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Executives

Rick Buterbaugh – VP, IR

Toby Darden – President and CEO

Phil Cook – SVP and CFO

Analysts

Mark Reichman – Sanders Morris Harris

Xin Liu – JPMorgan

Quicksilver Gas Services LP (KGS) Q2 2008 Earnings Call Transcript August 6, 2008 10:00 AM ET

Operator

Good morning. My name is Jennifer and I will be your conference operator today. At this time, I would like to welcome everyone to the Quicksilver Gas Services quarterly earnings conference call. (Operator instructions) Mr. Buterbaugh, you may begin your conference.

Rick Buterbaugh

Thank you, Jennifer, and good morning. Joining me today are Toby Darden, President and Chief Executive Officer; Glenn Darden, Chairman; and Phil Cook, Senior Vice President and Chief Financial Officer.

This morning the company issued a press release detailing Quicksilver Gas Services results for the second quarter of 2008. If you do not have a copy of the release, you can retrieve a copy on the company's Web site at www.KGSLP.com, under the News tab.

During today's call the company will be making forward-looking-statements which are subject to risks and uncertainties. Actual results might differ materially from those projected in these forward-looking-statements. Additional information concerning risk factors that could cause such differences is detailed in the company's filings with the SEC.

Today's presentation will include information regarding EBITDA and distributable cash flow, which are non-GAAP financial measures. As required by the SEC rules, reconciliations of EBITDA and distributable cash flow to their most directly comparable GAAP measures are available on our Web site under the Investor Relations tab.

Also during today's call we will be making reference to our prior forecast, which refers to estimates provided in our S-1 related to our initial public offering that was completed in August of 2007.

In the interest of time this morning, I will turn the call over now to Toby Darden for a review of our financial and operating activities.

Toby Darden

Thanks, Rick, and good morning. This Sunday, Quicksilver Gas Services will celebrate our first birthday as a public company, but Sunday will be like any other day at KGS. We will be providing quality service for our customers by getting their natural gas and natural gas liquids to multiple markets with multiple takeaway options.

We will be constructing additional pipeline and processing capacity to stay ahead of the wave of new production that our producer-shippers are successfully developing and bringing on line in our service areas in the Fort Worth Basin. And our talented team will be prosecuting its mission to drive unit cost down and operating margins up, leading to continued increases in distributable cash flow for our partners.

In the second quarter, KGS gathered volumes increased to 188 MMcf per day, up 159% over the prior year quarter and up more than 17% from the prior quarter. Our process volumes increased to 160 MMcf per day, up 137% over the prior year period and 19% quarter-over-quarter.

Our financial performance has followed suit with net income of $5.6 million, more than 160% increase over the prior year quarter and a 93% increase over the first quarter of 2008.

EBITDA for the second quarter at $11.5 million was almost 3 times the $4.2 million recorded for the first quarter of 2007, and a 37% increase over the previous period.

On the operational side we are expanding our facilities in anticipation of continued volume growth. Our third NGL processing plant, our Corvette plant [ph] located in Northeastern Hood County, will grow total processing capacity for KGS to 325 MMcf per day. The plant site will also host additional fee-based compression capacity to bring pressures lower in the field and allow our producers to flow higher volumes through our other facilities.

The plant and compression facility is on schedule to be completed in early 2009. During the quarter we connected 57 new wells to the gathering system and constructed and placed in service 32 miles of new gathering system.

Capital expenditures for the quarter totaled $46.5 million, including $500,000 for maintenance capital.

In line with our operating performance and capital requirements, the Board of Directors of our General Partner increased the unit distribution rate 11% to $0.35 per unit for the second quarter of 2008. The second quarter distribution will be paid August 14th, 2008 on all units to holders of record as of the close of business, July 31st, 2008.

On the growth side of our business, KGS is exploring with Quicksilver Resources, the opportunity to manage, develop and acquire the considerable midstream opportunities that accompany Quicksilver's acquisition of properties in the Alliance Airport area in Denton and Tarrant Counties in the Barnett Shale Fairway. Current production from these properties is approximately 50 MMcf per day and is expected to grow significantly over the next few years.

In addition, gathered volumes are growing on the Lake Arlington and Angel Hill gathering systems that KGS is obligated to purchase from Quicksilver Resources. It is anticipated that these acquisitions may be completed by year-end 2008.

With multiple growth opportunities in our inventory and compelling returns on these investments for our unit holders, we have made the decision to continue our focus on growth in the Fort Worth Basin. As a result, KGS has elected not to participate as a minority interest owner in the Pathfinder Interstate Pipeline project.

Overall, Quicksilver Gas Services game plan is simple; well located assets, a cost-conscious team, providing quality service to our customers and a winning combination for our partners.

I will now turn the call over to Phil Cook, our Chief Financial Officer, to walk you through the financial results. Phil?

Phil Cook

Thank you, Toby, and good morning. As all of you know, Quicksilver Gas Services became a public entity on August the 10th, 2007. In the S-1 we made a forecast of results of operations and minimum estimated EBITDA for the four quarters post the IPO date, which includes the quarter in which we went public. In other words, the forecast period in the S-1 was from July 1, 2007 to June 30, 2008. Today, if I refer to our forecast, it is the forecast included in the S-1.

For the second quarter of 2008, the company reported net income of $5.6 million, compared to $2.9 million in the previous quarter, a sequential increase of 93%. More importantly, EBITDA was $11.5 million for the second quarter of 2008, up nearly 37% from the $8.4 million of EBITDA generated in the 2008 first quarter.

Distributable cash flow for the quarter was $10.5 million as compared to distributable cash flow in the 2008 first quarter of $7.7 million, a 36% increase. For the 12 months ended June 30, 2008 distributable cash flow was forecast to be approximately $32 million and the actual came in at $31.6 million, right on top of our forecast.

Total gathered volumes for the second quarter of 2008 were 188 MMcf per day compared with gathered volumes for the previous quarter of 160 MMcf per day, a 17.5% increase and at the upper end of our guidance range.

Total processed volumes for the second quarter of 2008 were 160 MMcf a day compared with process volumes for the previous quarter of 134 MMcf a day, a 19% increase.

With respect to third party volumes, actual results for the second quarter of 2008 showed that third party gathered volumes were approximately 22% of total gathered volumes or 40 MMcf a day, and third party processed volumes were approximately 20% or 31 MMcf a day of our total processed volumes.

Revenue for the second quarter of 2008 as compared to the prior quarter increased $3 million, from $15.2 million in the first quarter of 2008 to $18.2 million in the current quarter.

Operating expenses, excluding depreciation for the quarter were $5.3 million compared to $5 million in the prior quarter.

The increase in revenues from the prior quarter, offset by a slight increase in expenses, resulted in significantly higher income in the second quarter as compared to the first quarter of this year.

Cash operating expense per unit for the quarter was $0.39 per Mcf of gathered volume as compared to $0.47 per Mcf of gathered volume in the prior quarter. So as you can see, sequentially we've improved our unit cost metrics by 17%.

G&A on a unit basis for the second quarter of 2008 was $0.08 as compared to $0.12 in the previous quarter. These improved results in operating expense and G&A reflect the continued growth in well connections to our system from Quicksilver Resources, as well as other third party producers as they end the increased utilization of the cryogenic facility in Hood County.

A little bit on liquidity. During the quarter the company spent gross $54.2 million on capital expenditures and accruals and increased the amount outstanding on its credit facility by approximately $27 million and its repurchase obligation to the parent by approximately $27 million as well.

At quarter-end, the available capacity on the revolving credit facility is $83.8 million. The capacity on the revolver is capped at $150 million under our agreement with the banks. During the third quarter we intend to request an increase in the borrowing base of our credit facility in accordance with that agreement. Our borrowing capacity will continue to be dependent on our EBITDA generation.

With respect to a little guidance for the third quarter, you should expect the following. Gathered volumes should be in the range of 220 MMcf a day to 230 MMcf a day. Processed volumes should be in a range of 165 MMcf a day to 175 MMcf a day.

Operating costs, excluding depreciation should be in a range of $0.27 to $0.28 per unit of gathered volume. Depreciation should be in the range of $0.17 per unit to $0.19 per unit of gathered volume and G&A expense should be in a range of $0.06 per unit to $0.08 per unit of gathered volume.

And now I'll turn the call back over to Rick for questions.

Rick Buterbaugh

Thanks, Phil. Jennifer, at this time we'd like to open the call to any questions.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from Mark Reichman.

Mark Reichman – Sanders Morris Harris

Good morning. Just a couple of questions. In the first quarter it looked like you connected 34 wells and then this second quarter 57, and I know the parent was planning to drill 200 or 220 this year. How do you see your well connects growing over the next couple of quarters?

Toby Darden

Well, we see them staying flat to increasing from here on out. I think Quicksilver Resources is still on target to have the total number of wells predicted.

Phil Cook

Yes, I'd say, Mark, that it's anywhere from 55 wells to 65 wells a quarter is what your anticipation should be.

Mark Reichman – Sanders Morris Harris

55 wells to 60 wells?

Phil Cook

Yes.

Mark Reichman – Sanders Morris Harris

Yes, that's kind of what I was thinking. The other question I had was, the number of wells connected went up, but CapEx looked like it went down versus the first quarter. Could you just kind of maybe give me a little bit of a primer in terms of how you're spending your CapEx and how it relates to the well connects and the gathering lines?

Phil Cook

Yes. Our capital is a bit lumpy and it's lumpy because we're in the process of building a new plant at the northern end of the Barnett acreage, so we had some front-end loaded capital with respect to that plant. Well connects are pretty even throughout the year and I think for budget purposes we used about $100,000 per well to $115,000 per well connect with respect to the capital that it cost. Of course, the plant is a significant expenditure. So depending on when payments are made is when that capital is recorded, made and/or committed to.

Mark Reichman – Sanders Morris Harris

I see. And just looking, it looks like your third party volumes are growing, I mean just versus the first quarter, the growth in revenue, I mean parent company versus third-party, on a percentage basis, the third-party revenues grew pretty handsomely. How do you see those – how do you see third-party volumes and revenues developing moving forward?

Phil Cook

I would say for the rest of the year third-party vol – first of all, I guess I'd say we've done a great job bringing third-party volume into this system and at the time that we were building the system we had a lot of people telling us that third parties wouldn't bring their gas to us. The fact of the matter is a lot of those third parties don't really have a choice, because they happen to have acreage right along our pipe. But, what I'd say with respect to the rest of the year from a volumetric point of view, I would expect third-party volume to stay pretty flat until the Corvette plant comes on.

Mark Reichman – Sanders Morris Harris

Okay. And then just lastly, could you provide some color on your decision on Pathfinder?

Toby Darden

Sure. Mark, we looked at the returns, the costs were going up, steel was rising, we think it's a good project and will be a great project for the remaining participants. But we also looked at the opportunities of growing more resources right here, or more assets right here in our backyard and it appeared like the Alliance project would give us plenty of things to work on here for the next little while, and the rates of return were higher. So it was a pretty easy decision for us.

Mark Reichman – Sanders Morris Harris

Okay, great. Thank you very much.

Operator

(Operator instructions) Your next question comes from Xin Liu.

Xin Liu – JPMorgan

Good morning.

Toby Darden

Good morning.

Phil Cook

Good morning.

Xin Liu – JPMorgan

Regarding the did I hear you right that you said you're going to acquire the assets in Lake Arlington by year-end in Tarrant County?

Toby Darden

We are looking at that as a timeframe, Xin.

Phil Cook

And it's actually in Denton and Wise County – Lake Arlington, I'm sorry, Tarrant County.

Xin Liu – JPMorgan

Okay, so both assets?

Phil Cook

Yes, we're looking at both of those.

Xin Liu – JPMorgan

Okay. Can you give us an update on the CapEx spend on Lake Arlington?

Phil Cook

For the rest of the year or what currently has been spent?

Xin Liu – JPMorgan

Has been spent?

Phil Cook

The capital that's been spent to-date is about $36 million through the end of June. And of course, that gathering system is not complete. We're completing it as we drill wells there. So I anticipate spending maybe another $35 million there.

Xin Liu – JPMorgan

Okay. And also on the Cowtown Pipeline and Hill County system, when do you expect those assets to come into KGS?

Phil Cook

Cowtown pipeline is in KGS. Hill County –

Xin Liu – JPMorgan

The part of Cowtown that's under the repurchase agreement.

Phil Cook

Those pipes are connected to the system and so KGS has the option to bring those laterals in or not. With respect to Lake Arlington and Hill County, it's an obligation on their part once commercial service has been commenced. So they're a little different. So, we absolutely anticipate that Arlington comes into KGS as well as Hill County at some point in time. Hill County may come in this year, it may be in 2009. The other laterals on the Cowtown system, we don't anticipate any of those today coming in, in the next quarter, let's say, but we look at those all the time with respect to their profitability.

Xin Liu – JPMorgan

Okay. And how do you plan to finance the acquisition?

Phil Cook

Initially, we'll use our revolver. And as I said, we've got $83.8 million available on the revolver at the end of June. We'll go for redetermination either in the third or fourth quarter and as you know, that revolver is based on our EBITDA generation, which continues to grow at a fairly good clip.

Xin Liu – JPMorgan

Okay. And on your note payable to the parent, I know you guys are not paying cash interest right now. When do you expect to pay cash interest on those?

Phil Cook

We will refinance the obligation to the parent with the credit facility and as soon as we draw on the credit facility we'll be paying cash interest.

Xin Liu – JPMorgan

For the notes payable, the $50 million subnotes payable to the parent?

Phil Cook

The $50 million gets paid over a set period of time with respect to the agreement that we've got in place and I think at the end of 2008 we have to begin making cash interest payments on that note.

Xin Liu – JPMorgan

Okay. Thanks.

Phil Cook

Thank you.

Toby Darden

Thank you, Xin.

Operator

There are no further questions.

Rick Buterbaugh

All right, thanks, Jennifer. Just as a reminder, a replay of this call will be available on the company's Web site for 30 days. Quicksilver Gas Services will release our third quarter 2008 earnings on Wednesday, November 5th. I'd like to thank you for your time and interest in Quicksilver Gas Services this morning. This concludes our call.

Operator

This concludes today's conference call. You may now disconnect.

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