more permanent financing once we start recognizing the cash flows from those projects.

(Patrick Lee) – Wells Fargo

OK. That's good. Thank you. I was also wondering, it sounded like I guess the Velma expansion facility is now at 45 million cubic feet. Did I hear correctly that you expected basically it to be fully utilized by the end of the year?

Trey Karlovich

That's correct.

(Patrick Lee) – Wells Fargo

OK. And then I was also wondering, could you provide kind of a break out of the contract mix for your three systems: West Texas, WestOK and Velma?

Trey Karlovich

(Patrick), we don't – we haven’t given it all by system. I can tell you Velma is primarily POP with fee business with our new contract with XTO on the new plant. West Texas is POP and WestOK is POP, (keep hole) and fee.

We do an overall, it's about 60% POP, approximately 25% (keep hole) and the remainder is fee. Those are round numbers. You can look at our investor presentation to get the actual – the exact numbers and then you can obviously call Matt Skelly if you have further questions.

(Patrick Lee) – Wells Fargo

OK. Final question, I was just wondering for the Mansfield system in the Barnett that you just acquired, what was the cost for them – I’m just wondering. And are there any opportunities to expand that system?

Gene Dubay

The Mansfield system? That system is dedicated to ARP production primarily. It is not a significant system. We spent about $18 million on that system, which you will see on our cash flow statement.

There are some other opportunities that we look at in the Barnett as ARP continues to grow there but there's nothing to announce at this point.

(Patrick Lee) – Wells Fargo

OK. Thank you.

Operator

Thank you. Your next audio question comes from (Justin Campo – Kane Anderson). Your line is open. Please go ahead.

(Justin Campo – Kane Anderson)

Hi, good morning.

Gene Dubay

Good morning, (Justin).

(Justin Campo – Kane Anderson)

Just wondering if you quantify in a little more detail the impact of the Mont Bellevue fractionator down time on your West Texas results for the quarter versus what they would have been normally.

Gene Dubay

(Justin), we're not giving an exact number for what that impact was. I mean, if you look at what the impact of that was, we had to reduce our ethane production significantly in order to stay with our allocation in May and June.

We were able to sell our barrels, however, it was at reduced price, so we did not have – we do not have a continuing impact from the May downtime. However, we are still allocated on liquids going forward and we expect hat to continue into the third and possibly fourth quarter.

(Justin Campo – Kane Anderson)

And so the barrels that Pioneer had stranded, unable to fractionate in June, were you able to recognize revenue somehow before Pioneer did or is there another mitigant there that I'm not picking up?

Gene Dubay

We were. We actually sold our barrels, again, at a reduced price. But we did sell our barrels.

(Justin Campo – Kane Anderson)

Got it. OK, that's it for me, thanks.

Operator

Thank you. And your next audio question comes from the line of Sharon Lui – Wells Fargo. Your line is open. Please go ahead.

Sharon Lui – Wells Fargo

I was just wondering if there's any way to, I guess, quantify the amount of ethane rejection WestOK and West Texas, for the balance of the year.

Trey Karlovich

Sharon, this is Trey. For the balance of the year, it's going to – I mean, WestOK is strictly economic. If the frac spread comes into lien where it makes sense to produce ethane, we will go back into ethane production. So it's really kind of hard to quantify what that number would be going forward. We're close to processing economics today based on where ethane price is.

At West Texas, again, that's going to depend primarily on what our liquid allocation is going forward.

Sharon Lui – Wells Fargo

OK. So I guess for West Texas, following up on the previous question, so there's no product and inventory due to the frac downtime.

Trey Karlovich

Correct.

Sharon Lui – Wells Fargo

OK, OK. Thank you.

Operator

Thank you. And your next audio question comes from the line of (inaudible). Your line is open. Please go ahead.

Unidentified Participant

Hi, good morning, guys.

Gene Dubay

Good morning.

Unidentified Participant

So just had a little bi of a question about the numbers, it looked like gross margin was a little bit light but it seems like you made up a lot of that with other income. I'm just trying to understand what the components of that line item are and how that alls adds up.

Trey Karlovich

This is Trey. So I mentioned it in my comments and we touched on it in the earnings release. Our realized cash flow from our hedge position does not actually flow through our gross margin calculation. But that's the biggest driver that needs to be factored in.

We had a $2 million gain for the quarter versus compared to last quarter it was a $2.5 million loss. That's an all-in number, including premium costs.

Unidentified Participant

So $2 million including premiums. All right, are there any other components in there?

Trey Karlovich

There's a few other things. We've got fees from our new Mansfield system and some other thing that make that up as well. But that's the biggest driver.

Unidentified Participant

OK, great. Thank you very much, Trey.

Operator

Thank you. (Operator Instructions)

Gene Dubay

If there's no more questions, you can wrap up.

Operator

Thank you. There are no further questions waiting. Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect and have a good day. Thank you.

Gene Dubay

Thank you.

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