S-1 1 d425210ds1.htm FORM S-1 Form S-1
Table of Contents
Index to Financial Statements

As filed with the Securities and Exchange Commission on December 31, 2012

Registration No. 333-            

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

New Source Energy Partners L.P.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   1311   38-3888132

(State or other jurisdiction of

incorporation or organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(IRS Employer

Identification Number)

914 North Broadway, Suite 230

Oklahoma City, Oklahoma 73102

(405) 272-3028

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

 

 

Kristian B. Kos

President and Chief Executive Officer

New Source Energy GP, LLC

914 North Broadway, Suite 230

Oklahoma City, Oklahoma 73102

(405) 272-3028

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

 

Copies to:

David P. Oelman

Jeffery K. Malonson

Vinson & Elkins L.L.P.

1001 Fannin, Suite 2500

Houston, Texas 77002

(713) 758-2222

 

Roger A. Stong

James W. Larimore

Crowe & Dunlevy, A Professional Corporation

20 North Broadway, Suite 1800

Oklahoma City, Oklahoma 73102

(405) 235-7700

 

 

Approximate date of commencement of proposed sale to the public: As soon as practicable after this Registration Statement becomes effective.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  ¨

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   x  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

 

 

CALCULATION OF REGISTRATION FEE

 

 

Title of Each Class of

Securities to be Registered

  Proposed Maximum
Aggregate Offering Price(1)(2)
 

Amount of

Registration Fee

Common units representing limited partner interests

  $106,260,000   $14,494

 

(1) Includes common units issuable upon exercise of the underwriters’ option to purchase additional common units.
(2) Estimated solely for the purpose of calculating the registration fee pursuant to Rule 457(o).

 

 

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine.

 

 

 


Table of Contents
Index to Financial Statements

The information in this preliminary prospectus is not complete and may be changed. These securities may not be sold until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell nor does it seek an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.

 

SUBJECT TO COMPLETION DATED DECEMBER 31, 2012

PRELIMINARY PROSPECTUS

LOGO

New Source Energy Partners L.P.

 

                 Common Units

Representing Limited Partner Interests

 

 

This is the initial public offering of our common units. No public market currently exists for our common units. We currently estimate that the initial public offering price per common unit will be between $          and $          per common unit. We intend to apply to list our common units on the New York Stock Exchange under the symbol “NSLP.”

Investing in our common units involves risks. Please read “Risk Factors” beginning on page 26.

These risks include the following:

 

   

We may not have sufficient cash flow from operations to pay the minimum quarterly distribution on our common units following the establishment of cash reserves and payment of fees and expenses, including payments to our general partner and its affiliates.

 

   

Our estimated oil and natural gas reserves will naturally decline over time, and we may be unable to sustain distributions at the level of our minimum quarterly distribution.

 

   

Oil, natural gas and natural gas liquids prices are very volatile and a decline in oil, natural gas or natural gas liquids prices could cause us to reduce our distributions or cease paying distributions altogether.

 

   

Our general partner and its affiliates will own a controlling interest in us and will have conflicts of interest with, and owe limited fiduciary duties to, us, which may permit them to favor their own interests to the detriment of our unitholders.

 

   

New Source Energy Corporation and other affiliates of our general partner will not be limited in their ability to compete with us.

 

   

Neither we nor our general partner have any employees and we will rely solely on the employees of certain of our affiliates to manage our business. The management team of New Source Energy Corporation, which includes the individuals who will manage us, will also perform substantially similar services for itself and will own and operate its own assets, and thus will not be solely focused on our business.

 

   

Our unitholders have limited voting rights and are not entitled to elect our general partner or its board of directors.

 

   

Our unitholders will experience immediate and substantial dilution of $         per unit.

 

   

Our tax treatment depends on our status as a partnership for federal income tax purposes.

 

   

Our unitholders will be required to pay taxes on their share of our income even if they do not receive any cash distributions from us.

In addition, we qualify as an “emerging growth company” as defined in Section 2(a)(19) of the Securities Act of 1933 and, as such, are allowed to provide in this prospectus more limited disclosures than an issuer that would not so qualify. Furthermore, for so long as we remain an emerging growth company, we will qualify for certain limited exceptions from investor protection laws such as the Sarbanes Oxley Act of 2002 and the Investor Protection and Securities Reform Act of 2010. Please read “Risk Factors” and “Summary—Emerging Growth Company Status.”

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

 

 

 

    Per
Common Unit
    Total  

Public offering price

  $                           $                

Underwriting discount(1)

  $        $     

Proceeds, before expenses, to New Source Energy Partners L.P.

  $        $     

 

(1) Excludes an aggregate structuring fee equal to 0.50% of the gross proceeds of this offering, as well as a financial advisory fee, payable to Robert W. Baird & Co. Incorporated. Please read “Underwriting.”

To the extent that the underwriters sell more than              common units in this offering, the underwriters have the option to purchase up to an additional              common units on the same terms and conditions as set forth above.

The underwriters expect to deliver the common units on or about                     , 2013.

 

 

 

Baird   Stifel Nicolaus Weisel
BMO Capital Markets   Oppenheimer & Co.
Janney Montgomery Scott    
  Stephens Inc.  
    Wunderlich Securities

                    , 2013


Table of Contents
Index to Financial Statements

TABLE OF CONTENTS

 

     Page  

SUMMARY

     1   

Overview

     1   

Our Properties

     2   

Our Development Agreement with the New Source Group

     3   

New Source Group’s Specialized Processes

     4   

Our Hedging Strategy

     4   

Our Relationship with the New Source Group

     5   

Our Business Strategies

     6   

Our Competitive Strengths

     7   

Risk Factors

     8   

Our Partnership Structure and Formation Transactions

     9   

Emerging Growth Company Status

     13   

Non-GAAP Financial Measure

     22   

RISK FACTORS

     26   

Risks Related to Our Business

     26   

Risks Related to Our Indebtedness

     38   

Risks Inherent in an Investment in Us

     40   

Tax Risks to Unitholders

     52   

USE OF PROCEEDS

     56   

CAPITALIZATION

     57   

DILUTION

     58   

OUR CASH DISTRIBUTION POLICY AND RESTRICTIONS ON DISTRIBUTIONS

     59   

General

     59   

Our Minimum Quarterly Distribution

     61   

Unaudited Pro Forma Available Cash for the Year Ended December  31, 2011 and Twelve Months Ended September 30, 2012

     63   

Estimated Adjusted EBITDA for the Year Ending December 31, 2013

     67   

Assumptions and Considerations

     72   

Sensitivity Analysis

     78   

PROVISIONS OF OUR PARTNERSHIP AGREEMENT RELATING TO CASH DISTRIBUTIONS

     82   

Distributions of Available Cash

     82   

Operating Surplus and Capital Surplus

     83   

Capital Expenditures

     85   

Subordination Period

     87   

Distributions of Available Cash from Operating Surplus During the Subordination Period

     89   

Distributions of Available Cash from Operating Surplus After the Subordination Period

     90   

General Partner Interest and Incentive Distribution Rights

     90   

Percentage Allocations of Available Cash from Operating Surplus

     91   

General Partner’s Right to Reset Incentive Distribution Levels

     91   

Distributions from Capital Surplus

     94   

Adjustment to the Minimum Quarterly Distribution and Target Distribution Levels

     94   

Distributions of Cash Upon Liquidation

     95   

SELECTED HISTORICAL FINANCIAL DATA

     97   

Non-GAAP Financial Measure

     99   

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     100   

Overview

     100   

How We Conduct Our Business and Evaluate Our Operations

     101   

Outlook

     104   

Results of Operations

     105   

 

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Table of Contents
Index to Financial Statements
     Page  

Liquidity and Capital Resources

     110   

Quantitative and Qualitative Disclosure About Market Risk

     115   

Critical Accounting Policies and Estimates

     117   

Inflation

     120   

Off-Balance Sheet Arrangements

     120   

BUSINESS AND PROPERTIES

     121   

Overview

     121   

Our Properties

     121   

Our Development Agreement with the New Source Group

     123   

New Source Group’s Specialized Processes

     124   

Our Hedging Strategy

     124   

Our Relationship with the New Source Group

     125   

Our Business Strategies

     126   

Our Competitive Strengths

     127   

Our Operations

     128   

Specialized Processes

     129   

Proved Undeveloped Reserves

     131   

Independent Reserve Engineers

     132   

Technology Used to Establish Proved Reserves

     132   

Internal Controls over Reserves Estimation Process

     133   

Operating Data

     133   

Principal Customers

     134   

Productive Wells

     134   

Acreage

     135   

Drilling Activity

     135   

Hedging Activity

     136   

Material Definitive Agreements

     136   

Title to Properties

     137   

Regulation of the Oil and Natural Gas Industry

     137   

Employees

     143   

Legal Proceedings

     143   

Insurance Matters

     143   

MANAGEMENT

     144   

Management of New Source Energy Partners L.P.

     144   

Board Leadership Structure and Role in Risk Oversight

     145   

Directors and Executive Officers

     146   

Committees of the Board of Directors

     148   

Reimbursement of Expenses

     149   

Executive Compensation

     149   

Long-Term Incentive Plan

     150   

Director Compensation

     154   

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     155   

CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS

     156   

Distributions and Payments to Our General Partner and Its Affiliates

     156   

Agreements Governing the Transactions

     158   

Relationships with Members of the New Source Group

     159   

Transactions with Promoters

     160   

Review, Approval or Ratification of Transactions with Related Persons

     160   

CONFLICTS OF INTEREST AND FIDUCIARY DUTIES

     162   

Conflicts of Interest

     162   

Fiduciary Duties

     169   

DESCRIPTION OF THE COMMON UNITS

     172   

The Units

     172   

 

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Table of Contents
Index to Financial Statements
     Page  

Transfer Agent and Registrar

     172   

Transfer of Common Units

     172   

THE PARTNERSHIP AGREEMENT

     174   

Organization and Duration

     174   

Purpose

     174   

Cash Distributions

     174   

Capital Contributions

     174   

Limited Voting Rights

     175   

Applicable Law; Forum, Venue and Jurisdiction

     176   

Limited Liability

     176   

Issuance of Additional Securities

     177   

Amendment of the Partnership Agreement

     178   

Merger, Consolidation, Conversion, Sale or Other Disposition of Assets

     180   

Termination and Dissolution

     181   

Liquidation and Distribution of Proceeds

     181   

Withdrawal or Removal of Our General Partner

     181   

Transfer of General Partner Units

     183   

Transfer of Incentive Distribution Rights

     183   

Transfer of Ownership Interests in Our General Partner

     183   

Change of Management Provisions

     183   

Limited Call Right

     183   

Meetings; Voting

     184   

Status as Limited Partner

     184   

Non-Citizen Assignees; Redemption

     184   

Non-Taxpaying Assignees; Redemption

     185   

Indemnification

     185   

Reimbursement of Expenses

     185   

Books and Reports

     186   

Right to Inspect Our Books and Records

     186   

Registration Rights

     187   

UNITS ELIGIBLE FOR FUTURE SALE

     188   

MATERIAL TAX CONSEQUENCES

     189   

Taxation of the Partnership

     189   

Tax Consequences of Unit Ownership

     191   

Tax Treatment of Operations

     195   

Disposition of Units

     199   

Uniformity of Units

     201   

Tax-Exempt Organizations and Other Investors

     202   

Administrative Matters

     203   

State, Local and Other Tax Considerations

     204   

INVESTMENT IN NEW SOURCE ENERGY PARTNERS L.P. BY EMPLOYEE BENEFIT PLANS

     205   

UNDERWRITING

     207   

VALIDITY OF THE COMMON UNITS

     212   

EXPERTS

     212   

WHERE YOU CAN FIND MORE INFORMATION

     212   

FORWARD-LOOKING STATEMENTS

     213   

INDEX TO FINANCIAL STATEMENTS

     F-1   

Appendix A

 

First Amended and Restated Agreement of Limited Partnership of New Source Energy Partners L.P.

 

Appendix B

  Glossary of Terms  

Appendix C

  Ralph E. Davis Associates, Inc. Summary of July 1, 2012 Reserves  

 

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Index to Financial Statements

You should rely only on the information contained in this prospectus. We have not, and the underwriters have not, authorized anyone to provide you with different information. If anyone provides you with different or inconsistent information, you should not rely on it. We are not, and the underwriters are not, making an offer to sell these securities in any jurisdiction where an offer or sale is not permitted.

Through and including                     , 2013 (25 days after the date of this prospectus), all dealers that effect transactions in our common units, whether or not participating in this offering, may be required to deliver a prospectus. This delivery is in addition to a dealer’s obligation to deliver a prospectus when acting as an underwriter and with respect to their unsold allotments or subscriptions.

This prospectus contains forward-looking statements that are subject to a number of risks and uncertainties, many of which are beyond our control. Please read “Risk Factors” and “Forward-Looking Statements.”

Industry and Market Data

The market data and certain other statistical information used throughout this prospectus are based on independent industry publications, government publications or other published independent sources. Some data is also based on our good faith estimates. Although we believe these third-party sources are reliable and that the information is accurate and complete, we have not independently verified the information.

Commonly Used Defined Terms

As used in this prospectus, unless we indicate otherwise, the following terms have the following meanings:

 

   

“we,” “our,” “us” or like terms refer collectively to New Source Energy Partners L.P. and its subsidiaries;

 

   

“our general partner” refers to New Source Energy GP, LLC, our general partner;

 

   

our “partnership agreement” refers to the amended and restated partnership agreement to be adopted prior to the closing of this offering, a form of which is included in this prospectus as Appendix A;

 

   

“New Source Energy” refers to New Source Energy Corporation on a stand-alone basis;

 

   

“New Dominion” refers to New Dominion, LLC, the entity that serves as the contract operator for New Source Energy and provides certain operational services to both us and New Source Energy;

 

   

“Scintilla” refers to Scintilla, LLC, the entity from which New Source Energy acquired substantially all of its assets in August 2011, including the Partnership Properties (defined below);

 

   

“New Source Group” collectively refers to New Source Energy, New Dominion and Scintilla; however, when used in the context of the development agreement described in this prospectus, the New Source Group refers to the parties (other than us) party thereto;

 

   

“Partnership Properties” or “our properties” refers to the properties, producing wells, and related oil and natural gas interests to be contributed to us by New Source Energy in connection with this offering; and

 

   

“our management,” “our employees,” or similar terms refer to the management of New Source Energy or the personnel of the New Source Group who perform operational and administrative services on behalf of us and our general partner under an omnibus agreement among us, our general partner and the New Source Group.

We include a glossary of some of the oil and natural gas industry terms used in this prospectus in Appendix B.

 

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Index to Financial Statements

SUMMARY

This summary highlights information contained elsewhere in this prospectus. You should read the entire prospectus carefully, including “Risk Factors” beginning on page 26 and the historical financial statements and the notes to those financial statements. The information presented in this prospectus assumes (i) an initial public offering price of $         per common unit (the midpoint of the price range set forth on the cover of this prospectus) and (ii) unless otherwise indicated, that the underwriters do not exercise their option to purchase up to          additional common units, unless otherwise indicated.

Unless we indicate otherwise, our financial, reserve and operating information in this prospectus reflects the results and financial position attributable to the Partnership Properties and is presented on a historical basis, without giving effect to this offering and the other transactions contemplated by this prospectus, including the formation transactions described in “—Our Partnership Structure and Formation Transactions.” The estimated proved reserve information for the Partnership Properties as of June 30, 2012 contained in this prospectus is based on a report prepared by Ralph E. Davis Associates, Inc., our independent reserve engineers, a summary of which is included in this prospectus as Appendix C. We refer to this report as our “reserve report.”

New Source Energy Partners L.P.

Overview

We are a Delaware limited partnership formed in October 2012 by New Source Energy to own and acquire oil and natural gas properties in the United States. Our primary business objective is to generate stable cash flows, allowing us to make quarterly cash distributions to our unitholders and, over time, to increase those quarterly cash distributions. Our properties consist of non-operated working interests in the Misener-Hunton formation (the “Hunton Formation”), a conventional resource reservoir located in east-central Oklahoma. This formation has a 90-year history of exploration and development and thousands of wellbore penetrations that have led to more accurate geologic mapping. The estimated proved reserves on our properties were approximately 14.2 MMBoe, as of June 30, 2012, of which approximately 58% were classified as proved developed reserves and of which approximately 76.4% were comprised of oil and natural gas liquids. Average net daily production from our properties during the nine months ended September 30, 2012 was 3,169 Boe/d, which is comprised of 171 Bbl/d of oil, 6,242 Mcf/d of natural gas and 1,958 Bbl/d of natural gas liquids. Based on net production from our properties for the six months ended June 30, 2012, the total proved reserves associated with our properties had a reserve to production ratio of 12.3 years. To mitigate the impact of commodity price volatility and thereby increase the predictability of our cash flow, New Source Energy will contribute to us, at the closing of this offering, commodity derivative contracts covering approximately 85% and 79% of our estimated total production for the years ending December 31, 2013 and 2014, respectively, based on production estimates contained in our reserve report.

As of June 30, 2012, we had 89,116 gross (31,554 net) acres, of which 6,796 gross (2,323 net) acres were undeveloped. As of June 30, 2012, we had 127 gross (28.5 net) proved undeveloped drilling locations, of which 66 gross (20.7 net) were infill drilling locations. Pursuant to a development agreement we will enter into at the closing of this offering, New Source Energy will have control over our drilling program and the sole right to determine which wells are drilled based on our annual drilling budget that will be determined and periodically updated by our general partner. Pursuant to our development agreement with the New Source Group, during each of our fiscal years ending December 31, 2013 through December 31, 2016, we have agreed to spend an average of $8.2 million to drill certain of our proved undeveloped locations and maintain our producing wells. Both we and New Source Energy believe that, by spending approximately $8.2 million annually from 2013 through 2016, we will be able to at least maintain our production at an average annual rate of 3,200 Boe/d through 2016.

 

 

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Index to Financial Statements

We believe our business relationship with the New Source Group will enhance our ability to grow our production and expand our proved reserves base over time. New Source Energy, an independent energy company engaged in the development and production of onshore oil and liquids-rich natural gas projects in the United States, owns a 50% membership interest in our general partner and will own approximately     % of our outstanding limited partner units, which includes all of our subordinated units. After giving effect to the formation transactions, New Source Energy had (i) total estimated proved reserves of 6.8 MMBoe as of June 30, 2012, of which approximately 85.1% were classified as proved undeveloped reserves, and (ii) interests in over 24,670 gross (12,368 net) acres of undeveloped properties. After additional capital is invested, we believe that many of these properties will become suitable for us, based on our criteria that suitable properties consist of mature onshore oil and natural gas reservoirs with long-lived, predictable production profiles.

Our Properties

Our properties are located in the Golden Lane field within the Hunton Formation of east-central Oklahoma and consist of mature, legacy oil and natural gas reservoirs. Our properties consist of non-operated working interests in producing and undeveloped leasehold acreage, including 215 gross (82.4 net) producing wells with working interests ranging from 21% to 87% (38.3% weighted average); and 127 gross (28.5 net) proved undeveloped drilling locations with working interests ranging from 1% to 84% (22.4% weighted average). As of June 30, 2012, we had 89,116 gross (31,554 net) acres in the Golden Lane field. Based on the production estimates from our reserve report and assuming our efforts to develop our properties are successful, our production in 2016 will be approximately 1,183.4 MBoe, or approximately 3,242 Boe/d, without (i) increasing the drilling schedule of our proved undeveloped properties, (ii) increasing our working interests in wells through forced pooling, or (iii) acquiring additional properties and production from either New Source Energy or third parties.

Currently, two rigs are being used to drill on properties owned by New Source Energy, including the Partnership Properties, and the number of rigs may be increased to up to six rigs over the next twelve months, some of which may be used to drill on the Partnership Properties. Over the past six years, the New Source Group has completed an average of 25 gross wells per year on properties currently held by New Source Energy, of which 132 gross wells were completed as a portion of the Partnership Properties.

The following table summarizes information related to our estimated oil and natural gas reserves as of June 30, 2012 and the average net production for the nine months ended September 30, 2012 from our properties.

 

    Estimated Proved Reserves
as of June 30, 2012 (1)
    Production for the Nine
Months Ended September
30, 2012
    Number of
Wells/Drilling
Locations as of
June 30, 2012
 
    Total
Proved
(MBoe)
    Percent
of
Total
    Percent
Oil
    Percent
NGLs
    Percent
Natural
Gas
    Percentage
of
Depletion (2)
    PV-10
(MM)(3)
    Average Net
Daily
Production
(Boe/d)
    Average
Working
Interest
    Gross     Net  

Proved developed reserves

    8,179.3        57.5     2.8     73.6     23.6     74   $ 120.9        3,169        38.3     215        82.4   

Proved undeveloped reserves

    6,037.1        42.5     4.8     60.5     34.7     —          40.9        —          22.4     127        28.5   
 

 

 

   

 

 

           

 

 

   

 

 

     

 

 

   

 

 

 

Total

    14,216.4        100.0     3.6     68.1     28.3     62   $ 161.8        3,169        32.4     342        110.9   
 

 

 

   

 

 

           

 

 

   

 

 

     

 

 

   

 

 

 

 

(1)

Proved reserves were calculated using prices equal to the twelve-month unweighted arithmetic average of the first-day-of-the-month price for each of the preceding twelve months, which were $95.67 per Bbl of crude oil, $40.57 per Bbl of natural gas liquids and $3.15 per Mcf of natural gas. Adjustments were made

 

 

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Index to Financial Statements
  for location and the grade of the underlying resource, which resulted in an average decrease of $2.92 per Bbl of crude oil, an average decrease of $1.24 per Bbl of natural gas liquids and an average decrease of $0.09 per Mcf of natural gas.
(2) Percentage of depletion was calculated by dividing cumulative production from our properties in these fields by the sum of proved reserves attributable to such properties and cumulative production from such properties.
(3) PV-10 is a non-GAAP financial measure and represents the present value of estimated future cash inflows from proved oil and natural gas reserves, less future development and production costs, discounted at 10% per annum to reflect timing of future cash flows and using the twelve-month unweighted arithmetic average of the first-day-of-the-month price for each of the preceding twelve months. PV-10 typically differs from the Standardized Measure of Discounted Future Net Cash Flows (“Standardized Measure”) because it does not include the effects of income tax. We were formed in October 2012 as a partnership that is not treated as a taxable entity for federal income tax purposes and, as a result, our PV-10 and Standardized Measure will be equivalent at future dates. Neither PV-10 nor Standardized Measure represents an estimate of fair market value of our natural gas and crude oil properties. PV-10 is used by the industry and by our management as an arbitrary reserve asset value measure to compare against past reserve bases and the reserve bases of other business entities that are not dependent on the taxpaying status of the entity.

Our Development Agreement with the New Source Group

We will enter into a development agreement with the New Source Group at the closing of this offering with respect to the drilling of our proved undeveloped reserves that comprise a portion of the Partnership Properties. Pursuant to the development agreement, our general partner will, at least annually and likely more frequently, at its discretion, determine our drilling budget. New Source Energy will then have the sole right to determine which wells are drilled based on our drilling budget. As of June 30, 2012, the Partnership Properties included 6.0 MMBoe of estimated proved undeveloped reserves, and we had identified 127 gross (28.5 net) drilling locations for prospective development, of which 66 gross (20.7 net) are infill drilling locations.

Pursuant to the development agreement, during each of our fiscal years ending December 31, 2013 through December 31, 2016, we have agreed to pay New Source Energy an average of $8.2 million to drill certain of our proved undeveloped locations and maintain our producing wells. Both we and New Source Energy believe that, by spending approximately $8.2 million annually from 2013 through 2016, we will be able to maintain our producing wells and drill a number of wells sufficient to at least maintain our production at an average annual rate of 3,200 Boe/d through 2016.

While we have committed to spending an average of $8.2 million annually from 2013 through 2016 pursuant to the development agreement, we intend to spend additional amounts in order to grow our production over time through drilling additional proved undeveloped properties, increasing our working interests in wells through forced pooling and acquiring properties from both New Source Energy and third parties. While we do not currently have an acquisition budget, nor do we assume forced pooling in our reserve reports, our reserve report assumes that we will spend an average of approximately $8.2 million annually from 2013 through 2016 on the development of our proved undeveloped properties and any maintenance of our producing wells, resulting in a production estimate for the year ending December 31, 2016 of 3,242 Boe/d.

Finally, beginning with the first quarter of 2014 and continuing through the fourth quarter of 2016, if our average production declines below 3,200 Boe/d for any preceding four quarter period, then holders of our subordinated units will not be entitled to receive the quarterly distributions otherwise payable on our subordinated units for such quarter. We expect that any funds not distributed to holders of our subordinated units will be reserved by the board of directors of our general partner for use in growing our production.

 

 

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New Source Group’s Specialized Processes

We believe that, through application of specialized processes outlined below, our properties are low risk due to predictable production profiles, long reserve lives and modest capital requirements. The New Source Group’s method of hydrocarbon recovery relies upon exploiting the reservoir through development, rather than exploration. The New Source Group’s technical team has geologic and engineering expertise in horizontal well design, submersible pump placement, fluid and hydrocarbon separation and saltwater disposal. We believe this experience allows us to realize production efficiencies utilizing methodologies that provide a predictable ultimate recovery of hydrocarbons. In developing properties in conventional resource plays, the New Source Group employs the following six essential components:

 

   

proper geologic assessment of the reservoir, which is facilitated by data from numerous existing well penetrations;

 

   

a well-trained and knowledgeable technical team to maintain efficient production;

 

   

strategic placement of wells to maximize the benefit of wells working in concert to create the appropriate draw down in reservoir pressure;

 

   

an economic high-volume saltwater transportation and disposal system;

 

   

abundant and economic high-current three-phase electrical power; and

 

   

a high-volume, liquids-rich gas gathering and processing system.

Our Hedging Strategy

New Source Energy will contribute to us, at the closing of this offering, commodity derivative contracts covering approximately 90% of our estimated oil and natural gas production from our total proved developed producing reserves as of June 30, 2012 and approximately 50% of our estimated oil and natural gas production from our total proved undeveloped reserves as of June 30, 2012 for the years ending December 31, 2013, 2014, 2015 and 2016, based on production estimates contained in our reserve report. In addition, New Source Energy will contribute to us, at the closing of this offering, commodity derivative contracts covering approximately 90% of our estimated NGL production from our total proved developed producing reserves as of June 30, 2012 and approximately 50% of our estimated NGL production from our total proved undeveloped reserves as of June 30, 2012 for the years ending December 31, 2013 and 2014, based on production estimates contained in our reserve report. We expect that as the market for NGL-based commodity derivative contracts becomes more developed over time, our ability to cover future NGL production beyond the two-year horizon in place at the closing of this offering will be strengthened. We expect the commodity derivative contracts contributed to us at the closing of this offering will cover approximately 85% and 79% of our estimated total production for the years ending December 31, 2013 and 2014, respectively, based on production estimates contained in our reserve report.

Following the closing of this offering, we expect to adopt a hedging policy designed to reduce the impact to our cash flows from commodity price volatility. Under this policy, we intend to enter into commodity derivative contracts covering approximately 60% to 90% of our estimated total production over a three-to-five year period at any given point in time. We may, however, from time to time hedge more or less than this approximate range.

Our commodity derivative contracts may consist of natural gas, oil and NGL financial swaps, put options and/or collar contracts and natural gas basis financial swaps. By removing a significant portion of price volatility associated with production, we believe we will mitigate, but not eliminate, the potential negative effects of reductions in commodity prices on our cash flow from operations for those periods. However, our hedging activity may also reduce our ability to benefit from increases in commodity prices. Additionally, we intend to individually identify these non-speculative hedges as “designated hedges” for U.S. federal income tax purposes as we enter into them. For a description of our commodity derivative contracts, please read “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Commodity Derivative Contracts.”

 

 

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Our Relationship with the New Source Group

New Source Energy is controlled by its principal stockholder, chairman and senior geologist, David J. Chernicky. Mr. Chernicky also owns all of the membership interests in New Dominion and Scintilla. Mr. Chernicky has historically acquired oil and natural gas properties through Scintilla, and New Dominion has acted as the operator for properties held by Scintilla for over 12 years, completing and economically producing from more than 98% of all wells it has drilled in the Hunton Formation. New Source Energy acquired substantially all of its assets from Scintilla in August 2011, including the Partnership Properties. Following the closing of this offering, New Source Energy will be our largest unitholder, holding              common units (approximately     % of all outstanding) and              subordinated units (100% of all outstanding), and will own 50% of the membership interests in our general partner.

The following table summarizes information by field regarding New Source Energy’s estimated oil and natural gas reserves as of June 30, 2012 and its average net production for the nine months ended September 30, 2012, after giving effect to New Source Energy’s contribution of the Partnership Properties to us.

 

Field   

Estimated Proved Reserves as of

June 30, 2012(1)

   

Production for the Nine
Months Ended
September 30, 2012

   

Projected
Undeveloped Drilling
Locations as of
June 30, 2012

 
   Total
Proved
(MBoe)
     Percent
of Total
    Percent
Proved
Developed
    Percent Oil     Percent
NGLs
    Average
Net Daily
Production
(Boe/d)
     Percent
of Total
    Gross      Net  

Golden Lane Extension

     1,939.5         28.7     —          3.4     59.9     —           —          105         8.3   

Luther

     4,825.1         71.3     20.9     2.5     35.7     215         100     59         14.5   
  

 

 

    

 

 

         

 

 

    

 

 

   

 

 

    

 

 

 

Total

     6,764.6         100     14.9     2.8     42.6     215         100     164         22.8   
  

 

 

    

 

 

         

 

 

    

 

 

   

 

 

    

 

 

 

 

(1) Proved reserves were calculated using prices equal to the twelve-month unweighted arithmetic average of the first-day-of-the-month price for each of the preceding twelve months, which were $95.67 per Bbl of crude oil, $40.57 per Bbl of natural gas liquids and $3.15 per Mcf of natural gas. Adjustments were made for location and the grade of the underlying resource, which resulted in an average decrease of $2.92 per Bbl of crude oil, an average decrease of $1.24 per Bbl of natural gas liquids and an average decrease of $0.09 per Mcf of natural gas.

As a result of its significant ownership interests in us and our general partner, we believe New Source Energy will be motivated to support the successful execution of our business strategy and will provide us with opportunities to pursue acquisitions that will be accretive to our unitholders. New Source Energy views our partnership as part of its growth strategy, and we believe that New Source Energy will be incentivized to contribute or sell additional assets to us and to pursue acquisitions jointly with us in the future. However, New Source Energy will regularly evaluate acquisitions and dispositions and may elect to acquire or dispose of properties in the future without offering us the opportunity to participate in those transactions. Moreover, after this offering, New Source Energy will continue to be free to act in a manner that is beneficial to its interests without regard to ours, which may include electing not to present us with future acquisition opportunities. Although we believe New Source Energy will be incentivized to offer properties to us for purchase, New Source Energy has no obligation to sell or offer properties to us following the closing of this offering. If New Source Energy fails to present us with, or successfully competes against us for, acquisition opportunities, then our ability to replace or increase our estimated proved reserves may be impaired, which would adversely affect our cash flow from operations and our ability to make cash distributions to our unitholders. Please read “Conflicts of Interest and Fiduciary Duties.”

 

 

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Our Business Strategies

Our primary business objective is to generate stable cash flows, allowing us to make quarterly cash distributions to our unitholders and, over time, to increase those quarterly cash distributions. To achieve our objective, we intend to execute the following business strategies:

 

 

Develop Existing Proved Undeveloped Inventory Pursuant to Our Development Agreement with the New Source Group. As of June 30, 2012, the Partnership Properties, all of which were located in our Golden Lane field, included 6.0 MMBoe of estimated proved undeveloped reserves through 127 gross (28.5 net) proved undeveloped drilling locations, of which 66 gross (20.7 net) were infill drilling locations. Pursuant to the development agreement, during each of our fiscal years ending December 31, 2013 through December 31, 2016, we have agreed to pay New Source Energy an average of $8.2 million to drill certain of our proved undeveloped locations and maintain our producing wells. Both we and New Source Energy believe that, by spending approximately $8.2 million annually from 2013 through 2016, we will be able to maintain our producing wells and drill a number of wells sufficient to at least maintain our production at an average annual rate of 3,200 Boe/d through 2016. Although we have committed to spending an average of $8.2 million annually through 2016 pursuant to the development agreement, we intend to spend additional amounts in order to grow our production over time through (i) drilling additional proved undeveloped properties, (ii) increasing our working interests in wells through forced pooling, and (iii) acquiring additional properties and production from either New Source Energy or third parties.

 

 

Reduce Exposure to Commodity Price Risk and Stabilize Cash Flow Through Commodity Hedging Policy. New Source Energy will contribute to us, at the closing of this offering, commodity derivative contracts covering approximately 90% of our estimated oil and natural gas production from our total proved developed producing reserves as of June 30, 2012 and approximately 50% of our estimated oil and natural gas production from our total proved undeveloped reserves as of June 30, 2012 for the years ending December 31, 2013, 2014, 2015 and 2016, based on production estimates contained in our reserve report. In addition, New Source Energy will contribute to us, at the closing of this offering, commodity derivative contracts covering approximately 90% of our estimated NGL production from our total proved developed producing reserves as of June 30, 2012 and approximately 50% of our estimated NGL production from our total proved undeveloped reserves as of June 30, 2012 for the years ending December 31, 2013 and 2014, based on production estimates contained in our reserve report. We expect that as the market for NGL-based commodity derivative contracts becomes more developed over time, our ability to cover future NGL production beyond the two-year horizon in place at the closing of this offering will be strengthened. We expect the commodity derivative contracts contributed to us at the closing of this offering will cover approximately 85% and 79% of our estimated total production for the years ending December 31, 2013 and 2014, respectively, based on production estimates contained in our reserve report. Following the closing of this offering, we expect to adopt a hedging policy designed to reduce the impact to our cash flows from commodity price volatility. Under this policy, we intend to enter into commodity derivative contracts covering approximately 60% to 90% of our estimated total production over a three-to-five year period at any given point in time.

 

 

Leverage Strategic Relationship with the New Source Group. We intend to maximize the benefits of our relationship with the New Source Group to help control our costs, access existing infrastructure at what we believe are favorable rates and acquire producing oil and natural gas properties that meet our acquisition criteria. After giving effect to the formation transactions, New Source Energy had (i) total estimated proved reserves of 6.8 MMBoe as of June 30, 2012, of which approximately 85.1% were classified as proved undeveloped reserves, and (ii) interests in over 24,670 gross (12,368 net) acres of undeveloped properties. After additional capital is invested, we believe that many of these properties will become suitable for us, based on our acquisition criteria. We may also have the opportunity to work jointly with New Source Energy to pursue certain acquisitions of oil and natural gas properties.

 

 

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Pursue Accretive Third Party Acquisitions of Long-Lived, Low-Risk, Producing Properties. Independent of the New Source Group, we intend to pursue acquisitions of third-party producing properties. We will pursue additional acquisition opportunities when we believe we possess a strategic or technical advantage due to our existing liquidity, operational experience and access to infrastructure.

For a more detailed description of our business strategies, please read “Business and Properties—Our Business Strategies” beginning on page 126.

Our Competitive Strengths

We believe that the following competitive strengths will allow us to successfully execute our business strategies and achieve our objective of generating and growing cash available for distribution:

 

 

Downside Protection through Development Agreement with the New Source Group. Pursuant to the development agreement, during each of our fiscal years ending December 31, 2013 through December 31, 2016, we have agreed to pay New Source Energy an average of $8.2 million to drill certain of our proved undeveloped locations and maintain our producing wells. Both we and New Source Energy believe that, by spending approximately $8.2 million annually from 2013 through 2016, we will be able to maintain our producing wells and drill a number of wells sufficient to at least maintain our production at an average annual rate of 3,200 Boe/d through 2016. Beginning with the first quarter of 2014 and continuing through the fourth quarter of 2016, if our average production declines below 3,200 Boe/d for any preceding four quarter period, then holders of our subordinated units will not be entitled to receive the quarterly distributions otherwise payable on our subordinated units for such quarter. We expect that any funds not distributed to holders of our subordinated units will be reserved by the board of directors of our general partner for use in our business.

 

 

Strong Hedge Portfolio. We expect the commodity derivative contracts contributed to us at the closing of this offering will cover approximately 85% and 79% of our estimated total production for the years ending December 31, 2013 and 2014, respectively, based on production estimates contained in our reserve report.

 

 

Incentivized Management Team with Proven Ability to Develop Conventional Resource Plays. Both New Source Energy and our management will have significant ownership stakes in us following completion of the IPO. New Source Energy will own approximately     % of our limited partner interests and 50% of our general partner, while Kristian B. Kos and David J. Chernicky will each own 25% of our general partner. Additionally, members of our management team collectively average over 25 years of industry experience, including our senior geologist, David J. Chernicky, who has over 28 years of experience in producing oil and natural gas from conventional resource plays in the area of our assets.

 

 

Strategic Relationship with the New Source Group. Our relationship with the New Source Group provides us with access to saltwater disposal and other key infrastructure at what we believe are favorable rates. The New Source Group has a strong track record, completing and economically producing from more than 98% of all wells it has drilled in the Hunton Formation since beginning to develop the play in 1999. This extensive knowledge and experience relating to the Hunton Formation also permits the New Source Group to more easily identify additional opportunities for the acquisition of prospective Hunton Formation interests.

 

 

Large, Multi-Year Drilling Inventory with Long-Lived, Predictable Production Profiles. As of June 30, 2012, we had 89,116 gross (31,554 net) acres, of which 6,796 gross (2,323 net) acres were undeveloped. As of June 30, 2012, we had 127 gross (28.5 net) proved undeveloped drilling locations, of which 66 gross (20.7 net) were infill drilling locations. The average productive life of our wells producing from the Hunton Formation (on 640-acre spacing) is 18.5 years. Our proved developed producing reserves have significant production history and predictable decline rates.

 

 

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Competitive Cost Structure. Pursuant to our omnibus agreement with the New Source Group, the New Source Group will provide us and our general partner with management and administrative services, and we will pay the New Source Group a quarterly fee of $675,000 from the closing of this offering until December 31, 2013. After December 31, 2013, in lieu of the quarterly fee, our general partner will reimburse the New Source Group, on a quarterly basis, for the actual direct and indirect expenses it incurs in its performance under the omnibus agreement, and we will reimburse our general partner for such payments it makes to the New Source Group. In addition, our position as non-operator and our ability to leverage our relationship as an affiliate of the New Source Group allow us to mitigate significant operating expenses. The New Source Group’s focus on conventional resource plays utilizing their specialized processes has resulted in low average all-in finding and development costs, including revisions, on the Partnership Properties of $6.00 per Boe over the three-year period ended December 31, 2011. These finding and development costs do not reflect or include the estimated future development costs associated with the proved undeveloped reserves attributable to the Partnership Properties.

For a more detailed discussion of our competitive strengths, please read “Business and Properties—Our Competitive Strengths” beginning on page 127.

Risk Factors

An investment in our common units involves risks. Below is a summary of certain key risk factors that you should consider in evaluating an investment in our common units. This list is not exhaustive. Please read the full discussion of these risks and other risks described under “Risk Factors” beginning on page 26.

Risks Related to Our Business

 

   

We may not have sufficient cash to pay the minimum quarterly distribution on our common units, following the establishment of cash reserves and payment of fees and expenses, including payments to our general partner and its affiliates.

 

   

We intend to rely on the New Source Group to execute our drilling program. If the New Source Group fails to or inadequately performs, our operations will be disrupted and our costs could increase or our reserves may not be developed, reducing our future levels of production and our cash from operations, which could affect our ability to make cash distributions to our unitholders.

 

   

Our commodity derivative arrangements may be ineffective in managing our commodity price risk and could result in financial losses or could reduce our income, which may adversely impact our ability to pay distributions to our unitholders.

 

   

Our estimated oil and natural gas reserves will naturally decline over time, and it is unlikely that we will be able to sustain distributions at the level of our minimum quarterly distribution without making accretive acquisitions or substantial capital expenditures that maintain our asset base.

 

   

Oil, natural gas and NGL prices are very volatile, and a decline in oil, natural gas or NGL prices will cause a decline in our cash flow from operations, which could cause us to reduce our distributions or cease paying distributions altogether.

Risks Inherent in an Investment in Us

 

   

Our general partner and its affiliates will own a controlling interest in us and will have conflicts of interest with, and owe limited fiduciary duties to, us, which may permit them to favor their own interests to the detriment of our unitholders.

 

   

New Source Energy and other affiliates of our general partner will not be limited in their ability to compete with us, which could cause conflicts of interest and limit our ability to acquire additional assets or businesses.

 

 

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Neither we nor our general partner have any employees and we will rely solely on the employees of certain of our affiliates to manage our business. The management team of New Source Energy, which includes the individuals who will manage us, will also perform substantially similar services for itself and will own and operate its own assets, and thus will not be solely focused on our business.

 

   

For as long as we are an emerging growth company, we will not be required to comply with certain reporting requirements, including those relating to accounting standards and disclosure about our executive compensation, and internal control auditing requirements that apply to other public companies.

 

   

Our unitholders have limited voting rights and are not entitled to elect our general partner or its board of directors. The owners of our general partner will have the power to appoint and remove our general partner’s directors.

 

   

Our general partner may elect to cause us to issue common units to it in connection with a resetting of the target distribution levels related to our general partner’s incentive distribution rights, without the approval of the conflicts committee of the board of directors of our general partner or our unitholders. This election may result in lower distributions to our common unitholders in certain situations.

 

   

Control of our general partner and its incentive distribution rights may be transferred to a third party without unitholder consent.

 

   

We may issue an unlimited number of additional units, including units that are senior to the common units, without unitholder approval, which would dilute unitholders’ ownership interests.

 

   

Even if our unitholders are dissatisfied, they cannot remove our general partner without consent of the owners of our general partner.

Tax Risks to Unitholders

 

   

Our tax treatment depends on our status as a partnership for U.S. federal income tax purposes, as well as our not being subject to a material amount of entity-level taxation by individual states. If the IRS were to treat us as a corporation for federal income tax purposes or we were to become subject to material additional amounts of entity-level taxation for state tax purposes, then our cash available for distribution to our unitholders could be substantially reduced.

 

   

Our unitholders will be required to pay taxes on their share of our income even if they do not receive any cash distributions from us.

Our Partnership Structure and Formation Transactions

We are a Delaware limited partnership formed in October 2012 by New Source Energy to own and acquire oil and natural gas properties in the United States. In connection with this offering, the following transactions, which we refer to as the formation transactions, will occur:

 

   

New Source Energy will contribute to us (i) the Partnership Properties and (ii) the commodity derivative contracts described in “—Our Hedging Strategy”;

 

   

We will issue to New Source Energy              common units and              subordinated units, representing an aggregate     % limited partner interest in us;

 

   

We will issue to our general partner general              partner units, representing a 2.0% general partner interest in us, and all of our incentive distribution rights, which will entitle our general partner to increasing percentages of the cash we distribute in excess of $         per unit per quarter;

 

   

We will adopt a long-term incentive plan for the issuance of equity incentive compensation and will issue              restricted common units to members of our management and the board of directors of our general partner;

 

 

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We and our general partner will enter into a development agreement with the New Source Group with respect to drilling our undeveloped reserves that comprise a portion of the Partnership Properties;

 

   

We expect to receive net proceeds of approximately $         million from the issuance and sale of              common units to the public (based on the midpoint of the price range set forth on the cover page of this prospectus), representing a     % limited partner interest in us, and we will use the net proceeds as described in “Use of Proceeds”;

 

   

We expect to borrow approximately $         million under a new $         million revolving credit facility, and we will use the proceeds as described in “Use of Proceeds”;

 

   

We will assume approximately $         million of New Source Energy’s debt that currently burdens the Partnership Properties. We will use $         million of the borrowings under our new revolving credit facility, in addition to a portion of the net proceeds from this offering, to repay in full such assumed debt at the closing of this offering. Please read “Use of Proceeds”; and

 

   

We and our general partner will enter into an omnibus agreement with the New Source Group, pursuant to which, among other things, the New Source Group will provide us and our general partner with management and administrative services.

If the underwriters exercise their option to purchase additional common units, we will use the net proceeds to reduce outstanding borrowings under our new revolving credit facility. If the underwriters exercise in full their option to purchase additional common units, the ownership interest of the public unitholders will increase to              common units, representing an aggregate         % limited partner interest in us, the ownership interest of our general partner will increase to              general partner units, representing a         % general partner interest in us, and the ownership interest of New Source Energy will remain at              common units and subordinated units, representing an aggregate         % limited partner interest in us.

 

 

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Our Ownership and Organizational Structure

The table and diagram below illustrates our ownership and organizational structure based on total units outstanding after giving effect to this offering and the related formation transactions and assumes that the underwriters do not exercise their option to purchase additional common units.

 

     Units    Ownership
Interest
 

Common units held by the public

     

Common units held by New Source Energy

     

Common units held by management and affiliates of New Source Energy(1)

     

Subordinated units held by New Source Energy

     

General partner units

        2.0
  

 

  

 

 

 

Total

     
  

 

  

 

 

 

 

LOGO

 

(1) Includes              restricted common units to be granted certain members of our management team and the board of directors of our general partner upon the closing of this offering.
(2) Our general partner, New Source Energy GP, LLC, will be owned 50% by New Source Energy and 25% by each of the David J. Chernicky Trust and Deylau, LLC, entities controlled by David J. Chernicky and Kristian B. Kos, respectively. Mr. Chernicky and Mr. Kos are the Chairman of the Board of Directors and the President and Chief Executive Officer, respectively, of our general partner. Mr. Chernicky is also the Chairman and controlling shareholder of New Source Energy. Mr. Kos is the President and Chief Executive Officer of New Source Energy.

Principal Executive Offices and Internet Address

Our principal executive offices are located at 914 North Broadway, Suite 230, Oklahoma City, Oklahoma, and our phone number is (405) 272-3028. Our website address is www.        .com. We expect to make our periodic reports and other information filed with or furnished to the Securities and Exchange Commission, which we refer to as the SEC, available free of charge through our website as soon as reasonably practicable after those reports and other information are electronically filed with or furnished to the SEC. Information on our website or any other website is not incorporated by reference into, and does not constitute a part of, this prospectus.

 

 

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Management of the Partnership

We are managed and operated by the board of directors and executive officers of New Source Energy GP, LLC, our general partner. Upon the closing of this offering, the board of directors of our general partner will have five members, at least one of whom will be an independent director. New Source Energy will appoint at least our second and third independent directors within 90 days and one year, respectively, of the date our common units are listed for trading on the New York Stock Exchange. The owners of our general partner have the right to appoint its entire board of directors. Unlike shareholders in a publicly traded corporation, our unitholders will not be entitled to elect our general partner or the board of directors of our general partner. Some of the executive officers and/or directors of our general partner currently serve as executive officers and/or directors of members of the New Source Group. For more information about the directors and officers of our general partner, please read “Management—Directors and Executive Officers.”

Prior to the closing of this offering, we and our general partner will enter into an omnibus agreement with the New Source Group, pursuant to which, among other things, the New Source Group will provide management and administrative services that we believe are necessary to allow our general partner to operate, manage and grow our business. Neither we nor our subsidiaries will have any employees. Following the closing of this offering, we will be responsible for the costs of any equity-based compensation awarded to our management or the board of directors of our general partner, and we will be responsible for transaction costs incurred in connection with any acquisition we complete during such period. From the closing of this offering through December 31, 2013, we will pay the New Source Group a quarterly fee of $675,000 for the provision of such services. After December 31, 2013, in lieu of the quarterly fee, our general partner will reimburse the New Source Group, on a quarterly basis, for the actual direct and indirect expenses it incurs in its performance under the omnibus agreement, and we will reimburse our general partner for such payments it makes to the New Source Group. The New Source Group will not be liable to us for its performance of, or failure to perform, services under this agreement unless there has been a final decision determining that the New Source Group acted in bad faith or engaged in fraud or willful misconduct or, in the case of a criminal matter, acted with knowledge that the conduct was unlawful. The New Source Group will have substantial discretion to determine in good faith which expenses to incur on our behalf and what portion to allocate to us. Please read “Certain Relationships and Related Party Transactions—Agreements Governing the Transactions—Omnibus Agreement.”

Summary of Conflicts of Interest and Fiduciary Duties

Our general partner has a legal duty to manage us in a manner beneficial to the holders of our common and subordinated units. This legal duty originates in statutes and judicial decisions and is commonly referred to as a “fiduciary duty.” However, the officers and directors of our general partner also have a fiduciary duty to manage the business of our general partner in a manner beneficial to its owners, which are New Source Energy and certain of its affiliates. The officers and directors of New Source Energy, in turn, have a fiduciary duty to manage its business in a manner beneficial to its owners. Additionally, certain of our general partner’s executive officers and directors will continue to have economic interests, investments and other economic incentives in such affiliates. As a result of these relationships, conflicts of interest exist and may arise in the future between us and our unitholders, on the one hand, and our general partner and its owners and affiliates, on the other hand. For example, our general partner is entitled to make determinations that affect our ability to generate the cash flows necessary to make cash distributions to our unitholders, including determinations related to:

 

   

purchases and sales of oil and natural gas properties and other acquisitions and dispositions, including whether to pursue acquisitions that are also suitable for the New Source Group;

 

   

the manner in which our business is operated;

 

   

the level of our borrowings;

 

   

the amount, nature and timing of our capital expenditures; and

 

 

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the amount of cash reserves necessary or appropriate to satisfy our general and administrative expenses, other expenses and debt service requirements, and to otherwise provide for the proper conduct of our business.

These determinations will have an effect on the amount of cash distributions we make to the holders of our units, which in turn has an effect on whether our general partner receives incentive cash distributions. For a more detailed description of the conflicts of interest and fiduciary duties of our general partner, please read “Risk Factors—Risks Inherent in an Investment in Us” and “Conflicts of Interest and Fiduciary Duties.”

Delaware law provides that Delaware limited partnerships may, in their partnership agreements, restrict or expand the fiduciary duties owed by the general partner to the limited partners and the partnership. Our partnership agreement limits the liability of our general partner and reduces the fiduciary duties it owes to holders of our common and subordinated units. Our partnership agreement also restricts the remedies available to holders of our common units for actions that might otherwise constitute a breach of the fiduciary duties that our general partner owes to our unitholders. By purchasing a common unit, unitholders agree to be bound by the terms of our partnership agreement and, pursuant to the terms of our partnership agreement, are treated as having consented to various actions contemplated in our partnership agreement and conflicts of interest that might otherwise be considered a breach of fiduciary or other duties under Delaware law. Please read “Conflicts of Interest and Fiduciary Duties—Fiduciary Duties” for a description of the fiduciary duties imposed on our general partner by Delaware law, the material modifications of these duties contained in our partnership agreement and certain legal rights and remedies available to our unitholders.

To increase our estimated proved reserves and levels of production, we intend to both deploy our capital resources to drill additional wells and otherwise develop our estimated reserves and acquire additional oil and natural gas properties. Several of the officers and directors of our general partner, who are responsible for managing our operations and acquisition activities, hold similar positions with other entities that are in the business of identifying and acquiring oil and natural gas properties. For example, our general partner will be owned 50% by New Source Energy, 25% by an entity controlled by Mr. Chernicky, the Chairman of our general partner, and 25% by an entity controlled by Mr. Kos, the President and Chief Executive Officer of our general partner. New Source Energy is in the business of acquiring oil and natural gas properties, and Messrs. Kos and Chernicky are also the President and Chief Executive Officer and Chairman and controlling shareholder, respectively, of New Source Energy.

Additionally, neither our partnership agreement nor the omnibus agreement contains any restrictions on the ability of the New Source Group to compete with us. The New Source Group is under no obligation to offer properties or refer acquisitions or other opportunities to us.

Emerging Growth Company Status

We are an “emerging growth company” as defined in the Jumpstart Our Business Startups Act, or “JOBS Act.” For as long as we are an emerging growth company, unlike other public companies, we will not be required to:

 

   

provide an auditor’s attestation report on management’s assessment of the effectiveness of our system of internal control over financial reporting pursuant to Section 404(b) of the Sarbanes-Oxley Act of 2002;

 

   

comply with any new requirements adopted by the Public Company Accounting Oversight Board, or the PCAOB, requiring mandatory audit firm rotation or a supplement to the auditor’s report in which the auditor would be required to provide additional information about the audit and the financial statements of the issuer;

 

 

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Index to Financial Statements
   

comply with any new audit rules adopted by the PCAOB after April 5, 2012, unless the SEC determines otherwise;

 

   

provide certain disclosure regarding executive compensation required of larger public companies; or

 

   

obtain shareholder approval of any golden parachute payments not previously approved.

We will cease to be an “emerging growth company” upon the earliest of:

 

   

when we have $1.0 billion or more in annual revenues;

 

   

when we have at least $700 million in market value of our common units held by non-affiliates;

 

   

when we issue more than $1.0 billion of non-convertible debt over a three-year period; or

 

   

the last day of the fiscal year following the fifth anniversary of our initial public offering.

In addition, Section 107 of the JOBS Act also provides that an emerging growth company can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards. In other words, an emerging growth company can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. However, we are choosing to “opt out” of such extended transition period, and as a result, we will comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for non-emerging growth companies. Section 107 of the JOBS Act provides that our decision to opt out of the extended transition period for complying with new or revised accounting standards is irrevocable.

 

 

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The Offering

 

Common units offered hereby

             common units, or              common units if the underwriters exercise in full their option to purchase additional common units.

 

Units outstanding after this offering

             common units and              subordinated units, representing     % and     %, respectively, limited partner interests in us (common units and subordinated units, representing     % and     %, respectively, limited partner interests in us if the underwriters exercise in full their option to purchase additional common units). The general partner will own          general partner units, or          general partner units if the underwriters exercise their option to purchase additional common units in full, in each case representing a 2.0% general partner interest in us.

 

Use of proceeds

We intend to use the estimated net proceeds of approximately $         million from this offering, based upon the assumed initial public offering price of $         per common unit (the midpoint of the price range set forth on the cover of this prospectus), after deducting underwriting discounts, structuring fees, fees and expenses associated with our new revolving credit facility and offering expenses, together with $         million of borrowings under our new revolving credit facility, as consideration (together with our issuance to New Source Energy of              common units and              subordinated units) for the contribution by New Source Energy of the Partnership Properties and commodity derivative contracts. We anticipate that we will assume approximately $         million of New Source Energy’s indebtedness that currently burdens the Partnership Properties, and we will use $         million of borrowings under our new revolving credit facility, in addition to a portion of the net proceeds from this offering, to repay in full such assumed debt at the closing of this offering. We will use any net proceeds from the exercise of the underwriters’ option to reduce outstanding borrowings under our new revolving credit facility. Please read “Use of Proceeds.”

 

Cash distributions

We expect to make a minimum quarterly distribution of $         per unit per quarter on all common, subordinated and general partner units ($         per unit on an annualized basis) to the extent we have sufficient cash from operations after establishment of cash reserves and payment of fees and expenses, including payments to our general partner and its affiliates. We refer to this cash as “available cash,” and it is defined in our partnership agreement included in this prospectus as Appendix A. Our ability to pay the minimum quarterly distribution is subject to various restrictions and other factors described in more detail under the caption “Our Cash Distribution Policy and Restrictions on Distributions.” For the first quarter that we are publicly traded, we will pay our unitholders a prorated distribution covering the period from the closing of this offering through                     , based on the actual length of that period.

 

 

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  Assuming our general partner maintains its 2.0% general partner interest in us, our partnership agreement requires us to distribute all of our available cash each quarter in the following manner during the subordinated period:

 

   

first, 98.0% to the holders of common units and 2.0% to our general partner, until each common unit has received the minimum quarterly distribution of $         plus any arrearages from prior quarters;

 

   

second, 98.0% to the holders of subordinated units and 2.0% to our general partner, until each subordinated unit has received the minimum quarterly distribution of $         ; and

 

   

third, 98.0% to all unitholders, pro rata, and 2.0% to our general partner, until each unit has received a distribution of $        .

 

  If cash distributions to our unitholders exceed $         per common and subordinated unit in any quarter, our general partner will receive, in addition to distributions on its general partner interest, increasing percentages, up to 23.0%, of the cash we distribute in excess of that amount. We refer to these distributions as “incentive distributions.” Please read “Provisions of Our Partnership Agreement Relating to Cash Distributions.”

 

  At the closing of this offering, our general partner will own all of our incentive distribution rights. New Source Energy will own a 50% membership interest in our general partner, an entity controlled by Mr. Chernicky will own a 25% membership interest in our general partner and an entity controlled by Mr. Kos will own the remaining 25% membership interest in our general partner. Please read “Certain Relationships and Related Party Transactions.”

 

  Pro forma cash available for distribution generated during the year ended December 31, 2011 was approximately $22.4 million, which would have been sufficient to allow us to pay the full minimum quarterly distribution on our common units, general partner units and subordinated units during that period (assuming the underwriters exercise in full their option to purchase additional common units).

 

  Pro forma cash available for distribution during the twelve months ended September 30, 2012 was approximately $17.9 million, which would have been sufficient to allow us to pay the full minimum quarterly distribution on our common units, general partner units and subordinated units during that period (assuming the underwriters exercise in full their option to purchase additional common units).

 

  For a calculation of our ability to have made distributions to our unitholders based on our pro forma results of operations on a quarter-by-quarter basis for the year ended December 31, 2011 and the twelve months ended September 30, 2012, please read “Our Cash Distribution Policy and Restrictions on Distributions.”

 

 

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  The amount of available cash we need to pay the minimum quarterly distribution for four quarters on our common units, general partner units and subordinated units to be outstanding immediately after this offering is approximately $         million (or an average of approximately $         million per quarter). Please read “Our Cash Distribution Policy and Restrictions on Distributions.”

 

  We believe, based on our financial forecast and related assumptions included in “Our Cash Distribution Policy and Restrictions on Distributions—Estimated Adjusted EBITDA for the Year Ending December 31, 2013,” that we will have sufficient available cash to pay the aggregate minimum quarterly distribution of $         million on all of our common units, general partner units and subordinated units for the year ending December 31, 2013. However, we do not have a legal obligation to pay distributions at our minimum quarterly distribution rate or at any other rate except as provided in our partnership agreement, and there is no guarantee that we will make quarterly cash distributions to our unitholders. Please read “Our Cash Distribution Policy and Restrictions on Distributions.”

 

Subordinated units

New Source Energy will initially own all of our subordinated units. The principal difference between our common units and subordinated units is that, in any quarter during the subordination period, the subordinated units are entitled to receive the minimum quarterly distribution only after the common units have received their minimum quarterly distribution plus any arrearages in the payment of the minimum quarterly distribution from prior quarters. Accordingly, holders of subordinated units may receive a smaller distribution than holders of common units or no distribution at all. Subordinated units will not accrue arrearages.

 

  The subordination period will begin on the closing date of this offering and will extend until the first business day on or after December 31, 2015 that we have earned and paid from operating surplus, in the aggregate, distributions on each outstanding common unit, subordinated unit and general partner unit and any other partnership interests that are senior or equal in right of distribution to the subordinated units equaling or exceeding the minimum quarterly distribution payable with respect to a period of twelve consecutive quarters immediately preceding such date, provided there are no arrearages in the minimum quarterly distribution on our common units at that time. For purposes of the subordination period, any quarter in which holders of our subordinated units are not entitled to receive the distributions otherwise payable on the subordinated units pursuant to the minimum annual production requirement under the development agreement shall be included in any period of twelve consecutive quarters, so long as aggregate distributions equaling or exceeding the minimum quarterly distribution on all common, subordinated, general partner unit and any other partnership interests that are senior or equal in right of distribution to the subordinated units were earned in respect of such quarter.

 

 

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  The subordination period will also end if our general partner is removed other than for cause, provided that units held by our general partner and its affiliates are not voted in favor of such removal.

 

  When the subordination period ends, all subordinated units will convert into common units on a one-for-one basis and all common units thereafter will no longer be entitled to arrearages.

 

Early conversion of subordinated units

If we have earned and paid from operating surplus at least $         (125% of the minimum quarterly distribution) for each quarter in any four consecutive quarter period ending on or after December 31, 2013 on each outstanding common unit, subordinated unit, general partner unit and any other partnership interest that is senior or equal in right of distribution to the subordinated units, in addition to the corresponding incentive distributions for each such quarter, all of the outstanding subordinated units will convert into common units. For purposes of early conversion of subordinated units, any quarter in which holders of our subordinated units are not entitled to receive the distributions otherwise payable on the subordinated units pursuant to the minimum annual production requirement under the development agreement shall be included in any period of four consecutive quarters so long as aggregate distributions equaling or exceeding the minimum quarterly distribution on all common, subordinated, general partner unit and any other partnership interests that are senior or equal in right of distribution to the subordinated units were earned in respect of such quarter.

 

Issuance of additional units

We can issue an unlimited number of additional units, including units that are senior to the common units in right of distributions, liquidation and voting, on terms and conditions determined by our general partner, without the approval of our unitholders. Please read “Units Eligible for Future Sale” and “The Partnership Agreement—Issuance of Additional Securities.”

 

Limited voting rights

Our general partner will manage us and operate our business. Unlike stockholders of a corporation, our unitholders will have only limited voting rights on matters affecting our business. Our unitholders will have no right to elect our general partner or its directors on an annual or other continuing basis. Our general partner may not be removed except by a vote of the holders of at least 66 2/3% of the outstanding common and subordinated units, including any units owned by our general partner and its affiliates, voting together as a single class. Upon the closing of this offering, New Source Energy will own an aggregate of approximately     % of our outstanding common and subordinated units (or     % of our outstanding common and subordinated units if the underwriters exercise their option to purchase additional common units in full) and will therefore be able to prevent the removal of our general partner. Please read “The Partnership Agreement—Limited Voting Rights.”

 

 

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Limited call right

If at any time our general partner and its affiliates own more than 80% of the outstanding common units, our general partner has the right, but not the obligation, to purchase all of the remaining common units at a purchase price not less than the then-current market price of the common units, as calculated pursuant to the terms of our partnership agreement. Upon the closing of this offering, New Source Energy will own approximately     % of our outstanding common units and 100% of our subordinated units (or     % of our outstanding common and subordinated units if the underwriters exercise their option to purchase additional common units in full). Please read “The Partnership Agreement—Limited Call Right.”

 

Estimated ratio of taxable income to distributions

We estimate that if our unitholders own the common units purchased in this offering through the record date for distributions for the period ending December 31, 2015, such unitholders will be allocated, on a cumulative basis, an amount of federal taxable income for that period that will be less than     % of the cash distributed to such unitholders with respect to that period. Please read “Material Tax Consequences—Tax Consequences of Unit Ownership—Ratio of Taxable Income to Distributions” for information regarding the bases for this estimate.

 

Material tax consequences

For a discussion of other material federal income tax consequences that may be relevant to prospective unitholders who are individual citizens or residents of the United States, please read “Material Tax Consequences.”

 

Agreement to be bound by the partnership agreement

By purchasing a common unit, you will be admitted as a unitholder of our partnership and will be deemed to have agreed to be bound by all of the terms of our partnership agreement.

 

Listing and trading symbol

We intend to apply to list our common units on the New York Stock Exchange under the symbol “NSLP.”

 

 

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Summary Historical Financial Data

We were formed in October 2012 and do not have historical financial operating results. The following table shows summary historical financial data attributable to the Partnership Properties, which will comprise the entirety of our operating assets following the closing of this offering, for the periods and as of the dates presented. The contribution of the Partnership Properties to us by New Source Energy will be a transaction between businesses under common control. Accordingly, we will reflect the Partnership Properties in our financial statements retroactively at carryover basis, and the accounts of the Partnership Properties will become our pre-formation date accounts. Due to the factors described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations—Operating Expenses—General and administrative,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations—Operating Expenses—Depreciation, depletion and amortization” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations—Income Taxes,” our future results of operations will not be comparable to the historical results attributable to the Partnership Properties.

The summary historical financial data attributable to the Partnership Properties as of and for the years ended December 31, 2010 and 2011 are derived from the audited historical financial statements included elsewhere in this prospectus. The summary historical financial data attributable to the Partnership Properties as of and for the nine months ended September 30, 2011 and 2012 are derived from the unaudited historical financial statements included elsewhere in this prospectus.

You should read the following table in conjunction with “—Our Partnership Structure and Formation Transactions,” “Use of Proceeds,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and our historical financial statements included elsewhere in this prospectus. Among other things, those historical financial statements include more detailed information regarding the basis of presentation for the following information.

 

 

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Index to Financial Statements

The following table presents Adjusted EBITDA, which we use in evaluating the liquidity of our business. This financial measure is not calculated or presented in accordance with generally accepted accounting principles, or GAAP. We explain this measure below and reconcile it to net cash from operating activities, its most directly comparable financial measure calculated and presented in accordance with GAAP.

 

    Year Ended
December 31,
    Nine Months Ended
September 30,
 
    2010     2011     2011     2012  
    (in thousands)  

Statement of Operations Data:

       

Revenues:

       

Oil sales

  $ 5,136      $ 4,489      $ 3,317      $ 4,371   

Natural gas sales

    9,409        8,713        6,786        4,177   

Natural gas liquids sales

    25,909        33,058        25,164        17,900   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

    40,454        46,260        35,267        26,448   
 

 

 

   

 

 

   

 

 

   

 

 

 

Operating costs and expenses:

       

Oil and natural gas production expenses

    7,639        7,875        6,161        4,789   

Oil and natural gas production taxes

    2,876        2,155        1,682        829   

General and administrative

    649        6,928        3,037        10,956   

Depreciation, depletion, and amortization

    14,909        14,738        10,767        11,052   

Accretion expense

    50        55        41        86   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total operating costs and expenses

    26,123        31,751        21,688        27,712   
 

 

 

   

 

 

   

 

 

   

 

 

 

Operating income (loss)

    14,331        14,509        13,579        (1,264

Other income (expense):

       

Interest expense

    (2,648     (3,735     (2,953     (2,422

Realized and unrealized gains (losses) from derivatives

    (516     (1,349     1,463        6,866   
 

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

    11,167        9,425        12,089        3,180   

Income tax expense

    —          10,502        11,555        1,166   
 

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

  $ 11,167      $ (1,077   $ 534      $ 2,014   
 

 

 

   

 

 

   

 

 

   

 

 

 

 

     As of December 31,      As of September 30,  
     2010      2011      2012  
     (in thousands)  

Balance Sheet Data:

        

Oil and natural gas sales receivables

   $ 6,122       $ 6,544       $ 5,269   

Other current assets

     938         1,134         —     

Total property and equipment, net

     86,049         94,468         92,137   

Other assets

     1,430         2,674         2,150   
  

 

 

    

 

 

    

 

 

 

Total assets

   $ 94,539       $ 104,820       $ 99,556   
  

 

 

    

 

 

    

 

 

 

Current liabilities

   $ 4,909       $ 4,076       $ 2,903   

Long-term debt

     60,000         68,500         68,000   

Other long-term liabilities

     2,056         13,824         13,331   

Total parent net investment

     27,574         18,420         15,322   
  

 

 

    

 

 

    

 

 

 

Total liabilities and parent net investment

   $ 94,539       $ 104,820       $ 99,556   
  

 

 

    

 

 

    

 

 

 

 

 

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     Year Ended
December  31,
    Nine Months  Ended
September 30,
 
     2010      2011           2011                 2012        

Other Financial Data:

         

Adjusted EBITDA

   $ 30,123       $ 32,273      $ 24,993      $ 23,256   

Cash Flow Data:

         

Net cash provided by operating activities

   $ 27,940       $ 30,133      $ 25,775      $ 22,749   

Net cash used in investing activities

   $ (19,226    $ (23,818   $ (19,671   $ (9,175

Net cash used in financing activities

   $ (8,714    $ (6,315   $ (6,104   $ (13,574

Non-GAAP Financial Measure

Adjusted EBITDA is a supplemental non-GAAP financial measure that is used by management and external users of our financial statements, such as industry analysts, investors, lenders and rating agencies, and is not a measure of net income or cash flows as determined by United States generally accepted accounting principles, or GAAP.

We define Adjusted EBITDA as earnings before interest expense, income taxes, depreciation, depletion and amortization, accretion expense, non-cash compensation expense and unrealized derivative gains and losses.

Our management believes Adjusted EBITDA is useful because it allows us to more effectively evaluate our operating performance and compare the results of our operations from period to period without regard to our financing methods or capital structure. We exclude the items listed above from net income in arriving at Adjusted EBITDA because these amounts can vary substantially from company to company within our industry depending upon accounting methods and book values of assets, capital structures and the method by which the assets were acquired. Adjusted EBITDA should not be considered as an alternative to, or more meaningful than, net income or cash flows from operating activities as determined in accordance with GAAP or as an indicator of our operating performance or liquidity. Certain items excluded from Adjusted EBITDA are significant components in understanding and assessing a company’s financial performance, such as a company’s cost of capital and tax structure, as well as the historic costs of depreciable assets, none of which are components of Adjusted EBITDA. Our computations of Adjusted EBITDA may not be comparable to other similarly titled measures of other companies. We believe that Adjusted EBITDA is a widely followed measure of operating performance and may also be used by investors to measure our ability to meet debt service requirements.

 

 

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The following tables present a reconciliation of the non-GAAP financial measure of Adjusted EBITDA to the GAAP financial measures of net income (loss) and net cash provided by operating activities, respectively.

 

     Year Ended
December 31,
    Nine Months Ended
September 30,
 
     2010     2011     2011     2012  
     (in thousands)  

Adjusted EBITDA Reconciliation to Net Income (loss):

        

Net income (loss)

   $ 11,167      $ (1,077   $ 534      $ 2,014   

Unrealized (gain) loss on derivatives

     1,349        (150     (2,259     (889

Non-cash compensation expense

     —          4,470        1,402        7,405   

Accretion expense

     50        55        41        86   

Interest expense

     2,648        3,735        2,953        2,422   

Depreciation, depletion and amortization

     14,909        14,738        10,767        11,052   

Income tax expense

     —          10,502        11,555        1,166   
  

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA

   $ 30,123      $ 32,273      $ 24,993      $ 23,256   
  

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA Reconciliation to Net Cash Provided By Operating Activities:

        

Net cash provided by operating activities

   $ 27,940      $ 30,133      $ 25,775      $ 22,749   

Cash interest expense

     2,262        2,250        1,829        1,969   

Current income tax liability assumed by parent

     —          —          —          172   

Changes in operating assets and liabilities

     (79     (110     (2,611     (1,634
  

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA

   $ 30,123      $ 32,273      $ 24,993      $ 23,256   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

 

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Summary Reserve Operating Data

The following tables present summary information regarding estimated net proved oil, natural gas and NGL reserves and the historical operating data attributable to the Partnership Properties for the periods indicated. The estimates of our net proved reserves as of June 30, 2012 are based on a reserve report prepared by Ralph E. Davis Associates, Inc., our independent reserve engineers.

For additional information regarding our reserves, please see “Business—Our Operations” and the unaudited supplementary information in the notes to our financial statements included elsewhere in this prospectus.

 

     Estimated Reserves  
     As of June 30, 2012  
     Crude Oil
(MBbls)
     Natural Gas
Liquids
(MBbls)
     Natural Gas
(MMcf)
     Total
(MBoe)(2)
 

Reserves Category(1):

           

Proved developed

     226.0         6,023.3         11,580.2         8,179.3   

Proved undeveloped

     288.7         3,652.5         12,575.4         6,037.1   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total proved

     514.7         9,675.8         24,155.6         14,216.4   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) All reserves are located within the United States.
(2) Determined using a ratio of six Mcf of natural gas to one Bbl of oil, condensate or NGLs based on an approximate energy equivalency.

 

     Year Ended December 31,      Nine Months
Ended
September 30,
 
     2009      2010      2011      2012  

Net Sales Data:

           

Crude oil (Bbls)

     74,908         68,071         48,770         46,931   

Natural gas (Mcf)

     2,611,060         2,376,592         2,378,232         1,710,243   

Natural gas liquids (Bbls)

     646,814         658,293         720,615         536,356   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total crude oil equivalent (Boe)(1)

     1,156,899         1,122,463         1,165,757         868,328   

Average daily volumes (Boe/d)

     3,170         3,075         3,194         3,169   

Average Sales Price (Excluding Derivatives):

           

Crude oil (per Bbl)

   $ 58.59       $ 75.45       $ 92.04       $ 93.14   

Natural gas (per Mcf)

   $ 2.92       $ 3.96       $ 3.66       $ 2.44   

Natural gas liquids (per Bbl)

   $ 28.97       $ 39.36       $ 45.87       $ 33.37   

Average equivalent price (per Boe)

   $ 26.58       $ 36.04       $ 39.68       $ 30.46   

Expenses (per Boe):

           

Lease operating expenses

   $ 4.23       $ 4.74       $ 4.76       $ 4.32   

Workover expenses

   $ 2.55       $ 2.07       $ 1.99       $ 1.20   

Production taxes

   $ 1.03       $ 2.56       $ 1.85       $ 0.95   

General and administrative(2)

   $ 0.49       $ 0.58       $ 2.11       $ 4.09   

Depreciation, depletion and amortization

   $ 11.92       $ 13.28       $ 12.64       $ 12.73   

 

(1) Determined using a ratio of six Mcf of natural gas to one Bbl of oil, condensate or NGLs based on an approximate energy equivalency.
(2)

General and administrative costs excluding non-cash compensation expense. In historical periods, the general and administrative expenses reflect an allocation of New Source Energy’s general and

 

 

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  administrative expenses based on the proportion of historical production attributable to the Partnership Properties. From the closing of this offering through December 31, 2013, we will pay the New Source Group a quarterly fee of $675,000 for the provision of management, administrative and operational services. After December 31, 2013, in lieu of the quarterly fee, our general partner will reimburse the New Source Group, on a quarterly basis, for the actual direct and indirect expenses it incurs in its performance under the omnibus agreement, and we will reimburse our general partner for such payments it makes to the New Source Group.

 

 

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RISK FACTORS

Limited partner interests are inherently different from the capital stock of a corporation, although many of the business risks to which we are subject are similar to those that would be faced by a corporation engaged in a business similar to ours. Prospective unitholders should carefully consider the following risk factors together with all of the other information included in this prospectus in evaluating an investment in our common units.

If any of the following risks were actually to occur, our business, financial condition or results of operations could be materially adversely affected. In that case, we might not be able to pay distributions on our common units, the trading price of our common units could decline and our unitholders could lose all or part of their investment.

Risks Related to Our Business

We may not have sufficient cash to pay the minimum quarterly distribution on our common units following the establishment of cash reserves and payment of fees and expenses, including payments to our general partner and its affiliates.

We may not have sufficient available cash each quarter to pay the minimum quarterly distribution of $ per unit or any other amount. Under the terms of our partnership agreement, the amount of cash available for distribution will be reduced by our operating expenses and the amount of any cash reserves established by our general partner to provide for future operations, future capital expenditures, including acquisitions of additional oil and natural gas properties, future debt service requirements and future cash distributions to our unitholders.

The amount of cash we distribute on our units principally depends on the cash we generate from operations, which depends on, among other things:

 

   

the amount of oil, natural gas and NGLs we produce;

 

   

the prices at which we sell our oil, natural gas and NGL production;

 

   

the amount and timing of settlements of our commodity derivatives;

 

   

the level of our operating costs, including maintenance capital expenditures and payments to our general partner; and

 

   

the level of our interest expense, which depends on the amount of our indebtedness and the interest payable thereon.

For a description of additional restrictions and factors that may affect our ability to make cash distributions to our unitholders, please read “Our Cash Distribution Policy and Restrictions on Distributions.”

The assumptions underlying the forecast of cash available for distribution that we include in “Our Cash Distribution Policy and Restrictions on Distributions” may prove inaccurate and are subject to significant risks and uncertainties, which could cause actual results to differ materially from our forecasted results.

The forecast of cash available for distribution set forth in “Our Cash Distribution Policy and Restrictions on Distributions” includes our forecast of our results of operations, Adjusted EBITDA and cash available for distribution for the year ending December 31, 2013. The assumptions underlying the forecast may prove inaccurate and are subject to significant risks and uncertainties that could cause actual results to differ materially from our forecasted results. If our actual results are significantly below forecasted results, or if our expenses are greater than forecasted, we may not generate enough cash available for distribution to pay the minimum quarterly distribution or any amount on our common units or subordinated units, which may cause the market price of our common units to decline materially.

 

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We intend to rely on the New Source Group to execute our drilling program. If the New Source Group fails to perform or inadequately performs, our operations will be adversely affected and our costs could increase or our reserves may not be developed, reducing our future levels of production and our cash flow from operations, which could affect our ability to make cash distributions to our unitholders.

At the closing of this offering, we will enter into agreements with the New Source Group, under which we will rely on the New Source Group to operate all of our existing producing wells and coordinate our development drilling program. For example, pursuant to our development agreement with the New Source Group, New Source Energy has control over our drilling program and the sole right to determine which wells are drilled based on our annual drilling budget that will be determined and periodically updated by our general partner. Under the omnibus agreement, the New Source Group will also provide us with management and administrative services that we believe are necessary to allow our general partner to operate, manage and grow our business. If the New Source Group fails to perform or inadequately performs these functions, our operations would be adversely affected and our costs could increase or our reserves may not be developed or properly developed, reducing our future levels of production and our cash flow from operations, which could affect our ability to make cash distributions to you.

Unless we replace the oil and natural gas reserves we produce, our revenues and production will decline, which would adversely affect our cash flow from operations and our ability to make distributions to our unitholders.

We will be unable to sustain our minimum quarterly distribution without substantial capital expenditures that maintain our asset base. Producing oil and natural gas reservoirs are characterized by declining production rates that vary depending upon reservoir characteristics and other factors. Our future oil and natural gas reserves and production and therefore our cash flow and ability to make distributions are highly dependent on our success in efficiently developing and exploiting our current reserves. Our production decline rates may be significantly higher than currently estimated if our wells do not produce as expected. Further, our decline rate may change when we drill additional wells or make acquisitions. We may not be able to develop, find or acquire additional reserves to replace our current and future production at economically acceptable terms, which would adversely affect our business, financial condition and results of operations and reduce cash available for distribution to our unitholders.

A decline in oil, natural gas and NGL prices may adversely affect our business, financial condition or results of operations and our ability to meet our capital expenditure obligations and financial commitments.

The price we receive for our oil, natural gas and NGLs heavily influences our revenue, profitability, access to capital and future rate of growth. Oil, natural gas and NGLs are commodities and, therefore, their prices are subject to wide fluctuations in response to relatively minor changes in supply and demand. Historically, the markets for oil and natural gas have been volatile. These markets will likely continue to be volatile in the future. The prices we receive for our production, and the levels of our production, depend on numerous factors beyond our control. These factors include the following:

 

   

worldwide and regional economic and political conditions impacting the global supply and demand for oil, natural gas and NGLs;

 

   

the price and quantity of imports of foreign oil and natural gas;

 

   

the level of global oil and natural gas exploration and production;

 

   

the level of global oil and natural gas inventories;

 

   

localized supply and demand fundamentals and transportation availability;

 

   

weather conditions and natural disasters;

 

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domestic and foreign governmental regulations;

 

   

speculation as to the future price of oil and the speculative trading of oil and natural gas futures contracts;

 

   

price and availability of competitors’ supplies of oil and natural gas;

 

   

the actions of the Organization of Petroleum Exporting Countries, or OPEC;

 

   

technological advances affecting energy consumption; and

 

   

the price and availability of alternative fuels.

Further, oil prices and natural gas prices do not necessarily fluctuate in direct relationship to each other. Because approximately 71.7% of our estimated proved reserves as of June 30, 2012 were oil and natural gas liquids reserves, our financial results are more sensitive to movements in oil prices. The price of oil has been extremely volatile, and we expect this volatility to continue. During the year ended December 31, 2011, the daily NYMEX West Texas Intermediate oil spot price ranged from a high of $113. 39 per Bbl to a low of $75.40 per Bbl, and the NYMEX natural gas Henry Hub spot price ranged from a high of $4.92 to a low of $2.84 per MMBtu.

Substantially all of our oil production is sold to purchasers under short-term (less than twelve months) contracts at market based prices. Lower oil, natural gas and NGL prices will reduce our cash flows, borrowing ability and the present value of our reserves. Lower prices may also reduce the amount of oil and natural gas that we can produce economically and may affect our proved reserves.

Our future revenues are dependent on our ability to successfully replace our proved developed producing reserves.

In general, production from oil and natural gas properties declines as reserves are depleted, with the rate of decline depending on reservoir characteristics. Our current proved reserves will decline as reserves are produced and, therefore, our level of production and cash flows will be affected adversely unless we participate in successful development activities or acquire properties containing proved reserves. Thus, our future oil and natural gas production and, therefore, our cash flow from operations are highly dependent upon the level of success we, in conjunction with the New Source Group, have in finding or acquiring additional reserves. However, we cannot assure you that our future activities will result in any specific amount of additional proved reserves or that the New Source Group will be able to drill productive wells at acceptable costs.

According to estimates included in our proved reserve report, if on January 1, 2012 drilling and development on our properties had ceased, including recompletions and workovers, then our proved developed producing reserves would decline at an annual effective rate of 13.2% over 10 years. If we fail to replace reserves, our level of production and cash flows will be affected adversely. Our total proved reserves will decline as reserves are produced unless the New Source Group conducts other successful exploration and development activities or we acquire properties containing proved reserves, or both.

We do not currently operate any of our drilling locations, and therefore, we will not be able to control the timing of exploration or development efforts, associated costs, or the rate of production of our assets.

We do not currently operate any of our properties and do not have plans to develop the capacity to operate any of our properties. As a non-operated working interest owner, we are dependent on the New Source Group to develop our properties. Our ability to achieve targeted returns on capital in drilling or acquisition activities and to achieve production growth rates will be materially affected by decisions made by the New Source Group over which we have little or no control. Such decisions include:

 

   

the timing of capital expenditures;

 

   

the timing of initiating the drilling and recompleting of wells;

 

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the extent of operating costs;

 

   

selection of technology and drilling and completion methods; and

 

   

the rate of production of reserves, if any.

If the contract operator for New Source Energy fails to perform its obligations under its agreements with New Source Energy, becomes subject to bankruptcy proceedings or otherwise proves to be an undesirable operator, our business could be adversely affected.

The successful execution of our strategy depends on continued utilization of New Dominion’s oil and gas infrastructure and technical staff as the operator of our properties. Failure to continue this relationship through (i) the termination or expiration of the operating agreements governing such relationship, or New Source Energy’s other arrangements with New Dominion and its affiliates or (ii) the bankruptcy or dissolution of New Dominion could have a material adverse effect on our operations and our financial results. In particular, if New Dominion becomes subject to bankruptcy proceedings, New Dominion or the bankruptcy trustee may be able to cancel one or more of its agreements with New Source Energy on the basis that they are “executory contracts.” If this were to occur, New Source Energy would be required either to renegotiate with New Dominion or its successor to continue to serve as the operator of New Source Energy’s properties and provide New Source Energy with access to the saltwater disposal and other infrastructure serving its existing properties or to select another operator and obtain access to similar infrastructure from other sources, any of which would most likely result in higher costs to us for such services and infrastructure, notwithstanding the omnibus agreement.

Properties that we acquire may not produce oil or natural gas as projected, and we may be unable to determine reserve potential, identify liabilities associated with the properties or obtain protection from sellers against them, which could cause us to incur losses.

Our principal growth strategy is to pursue selective acquisitions of producing and proved undeveloped properties in conventional resource reservoirs through the New Source Group. If we choose to participate in an acquisition identified by the New Source Group, we will perform a review of the target properties that we believe is consistent with industry practices. However, these reviews are inherently incomplete. Generally, it is not feasible to review in depth every individual property involved in each acquisition. Even a detailed review of records and properties may not necessarily reveal existing or potential problems, nor will it permit a buyer to become sufficiently familiar with the properties to assess fully their deficiencies and potential. We may not perform an inspection on every well, and environmental problems, such as groundwater contamination, are not necessarily observable even when an inspection is undertaken. Even when problems are identified, we may not be able to obtain effective contractual protection against all or part of those problems, and we may assume environmental and other risks and liabilities in connection with the acquired properties.

All of our producing properties and interests are currently located in the Hunton Formation in east-central Oklahoma, making us vulnerable to risks associated with operating in one primary geographic area.

All of our oil and gas assets and interests are currently in the Hunton Formation in east-central Oklahoma. As a result, we may be disproportionately exposed to the impact of delays or interruptions of production from wells in which we have an interest that are caused by transportation capacity constraints, curtailment of production, availability of equipment, facilities, personnel or services, significant governmental regulation, natural disasters, adverse weather conditions, plant closures for scheduled maintenance or interruption of transportation of oil or natural gas produced from the wells in this area. In addition, the effect of fluctuations on supply and demand may become more pronounced within specific geographic oil and gas producing areas such as in Oklahoma, which may cause these conditions to occur with greater frequency or magnify the effect of these conditions. Due to the concentrated nature of our portfolio of properties, a number of our properties could experience any of the same conditions at the same time, resulting in a relatively greater impact on our results of operations than they might have on other companies that have a more diversified portfolio of properties. Such delays or interruptions could have a material adverse effect on our financial condition and results of operations.

 

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We are subject to significant risks associated with the drilling and completion of wells in which we participate.

There are risks associated with the drilling of oil and natural gas wells, including landing the wellbore in the desired drilling zone, staying in the desired drilling zone while drilling horizontally through the formation, running casing the entire length of the wellbore and being able to run tools and other equipment consistently through the horizontal wellbore, fires and spills, among others. Risks in completing our wells include, but are not limited to, being able to produce the formation, being able to run tools the entire length of the wellbore during completion operations and successfully cleaning out the wellbore. The occurrence of any of these events could significantly reduce our revenues or cause substantial losses, impairing our future operating results. We may become subject to liability for pollution, blow-outs or other hazards. The payment of such liabilities could reduce the funds available to us or could, in an extreme case, result in a total loss of our properties and assets.

Our reliance on specialized processes creates uncertainties that could adversely affect our results of operations and financial condition.

One of our business strategies is to commercially develop conventional resource reservoirs using specialized processes employed by the New Source Group. One technique utilized by the New Source Group is the installation of electric submersible pumps to depressurize the targeted hydrocarbon-bearing reservoir, allowing the gas to expand and push oil and natural gas out of the pores in which they are trapped, in order to increase the production of oil and natural gas. The additional production and reserves attributable to the use of these techniques is inherently difficult to predict. If these specialized processes do not allow for the extraction of additional oil and natural gas production in the manner or to the extent that we anticipate, our future results of operations and financial condition could be materially adversely affected.

We depend on our key management personnel, and the loss of any of these individuals could adversely affect our business.

If we lose the services of our key management personnel (including Mr. Kos and Mr. Chernicky) or are unable to attract additional qualified personnel, our business, financial condition, results of operations, development efforts and ability to grow could suffer. We depend upon the knowledge, skill and experience of these individuals to assist us in improving the performance and reducing the risks associated with our participation in oil and natural gas development projects. In addition, the success of our business depends, to a significant extent, upon the abilities and continued efforts of our management.

Our key management personnel (including Mr. Kos and Mr. Chernicky) may terminate their employment with us at any time for any reason with little or no notice. Upon termination of their employment, such persons may engage in businesses that compete with us.

We rely on our relationships with affiliates to access infrastructure that is critical to the development of our assets. Adequate infrastructure may not be available at an economic rate.

Execution of our business strategy is dependent on the availability and capability of various infrastructure, including gas gathering and processing, saltwater disposal, and transportation. Future acquisitions may require us to expend significant capital to acquire, develop or access similar infrastructure. Such capital requirements may adversely impact our returns.

Our access to saltwater disposal infrastructure may not be sufficient to handle all saltwater produced, and environmental regulations may impact our ability to handle saltwater.

Our production is dependent on economically disposing of large amounts of saltwater utilizing the New Source Group’s existing saltwater disposal infrastructure. Changing environmental regulations or the unexpected production of excessive saltwater could render such infrastructure insufficient and require additional capital expenditures.

 

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Our ability to sell our production and/or receive market prices for our production may be adversely affected by lack of transportation, capacity constraints and interruptions.

The marketability of our production from our producing properties depends in part upon the availability, proximity and capacity of third-party refineries, natural gas gathering systems and processing facilities. We deliver crude oil and natural gas produced from these areas through transportation systems that we do not own. The lack of availability or capacity on these systems and facilities could reduce the price offered for our production or result in the shut-in of producing wells or the delay or discontinuance of development plans for properties.

A portion of our production may also be interrupted, or shut in, from time to time for numerous other reasons, including as a result of accidents, field labor issues or strikes, or the New Source Group might voluntarily curtail production in response to market conditions. If a substantial amount of our production is interrupted at the same time, it could adversely affect our cash flow from operations.

Our identified drilling locations are scheduled to be developed over several years, making them susceptible to uncertainties that could materially alter the occurrence or timing of their drilling.

We have identified and scheduled drilling locations on our acreage over a multi-year period. The ability of the New Source Group to drill and develop these locations depends on a number of factors, including the availability of capital, seasonal conditions, regulatory approvals, oil, natural gas and NGL prices, costs and drilling results. The final determination on whether to drill any of these drilling locations will be dependent upon the factors described elsewhere in this prospectus as well as, to some degree, the results of the New Source Group’s drilling activities with respect to our proved drilling locations. Because of these uncertainties, we do not know if the identified drilling locations will be drilled within our expected time frame or will ever be drilled. As such, our actual drilling activities may be materially different from those presently identified, which could adversely affect our business, results of operations or financial condition.

Our estimated proved reserves are based on many assumptions that may turn out to be inaccurate. Any significant inaccuracies in these reserve estimates or underlying assumptions will materially affect the quantities and present value of our reserves.

Reserve engineering is a subjective process of estimating underground accumulations of oil and natural gas that cannot be measured in an exact manner. It requires interpretations of available technical data and many assumptions, including assumptions relating to current and future economic conditions and commodity prices. Any significant inaccuracies in these interpretations or assumptions could materially affect the estimated quantities and present value of reserves shown in this prospectus.

To prepare our estimates, we must project production rates and the timing of development expenditures. We must also analyze available geological, geophysical, production and engineering data, and the quality and reliability of this data can vary. The process also requires economic assumptions about matters such as oil, natural gas and NGL prices, drilling and operating expenses, capital expenditures, taxes and availability of funds. There are numerous uncertainties inherent in estimating quantities of proved reserves and in projecting future rates of production.

Actual future production, oil, natural gas and NGL prices, revenues, taxes, development expenditures, operating expenses and quantities of recoverable oil and natural gas reserves will vary from our estimates. Any significant variance could materially affect the estimated quantities and present value of reserves shown in this prospectus. In addition, we may adjust estimates of proved reserves to reflect production history, results of development, prevailing oil, natural gas and NGL prices and other factors, many of which are beyond our control.

 

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A substantial portion of our estimated proved reserves is undeveloped and may not ultimately be developed or become commercially productive, which could have a material adverse effect on our future oil and natural gas reserves and production and, therefore, our future cash flow and income.

Approximately 42.5% of our total estimated proved reserves as of June 30, 2012 were proved undeveloped reserves and may not be ultimately developed or produced. In estimating our proved undeveloped reserves, we rely upon estimates of our working interest and net revenue interest based on our current ownership of leasehold in the proposed drilling unit, and we also use assumed production volumes based on production histories and geological information. Recovery of proved undeveloped reserves requires significant capital expenditures and successful drilling operations. The reserve data included in our reserve report assumes that substantial capital expenditures are required and will be made to develop these reserves. We cannot be certain that the estimated costs of the development of these reserves are accurate, that development will occur as scheduled or that the results of such development will be as estimated. Delays in the development of our reserves or increases in costs to drill and develop such reserves will reduce the standardized measure of our estimated proved undeveloped reserves and future net revenues estimated for such reserves and may result in some projects becoming uneconomic. In addition, delays in the development of reserves could cause us to have to reclassify our proved reserves as unproved reserves.

The present value of future net revenues from our proved reserves will not necessarily be the same as the current market value of our estimated oil and natural gas reserves.

You should not assume that the present value of future net revenues from our proved reserves is the current market value of our estimated oil and natural gas reserves. In accordance with SEC requirements for the years ended December 31, 2010 and 2011, we have based the estimated discounted future net revenues from our proved reserves on the unweighted arithmetic average of the first-day-of-the-month price for each of the preceding twelve months without giving effect to derivative transactions. Actual future net revenues from our oil and natural gas properties will be affected by factors such as:

 

   

the actual prices we receive for oil and natural gas;

 

   

our actual development and production expenditures;

 

   

the amount and timing of actual production; and

 

   

changes in governmental regulations or taxation.

The timing of both our production and our incurrence of expenses in connection with the development and production of oil and natural gas properties will affect the timing and amount of actual future net revenues from proved reserves, and thus their actual present value. In addition, the 10% discount factor we use when calculating discounted future net revenues may not be the most appropriate discount factor based on interest rates in effect from time to time and risks associated with us or the oil and natural gas industry in general. Actual future prices and costs may differ materially from those used in the present value estimates included in this prospectus.

Our development and acquisition projects require substantial capital expenditures. We may be unable to obtain needed capital or financing on satisfactory terms, which could lead to a decline in our oil and natural gas reserves.

The natural gas and oil industry is capital intensive. We make and expect to continue to make substantial capital expenditures in our business for the development, production and acquisition of oil, natural gas and NGL reserves. These expenditures will reduce our cash available for distribution. We intend to finance our future capital expenditures with cash flow from operations and our new revolving credit facility.

We may not be able to access the capital markets or otherwise secure such additional financing on reasonable terms or at all, and financing may not continue to be available to us under our existing or new financing arrangements. Our business strategy is reliant upon our ability to have access to a substantial amount of

 

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outside capital. The availability of these sources of capital will depend upon a number of factors, including general economic and financial market conditions, oil, natural gas and NGL prices and our market value and operating performance. If additional capital resources are unavailable, we may curtail our development and other activities or be forced to sell some of our assets on an untimely or unfavorable basis. Any such curtailment or sale could have a material adverse effect on our business, financial condition and results of operations.

Our cash flows from operations and access to capital are subject to a number of variables, including, among others:

 

   

our proved reserves;

 

   

the volume of oil, natural gas and NGLs we are able to produce and sell from existing wells;

 

   

the prices at which our oil, natural gas and NGLs are sold;

 

   

our ability to acquire, locate and produce new reserves; and

 

   

the ability of our banks to lend.

If our revenues or the borrowing base under our new revolving credit facility decrease as a result of lower oil, natural gas or NGL prices, operating difficulties, declines in reserves or for any other reason, we may have limited ability to obtain the capital necessary to sustain our operations at current levels. If additional capital is needed, we may not be able to obtain debt or equity financing.

Increased costs of capital could adversely affect our business.

Our business and operating results can be harmed by factors such as the availability, terms and cost of capital and increases in interest rates. Changes in any one or more of these factors could cause our cost of doing business to increase, limit our access to capital, limit our ability to pursue acquisition opportunities, reduce our cash flows available for drilling and place us at a competitive disadvantage. Continuing disruptions and volatility in the global financial markets may lead to an increase in interest rates or a contraction in credit availability impacting our ability to finance our operations. We require continued access to capital. A significant reduction in the availability of credit could materially and adversely affect our ability to achieve our planned growth and operating results.

If oil, natural gas and NGL prices decrease, we may be required to take write-downs of the carrying values of our oil and natural gas properties.

We review our proved oil and natural gas properties for impairment whenever events and circumstances indicate that a decline in the recoverability of their carrying value may have occurred. Based on specific market factors and circumstances at the time of prospective impairment reviews, and the continuing evaluation of development plans, production data, economics and other factors, we may be required to write down the carrying value of our oil and natural gas properties, which may result in a decrease in the amount available under our new revolving credit facility. A write-down constitutes a non-cash charge to earnings. We may incur impairment charges in the future that could have a material adverse effect on our ability to borrow under our new revolving credit facility and our results of operations for the periods in which such charges are taken.

Our insurance policies might be inadequate to cover our liabilities.

Insurance costs are expected to continue to increase over the next few years, and we may decrease coverage and retain more risk to mitigate future cost increases. If we incur substantial liability, and the damages are not covered by insurance or are in excess of policy limits, then our business, results of operations and financial condition may be materially adversely affected.

 

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Competition in the oil and natural gas industry is intense, and many of our competitors have greater resources than we do.

We operate in a highly competitive environment for acquiring prospects and productive properties, marketing oil and natural gas and securing equipment and trained personnel. As a relatively small oil and natural gas company, many of our competitors are major and large independent oil and natural gas companies that possess and employ financial, technical and personnel resources substantially greater than ours. Those companies may be able to develop and acquire more prospects and productive properties than our financial or personnel resources permit and may be willing to pay premium prices that we cannot afford to match. Our ability to acquire additional prospects and develop reserves in the future will depend on our ability to evaluate and select suitable properties and consummate transactions in a highly competitive environment. Also, there is substantial competition for capital available for investment in the oil and natural gas industry. Larger competitors may be better able to withstand sustained periods of unsuccessful drilling and absorb the burden of changes in laws and regulations more easily than we can, which would adversely affect our competitive position. We may not be able to compete successfully in the future in acquiring prospective reserves, developing reserves, marketing hydrocarbons, attracting and retaining quality personnel or raising additional capital.

Our commodity derivative arrangements may be ineffective in managing our commodity price risk and could result in financial losses or could reduce our income, which may adversely impact our ability to pay distributions to our unitholders.

We enter into financial hedge arrangements (i.e., commodity derivative agreements) from time to time in order to manage our commodity price risk and to provide a more predictable cash flow from operations. We do not intend to designate our derivative instruments as cash flow hedges for accounting purposes. The fair value of our derivative instruments will be marked to market at the end of each quarter, and the resulting unrealized gains or losses due to changes in the fair value of our derivative instruments will be recognized in current earnings. Accordingly, our earnings may fluctuate significantly as a result of changes in fair value of our derivative instruments.

Actual future production of our properties may be significantly higher or lower than we estimate at the time we enter into commodity derivative contracts for such period. If the actual amount of production is higher than we estimated, we will have greater commodity price exposure than we intended. If the actual amount of production is lower than the notional amount that is subject to our derivative financial instruments, we might be forced to satisfy all or a portion of our derivative transactions without the benefit of the cash flow from our sale of the underlying physical commodity, resulting in a substantial diminution of our liquidity. As a result of these factors, to the extent we engage in hedging activities, such hedging activities may not be as effective as we intend in reducing the volatility of our cash flows.

Derivative instruments also expose us to the risk of financial loss in some circumstances, including when:

 

   

production is less than the volume covered by the derivative instruments;

 

   

the counter-party to the derivative instrument defaults on its contract obligations;

 

   

there is an increase in the differential between the underlying price in the derivative instrument and actual prices received; or

 

   

the steps we take to monitor our derivative financial instruments do not detect and prevent transactions that are inconsistent with our risk management strategies.

In addition, depending on the type of derivative arrangements we enter into, the agreements could limit the benefit we would receive from increases in oil, natural gas or natural gas liquids prices. We cannot assure you that the commodity derivative contracts we have entered into, or will enter into, will adequately protect us from fluctuations in oil prices.

 

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The recent adoption of derivatives legislation by the United States Congress could have an adverse effect on our ability to use derivative instruments to reduce the effect of commodity price, interest rate and other risks associated with our business.

The U.S. Congress recently adopted the Dodd-Frank Wall Street Reform and Consumer Protection Act which, among other provisions, establishes federal oversight and regulation of the over-the-counter derivatives market and entities, such as us, that participate in that market. In its rulemaking under the new legislation, the Commodities Futures Trading Commission (the “CFTC”) has proposed regulations to set position limits for certain futures and option contracts in the major energy markets and for swaps that are their economic equivalent. Certain bona fide hedging transactions or positions would be exempt from these position limits. It is not possible at this time to predict when the CFTC will finalize these regulations. The financial reform legislation may also require us to comply with margin requirements and with certain clearing and trade-execution requirements in connection with our commodity price management activities, although the application of those provisions to us is uncertain at this time. The financial reform legislation may also require some counterparties to spin off some of their derivatives activities to separate entities, which may not be as creditworthy. The new legislation and any new regulations could significantly increase the cost of derivative contracts (including through requirements to post collateral which could adversely affect our available liquidity), materially alter the terms of derivative contracts, reduce the availability of derivatives to protect against risks we encounter, reduce our ability to monetize or restructure our existing commodity price contracts, and increase our exposure to less creditworthy counterparties. If we reduce our use of derivatives as a result of the legislation and regulations, our results of operations may become more volatile and our cash flows may be less predictable, which could adversely affect our ability to plan for and fund capital expenditures. Finally, the legislation was intended, in part, to reduce the volatility of oil, natural gas and NGL prices, which some legislators attributed to speculative trading in derivatives and commodity instruments related to oil and natural gas. Our revenues could therefore be adversely affected if commodity prices decline as a consequence of the legislation and regulations. Any of these consequences could have a material adverse effect on us, our financial condition, and our results of operations.

Our production of oil and natural gas is sold to a limited number of customers and the credit default of one of these customers could have a temporary adverse effect on us.

Our revenues are generated under contracts with a limited number of customers. Historically, all of the natural gas from our properties has been sold to Scissortail Energy, LLC and DCP Midstream, LP and all of the oil from our properties has been sold to United Petroleum Purchasing Company, Sunoco, Inc. and Enterprise Products Company. Our results of operations would be adversely affected as a result of non-performance by any of our customers. A non-payment default by one of these large customers could have an adverse effect on us, temporarily reducing our cash flow.

Increases in interest rates could adversely impact our unit price and our ability to issue additional equity and incur debt.

As with other yield-oriented securities, our unit price is impacted by the level of our cash distributions to our unitholders and the implied distribution yield. The distribution yield is often used by investors to compare and rank similar yield-oriented securities for investment decision-making purposes. Therefore, changes in interest rates, either positive or negative, may affect the yield requirements of investors who invest in our common units, and a rising interest rate environment could have an adverse impact on our unit price, our ability to issue additional equity or incur debt, and the cost to us of any such issuance or incurrence.

Changes in the legal and regulatory environment governing the oil and natural gas industry, particularly changes in the current Oklahoma forced pooling system, could have a material adverse effect on our business.

Our business is subject to various forms of extensive government regulation, including laws and regulations concerning the location, spacing and permitting of the oil and natural gas wells the New Source Group drills and the disposal of saltwater produced from such wells, among other matters. In particular, our business relies

 

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heavily on a methodology available in Oklahoma known as “forced pooling,” which refers to the ability of a holder of an oil and natural gas interest in a particular prospective drilling spacing unit to apply to the Oklahoma Corporation Commission for an order forcing all other holders of oil and natural gas interests in such area into a common pool for purposes of developing that drilling spacing unit. Changes in the legal and regulatory environment governing our industry, particularly any changes to Oklahoma forced pooling procedures that make forced pooling more difficult to accomplish, could result in increased compliance costs and adversely affect our business and results of our operations.

Certain federal income tax deductions currently available with respect to oil and natural gas exploration and development may be eliminated as a result of future legislation.

Among the changes contained in the President’s fiscal year 2013 budget proposal, released by the White House on February 13, 2012, is the elimination or deferral of certain key U.S. federal income tax deductions currently available to oil and gas exploration and production companies. Such changes include, but are not limited to, (i) the repeal of the percentage depletion allowance for oil and natural gas properties; (ii) the elimination of current deductions for intangible drilling and development costs; (iii) the elimination of the deduction for certain U.S. production activities; and (iv) an extension of the amortization period for certain geological and geophysical expenditures. Recently, members of the U.S. Congress have considered similar changes to the existing federal income tax laws that affect oil and natural gas exploration and production companies, which, if enacted, would negatively affect our financial condition and results of operations. The passage of any legislation as a result of the budget proposal or any other similar change in U.S. federal income tax law could eliminate or defer certain tax deductions within the industry that are currently available with respect to oil and natural gas exploration and development, and any such change could increase the taxable income allocable to our unitholders and negatively impact the value of an investment in our common units.

Our operations are subject to health, safety, and environmental laws and regulations which may expose us to significant costs and liabilities.

Our oil and natural gas exploration, production and processing operations are subject to stringent and complex federal, state, and local laws and regulations governing health and safety aspects of our operation, the discharge of materials into the environment and the protection of the environment. These laws and regulations may impose on our operations numerous requirements, including the obligation to obtain a permit before conducting drilling or underground injection activities; restrictions on the types, quantities and concentration of materials that can be released into the environment; limitations or prohibitions of drilling activities on certain lands lying within wilderness, wetlands and other protected areas; specific health and safety criteria to protect workers; and the responsibility for cleaning up any pollution resulting from operations. Numerous governmental authorities such as the U.S. Environmental Protection Agency, or the EPA, and analogous state agencies have the power to enforce compliance with these laws and regulations and the permits issued under them, oftentimes requiring difficult and costly actions. These laws and regulations may result in the assessment of administrative, civil or criminal penalties for any violations; the imposition of investigatory or remedial obligations; the issuance of injunctions limiting or preventing some or all of our operations; and delays in granting permits and cancellation of leases.

There is an inherent risk of incurring significant environmental costs and liabilities in the performance of our operations, some of which may be material, due to the New Source Group’s handling of petroleum hydrocarbons and wastes, emissions to air and water, the underground injection or other disposal of wastes and historical industry operations and waste disposal practices. Under certain environmental laws and regulations, we may be liable regardless of whether we were at fault for the full cost of removing or remediating contamination, even when multiple parties contributed to the release and the contaminants were released in compliance with all applicable laws. In addition, accidental spills or releases on our properties may expose us to significant costs or liabilities that could have a material adverse effect on our financial condition or results of operations. Aside from government agencies, the owners of properties where our wells are located, the operators of facilities where our petroleum hydrocarbons or wastes are taken for processing, reclamation or disposal and other private parties may

 

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be able to sue us to enforce compliance with environmental laws and regulations, collect penalties for violations or obtain damages for any related personal injury or property damage. Some of our properties are located near current or former third-party oil and natural gas operations or facilities, and there is a risk that contamination has migrated from those sites to ours. Changes in environmental laws and regulations occur frequently, and any changes that result in more stringent or costly material handling, emission, waste management or cleanup requirements could require us to make significant expenditures to attain and maintain compliance or may otherwise have a material adverse effect on our own results of operations, competitive position or financial condition. We may not be able to recover some or any of these costs from insurance.

Climate change laws and regulations restricting emissions of “greenhouse gases” could result in increased operating costs and reduced demand for the oil and natural gas that we produce, while the physical effects of climate change could disrupt our production and cause us to incur significant costs in preparing for or responding to those effects.

There is a growing belief that emissions of greenhouse gases (“GHGs”) may be linked to climate change. Climate change and the costs that may be associated with its impacts and the regulation of GHGs have the potential to affect our business in many ways, including negatively impacting the costs we incur in producing oil and natural gas and the demand for and consumption of oil and natural gas (due to change in both costs and weather patterns).

In December 2009, the EPA determined that atmospheric concentrations of carbon dioxide, methane, and certain other GHGs present an endangerment to public health and welfare because such gases are, according to the EPA, contributing to the warming of the earth’s atmosphere and other climatic changes. Consistent with its findings, the EPA has proposed or adopted various regulations under the Clean Air Act to address GHGs. Among other things, the EPA is limiting emissions of greenhouse gases from new cars and light duty trucks beginning with the 2012 model year. In addition, the EPA has published a final rule to address the permitting of GHG emissions from stationary sources under the Prevention of Significant Deterioration, or “PSD,” and Title V permitting programs, pursuant to which these permitting requirements have been “tailored” to apply to certain stationary sources of GHG emissions in a multi-step process, with the largest sources first subject to permitting. Facilities required to obtain PSD permits for their GHG emissions will be required to meet emissions limits that are based on the “best available control technology,” which will be established by the permitting agencies on a case-by-case basis. The EPA has also adopted regulations requiring the reporting of GHG emissions from specified large GHG emission sources in the United States, including certain oil and natural gas production facilities, which may include certain of our operations, beginning in 2012 for emissions occurring in 2011 and which may form the basis for further regulation. Many of the EPA’s GHG rules are subject to legal challenges, but have not been stayed pending judicial review. Depending on the outcome of such proceedings, such rules may be modified or rescinded or the EPA could develop new rules. The EPA’s GHG rules could adversely affect our operations and restrict or delay our ability to obtain air permits for new or modified facilities.

Moreover, Congress has from time to time considered adopting legislation to reduce emissions of GHGs or promote the use of renewable fuels. As an alternative, some proponents of GHG controls have advocated mandating a national “clean energy” standard. In 2011, President Obama encouraged Congress to adopt a goal of generating 80% of U.S. electricity from “clean energy” by 2035 with credit for renewable and nuclear power and partial credit for clean coal and “efficient natural gas.” Because of the lack of any comprehensive federal legislative program expressly addressing GHGs, there currently is a great deal of uncertainty as to how and when additional federal regulation of GHGs might take place and as to whether the EPA should continue with its existing regulations in the absence of more specific Congressional direction.

In the meantime, many states already have taken such measures, which have included renewable energy standards, development of GHG emission inventories and/or cap and trade programs. Cap and trade programs typically work by requiring major sources of emissions or major producers of fuels to acquire and surrender emission allowances, with the number of available allowances reduced each year until the overall GHG emission

 

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reduction goal is achieved. These allowances are expected to escalate significantly in cost over time. The adoption of legislation or regulatory programs to reduce emissions of GHGs could require us to incur increased operating costs, such as costs to purchase and operate emissions control systems, to acquire emissions allowances or comply with new regulatory or reporting requirements or to purchase electricity. If we are unable to recover or pass through a significant level of our costs related to complying with climate change regulatory requirements imposed on us, it could have a material adverse effect on our results of operations and financial condition. Any such legislation or regulatory programs could also increase the cost of consuming, and thereby reduce demand for, the oil and natural gas we produce. Consequently, legislation and regulatory programs to reduce emissions of GHGs could have an adverse effect on our business, financial condition and results of operations.

Finally, it should be noted that some scientists have concluded that increasing concentrations of GHGs in the earth’s atmosphere may produce climate changes that have significant physical effects, such as increased frequency and severity of storms and floods. If any such effects were to occur, they could have an adverse effect on our exploration and production operations. Significant physical effects of climate change could also have an indirect effect on our financing and operations by disrupting the transportation or process-related services provided by midstream companies, service companies or suppliers with whom we have a business relationship. Our insurance may not cover some or any of the damages, losses, or costs that may result from potential physical effects of climate change.

Risks Related to Our Indebtedness

Our new revolving credit facility will have substantial restrictions and financial covenants that may restrict our business and financing activities and our ability to pay distributions to our unitholders.

The operating and financial restrictions and covenants in our new revolving credit facility and any future financing agreements may restrict our ability to finance future operations or capital needs or to engage, expand or pursue our business activities or to pay distributions to our unitholders. Please read “Management’s Discussion and Analysis of Financial Condition and Results of Operations—New Revolving Credit Facility.” Our ability to comply with these restrictions and covenants in our new revolving credit facility in the future is uncertain and will be affected by the levels of cash flow from our operations and events or circumstances beyond our control. If market or other economic conditions deteriorate, our ability to comply with these covenants may be impaired. If we violate any provisions of our new revolving credit facility that are not cured or waived within the appropriate time periods provided in our new revolving credit facility, all or a significant portion of our indebtedness may become immediately due and payable, our ability to make distributions to our unitholders will be inhibited and our lenders’ commitment to make further loans to us may terminate. We might not have, or be able to obtain, sufficient funds to make these accelerated payments. In addition, our obligations under our new revolving credit facility will be secured by substantially all of our assets, and if we are unable to repay our indebtedness under our new revolving credit facility, the lenders could seek to foreclose on our assets.

We anticipate that, like New Source Energy’s credit facility, our new revolving credit facility will be reserve-based, and thus we will be permitted to borrow under our new revolving credit facility in an amount up to the borrowing base, which is primarily based on the value of our oil and natural gas properties and our commodity derivative contracts as determined semi-annually by our lenders in their sole discretion. Our borrowing base will be subject to redetermination on a semi-annual basis based on an engineering report with respect to our estimated natural gas, NGL and oil reserves, which will take into account the prevailing natural gas, NGL and oil prices at such time, as adjusted for the impact of our derivative contracts. In the future, we may not be able to access adequate funding under our new revolving credit facility as a result of (i) a decrease in our borrowing base due to a subsequent borrowing base redetermination, or (ii) an unwillingness or inability on the part of our lending counterparties to meet their funding obligations.

A future decline in commodity prices could result in a redetermination that lowers our borrowing base in the future and, in such case, we could be required to repay any indebtedness in excess of the borrowing base, or we will be required to pledge other oil and natural gas properties as additional collateral. We do not anticipate

 

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having any substantial unpledged properties, and we may not have the financial resources in the future to make any mandatory principal prepayments required under our new revolving credit facility. Additionally, we anticipate that if, at the time of any distribution, our borrowings equal or exceed the maximum percentage allowed of the then-specified borrowing base, we will not be able to pay distributions to our unitholders in any such quarter without first making the required repayments of indebtedness under our new revolving credit facility.

The variable rate indebtedness in our new revolving credit facility will subject us to interest rate risk, which could cause our debt service obligations to increase significantly.

Our borrowings under our new revolving credit facility will bear interest at rates that may vary, exposing us to interest rate risk. If such rates increase, our debt service obligations on the variable rate indebtedness would increase even though the amount borrowed remained the same, and our net income and cash available for servicing our indebtedness would decrease.

Availability under our new revolving credit facility will be based on a borrowing base which is subject to redetermination by our lenders. If our borrowing base is reduced, we may be required to repay amounts outstanding under our new revolving credit facility.

Our ability to make payments due under our new revolving credit facility will depend upon our future operating performance, which is subject to general economic and competitive conditions and to financial, business and other factors, many of which we cannot control. In addition, our borrowing base will be subject to semi-annual redetermination by our lenders based on valuation of our proved reserves and the lenders’ internal criteria. In the event the amount outstanding under our new revolving credit facility at any time exceeds the borrowing base at such time, we may be required to repay a portion of our outstanding borrowings on an accelerated basis. If we do not have sufficient funds on hand for repayment in such event, or to service our debt obligations generally, we may be required to seek a waiver or amendment from our lenders, refinance our new revolving credit facility, sell assets or sell additional securities. We may not be able to obtain such financing or complete such transactions on terms acceptable to us, or at all. In addition, our new revolving credit facility may limit our ability to take certain of such actions. Failure to make the required repayment could result in a default under our new revolving credit facility. Our failure to generate sufficient funds to pay our debts or to undertake any of these actions successfully, or to comply with the covenants under our new revolving credit facility mentioned above, could materially adversely affect our business.

Our level of indebtedness may increase and reduce our financial flexibility.

As of September 30, 2012, we had approximately $68.0 million in outstanding debt. We expect to have $40.0 million in outstanding debt at the closing of this offering, and in the future we may incur additional indebtedness to make future acquisitions or to develop our properties.

Our level of indebtedness could affect our operations in several ways, including the following:

 

   

a significant portion of our cash flows could be used to service our indebtedness;

 

   

a high level of debt would increase our vulnerability to general adverse economic and industry conditions;

 

   

the covenants contained in the agreements governing our outstanding indebtedness could limit our ability to borrow additional funds, dispose of assets, pay dividends and make certain investments;

 

   

a high level of debt could place us at a competitive disadvantage compared to our competitors that are less leveraged and therefore, may be able to take advantage of opportunities that our indebtedness would prevent us from pursuing;

 

   

our debt covenants may also affect our flexibility in planning for, and reacting to, changes in the economy and in our industry;

 

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a high level of debt may make it more likely that a reduction in the borrowing base of our new revolving credit facility following a periodic redetermination could require us to repay a portion of our then outstanding bank borrowings; and

 

   

a high level of debt may impair our ability to obtain additional financing in the future for working capital, capital expenditures, acquisitions, general partnership or other purposes.

A high level of indebtedness increases the risk that we may default on our debt obligations. Our ability to meet our debt obligations and to reduce our level of indebtedness depends on our future performance. General economic conditions, oil, natural gas and natural gas liquids prices, and financial, business and other factors affect our operations and our future performance. Many of these factors are beyond our control. We may not be able to generate sufficient cash flows to pay the interest on our debt and future working capital, borrowings or equity financing may not be available to pay or refinance such debt. Factors that will affect our ability to raise cash through an offering of our capital stock or a refinancing of our debt include financial market conditions, the value of our assets and our performance at the time we need capital.

Our indebtedness under our new revolving credit facility will be secured by substantially all of our assets. Therefore, if we default on any of our obligations under the credit facility it could result in our lenders foreclosing on our assets or otherwise being entitled to revenues generated by and through our assets.

Risks Inherent in an Investment in Us

Our general partner and its affiliates will own a controlling interest in us and will have conflicts of interest with, and owe limited fiduciary duties to, us, which may permit them to favor their own interests to the detriment of our unitholders.

Our general partner will have control over all decisions related to our operations. Upon the closing of this offering, New Source Energy will control an aggregate     % of our outstanding common units and all of our subordinated units, and 100% of the voting membership interests in our general partner will be owned by New Source Energy and certain of its affiliates. Mr. Chernicky, in turn, owns 83.3% of the voting common stock of New Source Energy. The directors and officers of our general partner have a fiduciary duty to manage our general partner in a manner beneficial to the owners of our general partner. However, certain directors and officers of our general partner, including Mr. Chernicky and Mr. Kos, are directors and/or officers of affiliates of our general partner (including members of the New Source Group), and will continue to have economic interests, investments and other economic incentives in the New Source Group. Conflicts of interest exist and may arise in the future between our general partner and its affiliates (including members of the New Source Group), on the one hand, and us and our unitholders, on the other hand. In resolving these conflicts, our general partner may favor its own interests and the interests of its affiliates over the interests of our unitholders and us. Please read “Conflicts of Interest and Fiduciary Duties—Conflicts of Interest—Our partnership agreement limits our general partner’s fiduciary duties to our unitholders and restricts the remedies available to unitholders for actions taken by our general partner that might otherwise constitute breaches of fiduciary duty.” These potential conflicts include, among others, the following situations:

 

   

neither our partnership agreement nor any other agreement requires New Source Energy to pursue a business strategy that favors us. The directors and officers of New Source Energy have a fiduciary duty to make decisions in the best interests of its equity holders, which may be contrary to our interests;

 

   

our general partner is allowed to take into account the interests of parties other than us, such as its owners, in resolving conflicts of interest, which has the effect of limiting its fiduciary duty to our unitholders;

 

   

New Source Energy is not limited in its ability to compete with us, including with respect to future acquisition opportunities, and is under no obligation to offer assets to us. Please read “Conflicts of Interest and Fiduciary Duties—Conflicts of Interest—New Source Energy and other affiliates of our general partner will not be limited in their ability to compete with us, which could cause conflicts of interest and limit our ability to acquire additional assets or businesses”;

 

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except in limited circumstances, our general partner has the power and authority to conduct our business without unitholder approval;

 

   

many of the officers and directors of our general partner who will provide services to us will devote time to affiliates of our general partner, including New Source Energy, and may be compensated for services rendered to such affiliates;

 

   

our general partner has limited its liability and reduced its fiduciary duties, and has also restricted the remedies available to our unitholders for actions that, without such limitations, reductions, and restrictions, might constitute breaches of fiduciary duty. By purchasing common units, unitholders are consenting to some actions and conflicts of interest that might otherwise constitute a breach of fiduciary or other duties under applicable law;

 

   

New Source Energy determines the amount and timing of our drilling program under our development agreement;

 

   

our general partner determines the amount and timing of our asset purchases and sales, borrowings, issuance of additional partnership interests, other investments, including investment capital expenditures in other partnerships with which our general partner is or may become affiliated, and the creation, reduction or increase of cash reserves, each of which can affect the amount of cash that is distributed to unitholders;

 

   

our general partner determines whether a cash expenditure is classified as a growth capital expenditure, which does not reduce operating surplus. This determination can affect the amount of cash that is distributed to our unitholders and to our general partner, the amount of adjusted operating surplus in any given period and the ability of the subordinated units to convert into common units;

 

   

we and our general partner will enter into an omnibus agreement with the New Source Group in connection with this offering, pursuant to which, among other things, the New Source Group will operate our assets and perform other management and administrative services for us and our general partner;

 

   

our general partner may cause us to borrow funds in order to permit the payment of cash distributions, even if the purpose or effect of the borrowing is to make a distribution on the subordinated units, to make incentive distributions or to accelerate the expiration of the subordination period;

 

   

our partnership agreement permits us to classify up to $         million as operating surplus, even if it is generated from asset sales, non-working capital borrowings or other sources that would otherwise constitute capital surplus. This cash may be used to fund distributions on our subordinated units or to our general partner in respect of the general partner interest or the incentive distribution rights;

 

   

our general partner decides whether to retain separate counsel, accountants, or others to perform services for us;

 

   

our general partner may elect to cause us to issue common units to it in connection with a resetting of the target distribution levels related to our general partner’s incentive distribution rights without the approval of the conflicts committee of the board of directors of our general partner or our unitholders. This election may result in lower distributions to our common unitholders in certain situations;

 

   

our partnership agreement does not restrict our general partner from causing us to pay it or its affiliates for any services rendered to us or entering into additional contractual arrangements with any of these entities on our behalf;

 

   

our general partner intends to limit its liability regarding our contractual and other obligations and, in some circumstances, is entitled to be indemnified by us;

 

   

our general partner may exercise its limited right to call and purchase common units if it and its affiliates own more than 80% of the common units; and

 

   

our general partner controls the enforcement of obligations owed to us by our general partner and its affiliates, including New Source Energy.

 

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Please read “Certain Relationships and Related Party Transactions” and “Conflicts of Interest and Fiduciary Duties.”

New Source Energy and other affiliates of our general partner will not be limited in their ability to compete with us, which could cause conflicts of interest and limit our ability to acquire additional assets or businesses.

Our partnership agreement provides that the New Source Group is not restricted from owning assets or engaging in businesses that compete directly or indirectly with us. In addition, the New Source Group may acquire, develop or dispose of additional oil and natural gas properties or other assets in the future, without any obligation to offer us the opportunity to purchase or develop any of those assets.

The members of the New Source Group are established participants in the oil and natural gas industry, and each have resources greater than ours, which factors may make it more difficult for us to compete with them with respect to commercial activities as well as for potential acquisitions. As a result, competition from these affiliates could adversely impact our results of operations and cash available for distribution to our unitholders. Please read “Conflicts of Interest and Fiduciary Duties.”

Neither we nor our general partner have any employees and we will rely primarily on the employees of the New Source Group to manage our business. The management team of New Source Energy, which includes the individuals who will manage us, will also perform substantially similar services for its assets and operations, and thus will not be solely focused on our business.

Neither we nor our general partner have any employees and we will rely primarily on the New Source Group to operate our assets. Upon the closing of this offering, we and our general partner will enter into an omnibus agreement with the New Source Group, pursuant to which, among other things, the New Source Group will agree to operate our assets, perform our drilling operations and provide other management and administrative services for us and our general partner.

The New Source Group will provide substantially similar services with respect to its own assets and operations. Because the New Source Group will be providing services to us that are substantially similar to those performed for its members, the New Source Group may not have sufficient human, technical and other resources to provide those services at a level that the New Source Group would be able to provide to us if it were solely focused on our business and operations. The New Source Group may make internal decisions on how to allocate its available resources and expertise that may not always be in our best interest compared to the interests of our affiliates. There is no requirement that the New Source Group favor us over itself in providing its services. If the employees of the New Source Group do not devote sufficient attention to the management and operation of our business, our financial results may suffer and our ability to make distributions to our unitholders may be reduced.

We have material weaknesses in our internal control over financial reporting. If one or more material weaknesses persist or if we fail to establish and maintain effective internal control over financial reporting, our ability to accurately report our financial results could be adversely affected.

In connection with the preparation of New Source Energy’s financial statements for the nine months ended September 30, 2011, New Source Energy identified errors in the prior calculation of its natural gas and NGL sales volumes and the related effects of those sales volumes on the calculations of depreciation, depletion and amortization expenses attributable to time periods in which its oil and natural gas properties were owned by Scintilla. New Source Energy corrected these errors, which resulted in net increases of its depreciation, depletion and amortization expenses for the years ended December 31, 2008, 2009 and 2010 of $3.8 million, $3.4 million and $4.0 million, respectively, and corresponding decreases of its net income for these periods. These changes also resulted in net decreases of New Source Energy’s oil and natural gas properties, net as of December 31, 2008, 2009 and 2010 of $6.4 million, $9.8 million and $13.8 million, respectively.

 

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Also during the preparation of New Source Energy’s financial statements for the nine months ended September 30, 2011, New Source Energy identified an error in the accounting for the acquisition of the Other Contributed Assets and recorded goodwill related to the acquisition of these properties in the amount of the deferred income tax liability resulting from the carryover of tax attributes from the prior owners to New Source Energy.

Management considers the failure to identify these errors in a timely manner to be material weaknesses in New Source Energy’s internal control over financial reporting under the standards established by the United States Public Company Accounting Oversight Board, or the “PCAOB Standards.” Under the PCAOB standards, a material weakness is defined as a deficiency, or a combination of deficiencies, in internal control, such that there is a reasonable possibility that a material misstatement of the entity’s financial statements will not be prevented, or detected and corrected on a timely basis. In response to these material weaknesses, New Source Energy evaluated its historical financial and operations data for further deficiencies and has changed the method by which it computes its natural gas and NGL sales volumes to ensure that such volumes match the actual volumes processed by its first purchasers. New Source Energy also instituted additional control procedures around the research and recording of non-recurring transactions.

After the closing of this offering, our management team and financial reporting oversight personnel will be those of New Source Energy, and thus, we will face the same control deficiencies described above. New Source Energy has taken all remedial actions it believes to be necessary, and we and New Source Energy are not aware of other material deficiencies at this time. However, until we have further experience with the results of such remedial actions, we cannot assure you that the measures taken to date, or any future measures we may implement, will ensure that we maintain adequate control over our financial processes and reporting. In addition, it is possible that we or our independent registered public accounting firm may identify additional errors in our financial statements that may be considered significant deficiencies or material weaknesses in our internal control over financial reporting.

The Sarbanes-Oxley Act of 2002 requires, among other things, that we assess the effectiveness of our internal control over financial reporting on an annual basis and the effectiveness of our disclosure controls and procedures on a quarterly basis. We will be required to perform system and process evaluation and testing of our internal control over financial reporting to allow management to report on, and, after we are no longer an emerging growth company, our independent registered public accounting firm will be asked to attest to, the effectiveness of our internal control over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act of 2002. Our testing, or subsequent testing by our independent registered public accounting firm, may reveal other material weaknesses or that the material weaknesses described above have not been fully remediated.

If we do not remediate the material weaknesses described above, other material weaknesses are identified or we are not able to comply with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 in a timely manner, our reported financial results could be restated or we could receive an adverse opinion regarding our internal control from our independent registered public accounting firm. As a result, we could also fail to meet the periodic reporting obligations applicable to us after the completion of this offering and become subject to investigations or sanctions by regulatory authorities, which would require additional financial and management resources. Any of the foregoing events could cause investors to lose confidence in our reported financial information and lead to a decline in the trading price for our common units.

If we fail to develop or maintain an effective system of internal controls, we may not be able to accurately report our financial results or prevent fraud. As a result, current and potential unitholders could lose confidence in our financial reporting, which would harm our business and the trading price of our units.

Effective internal controls are necessary for us to provide reliable financial reports, prevent fraud and operate successfully as a public company. If we cannot provide reliable financial reports or prevent fraud, our reputation and operating results would be harmed. We cannot be certain that our efforts to develop and maintain our internal controls will be successful, that we will be able to maintain adequate controls over our financial

 

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processes and reporting in the future or that we will be able to comply with our obligations under Section 404 of the Sarbanes Oxley Act of 2002. Any failure to develop or maintain effective internal controls, or difficulties encountered in implementing or improving our internal controls, could harm our operating results or cause us to fail to meet our reporting obligations. Ineffective internal controls could also cause investors to lose confidence in our reported financial information, which would likely have a negative effect on the trading price of our units.

For as long as we are an emerging growth company, we will not be required to comply with certain reporting requirements, including those relating to accounting standards and disclosure about our executive compensation, that apply to other public companies.

In April 2012, President Obama signed into law the Jumpstart Our Business Startups Act, or the JOBS Act. The JOBS Act contains provisions that, among other things, relax certain reporting requirements for “emerging growth companies,” including certain requirements relating to accounting standards and compensation disclosure. We are classified as an emerging growth company. For as long as we are an emerging growth company, which may be up to five full fiscal years, unlike other public companies, we will not be required to (1) provide an auditor’s attestation report on management’s assessment of the effectiveness of our system of internal control over financial reporting pursuant to Section 404, (2) comply with any new requirements adopted by the Public Company Accounting Oversight Board, or the PCAOB, requiring mandatory audit firm rotation or a supplement to the auditor’s report in which the auditor would be required to provide additional information about the audit and the financial statements of the issuer, (3) comply with any new audit rules adopted by the PCAOB after April 5, 2012, unless the SEC determines otherwise, (4) provide certain disclosure regarding executive compensation required of larger public companies, (5) hold nonbinding unitholder advisory votes on executive compensation or (6) obtain unitholder approval of any golden parachute payments not previously approved.

Cost reimbursements due to the New Source Group for services provided to us or on our behalf will be substantial and will reduce our cash available for distribution to our unitholders.

At the closing of this offering, we will enter into an omnibus agreement with the New Source Group and our general partner pursuant to which, among other things, we will make payments to the New Source Group for management and administrative services provided on our behalf. From the closing of this offering through December 31, 2013, we will pay the New Source Group a quarterly fee of $675,000 for the provision of such services. After December 31, 2013, in lieu of the quarterly fee, our general partner will reimburse the New Source Group, on a quarterly basis, for all actual direct and indirect expenses it incurs in its performance under the omnibus agreement, and we will reimburse our general partner for such payments it makes to the New Source Group in an amount equal to the cost of such actual and indirect expenses, without a cap on the amount of such reimbursement. Additionally, following the closing of this offering, we will be responsible for the costs of any equity-based compensation awarded to our management or the board of directors of our general partner, and we will be responsible for transaction costs incurred in connection with any acquisition we complete during such period. These payments will be substantial and will reduce the amount of cash available for distribution to unitholders.

Our general partner may elect to cause us to issue common units to it in connection with a resetting of the target distribution levels related to our general partner’s incentive distribution rights without the approval of the conflicts committee of the board of directors of our general partner or our unitholders. This election may result in lower distributions to our common unitholders in certain situations.

Our general partner has the right (but not the obligation), at any time when there are no subordinated units outstanding and it has received incentive distributions at the highest level to which it is entitled (25%) for each of the prior four consecutive fiscal quarters, to reset the initial target distribution levels at higher levels based on our cash distribution at the time of the exercise of the reset election. Following any reset election by our general partner, the minimum quarterly distribution will be reset to an amount equal to the average cash contribution per

 

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common unit for the two fiscal quarters immediately preceding the reset election (such amount is referred to as the “reset minimum quarterly distribution”) and the target distribution levels will be reset to correspondingly higher levels based on percentage increases above the reset minimum quarterly distribution.

If our general partner elects to reset the target distribution levels, it will be entitled to receive a number of common units and general partner units. The number of common units to be issued to our general partner will be equal to that number of common units which would have entitled their holder to an average aggregate quarterly cash distribution in the prior two quarters equal to the average of the distributions to our general partner on the incentive distribution rights in the prior two quarters. Our general partner will be issued the number of general partner units necessary to maintain our general partner’s interest in us that existed immediately prior to the reset election. We anticipate that our general partner would exercise this reset right (if at all) to facilitate acquisitions or internal growth projects that would not be sufficiently accretive to cash distributions per common unit without such conversion; however, it is possible that our general partner could exercise this reset election at a time when it is experiencing, or expects to experience, declines in the cash distributions it receives related to its incentive distribution rights and may, therefore, desire to be issued common units rather than retain the right to receive incentive distributions based on the initial target distribution levels. As a result, a reset election may cause our common unitholders to experience a reduction in the amount of cash distributions that our common unitholders would have otherwise received had we not issued new common units and general partner units to our general partner in connection with resetting the target distribution levels. Please read “Provisions of Our Partnership Agreement Relating to Cash Distributions—General Partner’s Right to Reset Incentive Distribution Levels.”

Our unitholders who fail to furnish certain information requested by our general partner or who our general partner determines are not eligible citizens may not be entitled to receive distributions in kind upon our liquidation and their common units will be subject to redemption.

We have the right to redeem all of the units of any holder that is not an eligible citizen if we are or become subject to federal, state, or local laws or regulations that, in the reasonable determination of our general partner, create a substantial risk of cancellation or forfeiture of any property in which we have an interest because of the nationality, citizenship or other related status of any limited partner. Our general partner may require any limited partner or transferee to furnish information about his nationality, citizenship or related status. If a limited partner fails to furnish information about his nationality, citizenship or other related status within 30 days after a request for the information or our general partner determines after receipt of the information that the limited partner is not an eligible citizen, the limited partner may be treated as a non-citizen assignee. A non-citizen assignee does not have the right to direct the voting of his units and may not receive distributions in kind upon our liquidation. Furthermore, we have the right to redeem all of the common units and subordinated units of any holder that is not an eligible citizen or fails to furnish the requested information. Please read “The Partnership Agreement—Non-Citizen Assignees; Redemption.”

Common units held by persons who are non-taxpaying assignees will be subject to the possibility of redemption.

If our general partner determines that our not being treated as an association taxable as a corporation or otherwise taxable as an entity for U.S. federal income tax purposes, coupled with the tax status (or lack of proof thereof) of one or more of our limited partners, has, or is reasonably likely to have, a material adverse effect on our ability to operate our assets or generate revenues from our assets, then our general partner may adopt such amendments to our partnership agreement as it determines are necessary or advisable to obtain proof of the U.S. federal income tax status of our limited partners (and their owners, to the extent relevant) and permit us to redeem the units held by any person whose tax status has or is reasonably likely to have a material adverse effect on our ability to operate our assets or generate revenues from our assets or who fails to comply with the procedures instituted by our general partner to obtain proof of the U.S. federal income tax status. Please read “The Partnership Agreement—Non-Taxpaying Assignees; Redemption.”

 

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Our unitholders have limited voting rights and are not entitled to elect our general partner or its board of directors. The owners of our general partner will have the power to appoint and remove our general partner’s directors.

Unlike the holders of common stock in a corporation, unitholders have only limited voting rights on matters affecting our business and, therefore, limited ability to influence management’s decisions regarding our business. Unitholders will not elect our general partner or its board of directors on an annual or other continuing basis. The board of directors of our general partner will be appointed by its owners, which are New Source Energy and certain of its affiliates. Furthermore, if the unitholders are dissatisfied with the performance of our general partner, they will have little ability to remove our general partner. As a result of these limitations, the price at which the common units will trade could be diminished because of the absence or reduction of a takeover premium in the trading price.

Our general partner will have control over all decisions related to our operations. Since, upon the closing of this offering, New Source Energy will own a 50% membership interest in our general partner, approximately % of our outstanding common units, and all of our subordinated units, the other unitholders will not have an ability to influence any operating decisions and will not be able to prevent us from entering into any transactions. Our partnership agreement generally may not be amended during the subordination period without the approval of our public common unitholders. However, our partnership agreement can be amended with the consent of our general partner and the approval of the holders of a majority of our outstanding common units (including common units held by New Source Energy) after the subordination period has ended. Assuming we do not issue any additional common units and New Source Energy does not transfer its common units, New Source Energy and certain of its affiliates will have the ability to amend our partnership agreement, including our policy to distribute all of our available cash to our unitholders, without the approval of any other unitholder once the subordination period ends. Furthermore, the goals and objectives of New Source Energy and such affiliates relating to us may not be consistent with those of a majority of the other unitholders. Please read “—Our general partner and its affiliates own a controlling interest in us and will have conflicts of interest with, and owe limited fiduciary duties to, us, which may permit them to favor their own interests to the detriment of our unitholders.”

Our general partner will be required to deduct estimated maintenance capital expenditures from our operating surplus, which may result in less cash available for distribution to unitholders from operating surplus than if actual maintenance capital expenditures were deducted.

Maintenance capital expenditures are those capital expenditures required to maintain our long-term asset base, including expenditures to replace our oil and natural gas reserves (including non-proved reserves attributable to undeveloped leasehold acreage), whether through the development, exploitation and production of an existing leasehold or the acquisition or development of a new oil or natural gas property. Our partnership agreement requires our general partner to deduct estimated, rather than actual, maintenance capital expenditures from operating surplus in determining cash available for distribution from operating surplus. The amount of estimated maintenance capital expenditures deducted from operating surplus will be subject to review and change by our conflicts committee at least once a year. Our partnership agreement does not cap the amount of maintenance capital expenditures that our general partner may estimate. In years when our estimated maintenance capital expenditures are higher than actual maintenance capital expenditures, the amount of cash available for distribution to unitholders from operating surplus will be lower than if actual maintenance capital expenditures had been deducted from operating surplus. On the other hand, if our general partner underestimates the appropriate level of estimated maintenance capital expenditures, we will have more cash available for distribution from operating surplus in the short term but will have less cash available for distribution from operating surplus in future periods when we have to increase our estimated maintenance capital expenditures to account for the previous underestimation.

 

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Our partnership agreement limits our general partner’s fiduciary duties to unitholders and restricts the remedies available to unitholders for actions taken by our general partner that might otherwise constitute breaches of fiduciary duty.

Our partnership agreement contains provisions that reduce the fiduciary standards to which our general partner would otherwise be held by state fiduciary duty laws. For example, our partnership agreement:

 

   

permits our general partner to make a number of decisions in its individual capacity, as opposed to in its capacity as our general partner. This entitles our general partner to consider only the interests and factors that it desires, and it has no duty or obligation to give any consideration to any interest of, or factors affecting, us, our affiliates or any limited partner. Examples include the exercise of its limited call right, the exercise of its rights to transfer or vote the units it owns, the exercise of its registration rights and its determination whether or not to consent to any merger or consolidation involving us or to any amendment to the partnership agreement;

 

   

provides that our general partner will not have any liability to us or our unitholders for decisions made in its capacity as general partner so long as such decisions are made in good faith and with the honest belief that the decision was in our best interest;

 

   

generally provides that affiliated transactions and resolutions of conflicts of interest not approved by the conflicts committee of the board of directors of our general partner acting in good faith and not involving a vote of unitholders must be (i) on terms no less favorable to us than those generally being provided to or available from unrelated third parties or (ii) must be “fair and reasonable” to us, as determined by our general partner in good faith. In determining whether a transaction or resolution is “fair and reasonable,” our general partner may consider the totality of the relationships between the parties involved, including other transactions that may be particularly advantageous or beneficial to us;

 

   

provides that our general partner and its officers and directors will not be liable for monetary damages to us or our limited partners for any acts or omissions unless there has been a final and non-appealable judgment entered by a court of competent jurisdiction determining that our general partner or its officers and directors acted in bad faith or engaged in fraud or willful misconduct or, in the case of a criminal matter, acted with knowledge that the conduct was criminal; and

 

   

provides that in resolving conflicts of interest, it will be presumed that in making its decision our general partner’s board of directors or the conflicts committee of our general partner’s board of directors acted in good faith, and in any proceeding brought by or on behalf of any limited partner or us, the person bringing or prosecuting such proceeding will have the burden of overcoming such presumption.

By purchasing a common unit, a unitholder will become bound by the provisions in the partnership agreement, including the provisions discussed above. Please read “Conflicts of Interest and Fiduciary Duties—Fiduciary Duties.”

Even if our unitholders are dissatisfied, they cannot remove our general partner without consent of the owners of our general partner.

The public unitholders will be unable initially to remove our general partner without New Source Energy and certain of its affiliates consent because New Source Energy and certain of its affiliates will own sufficient units upon the closing of this offering to be able to prevent our general partner’s removal. The vote of the holders of at least 66 2/3% of all outstanding units voting together as a single class is required to remove our general partner. Upon the closing of this offering, New Source Energy will own a 50% membership interest in our general partner and approximately     % of our outstanding common and subordinated units (approximately     % if the underwriters exercise their option to purchase additional common units in full).

 

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Control of our general partner and its incentive distribution rights may be transferred to a third party without unitholder consent.

Our general partner may transfer its general partner interest to a third party in a merger or in a sale of all or substantially all of its assets without the consent of the unitholders. Furthermore, our partnership agreement does not restrict the ability of the owners of our general partner, who are New Source Energy and certain of its affiliates, from transferring all or a portion of their ownership interest in our general partner to a third party. The new owner of our general partner would then be in a position to replace the board of directors and officers of our general partner with their own choices and thereby influence the decisions made by the board of directors and officers in a manner that may not be aligned with the interests of our unitholders.

In addition, our general partner may transfer its incentive distribution rights to a third party at any time without the consent of our unitholders. If our general partner transfers its incentive distribution rights to a third party but retains its general partner interest, our general partner may not have the same incentive to grow our partnership and increase quarterly distributions to unitholders over time as it would if it had retained ownership of its incentive distribution rights.

We may not make cash distributions during periods when we record net income.

The amount of cash we have available for distribution to our unitholders depends primarily on our cash flow, including cash from reserves established by our general partner, working capital or other borrowings, and not solely on profitability, which will be affected by non-cash items. As a result, we may make cash distributions to our unitholders during periods when we record net losses and may not make cash distributions to our unitholders during periods when we record net income.

We may issue an unlimited number of additional units, including units that are senior to the common units, without unitholder approval, which would dilute unitholders’ ownership interests.

Our partnership agreement does not limit the number of additional common units that we may issue at any time without the approval of our unitholders. In addition, we may issue an unlimited number of units that are senior to the common units in right of distribution, liquidation and voting. The issuance by us of additional common units or other equity interests of equal or senior rank will have the following effects:

 

   

our unitholders’ proportionate ownership interest in us will decrease;

 

   

the amount of cash available for distribution on each unit may decrease;

 

   

because a lower percentage of total outstanding units will be subordinated units, the risk that a shortfall in the payment of the minimum quarterly distribution will be borne by our common unitholders will increase;

 

   

the ratio of taxable income to distributions may increase;

 

   

the relative voting strength of each previously outstanding unit may be diminished; and

 

   

the market price of our common units may decline.

Our partnership agreement restricts the limited voting rights of unitholders, other than our general partner and its affiliates, owning 20% or more of our common units, which may limit the ability of significant unitholders to influence the manner or direction of management.

Our partnership agreement restricts unitholders’ limited voting rights by providing that any common units held by a person, entity or group that owns 20% or more of any class of common units then outstanding (other than our general partner, its affiliates, their transferees and persons who acquired such common units with the prior approval of the board of directors of our general partner) cannot vote on any matter. Our partnership

 

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agreement also contains provisions limiting the ability of unitholders to call meetings or to acquire information about our operations, as well as other provisions limiting unitholders’ ability to influence the manner or direction of management.

Once our common units are publicly traded, New Source Energy may sell common units in the public markets, which sales could have an adverse impact on the trading price of the common units.

After the sale of the common units offered hereby, New Source Energy will own approximately     % of our outstanding common units and all of our subordinated units, which will convert into common units at the end of the subordination period. Once our common units are publicly traded, the sale of these units, including common units issued upon the conversion of the subordinated units, in the public markets could have an adverse impact on the price of the common units or on any trading market that may develop.

Our general partner has a call right that may require common unitholders to sell their common units at an undesirable time or price.

If at any time our general partner and its affiliates own more than 80% of the common units, our general partner will have the right, which it may assign to any of its affiliates or to us, but not the obligation, to acquire all, but not less than all, of the common units held by unaffiliated persons at a price that is not less than the then-current market price of the common units. As a result, our unitholders may be required to sell their common units at an undesirable time or price and may not receive any return on their investment. Our unitholders also may incur a tax liability upon a sale of their common units. Upon the closing of this offering, New Source Energy will own approximately     % of our outstanding common units and all of our subordinated units. For additional information about this call right, please read “The Partnership Agreement—Limited Call Right.”

If we distribute cash from capital surplus, which is analogous to a return of capital, our minimum quarterly distribution will be reduced proportionately, and the distribution thresholds after which the incentive distribution rights entitle our general partner to an increased percentage of distributions will be proportionately decreased.

Our cash distributions will be characterized as coming from either operating surplus or capital surplus. Operating surplus is defined in our partnership agreement, and generally means amounts we receive from operating sources, such as sale of our oil and natural gas production, less operating expenditures, such as production costs and taxes, and less estimated maintenance capital expenditures, which are generally amounts we estimate we will need to spend in the future to maintain our production levels over the long term. Capital surplus is defined in our partnership agreement included in this prospectus as Appendix A, and generally would result from cash received from non-operating sources such as sales of properties and issuances of debt and equity interests. Cash representing capital surplus, therefore, is analogous to a return of capital. Distributions of capital surplus are made to our unitholders and our general partner in proportion to their percentage interests in us, or 98.0% to our unitholders and 2.0% to our general partner, and will result in a decrease in our minimum quarterly distribution. For a more detailed description of operating surplus, capital surplus and the effect of distributions from capital surplus, please read “Provisions of Our Partnership Agreement Relating to Cash Distributions.”

Our partnership agreement allows us to add to operating surplus $         million. As a result, a portion of this amount, which is analogous to a return of capital, may be distributed to the general partner and its affiliates, as holders of incentive distribution rights, rather than to holders of common units as a return of capital.

Our unitholders’ liability may not be limited if a court finds that unitholder action constitutes control of our business.

A general partner of a partnership generally has unlimited liability for the obligations of the partnership, except for those contractual obligations of the partnership that are expressly made without recourse to the general

 

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partner. Our partnership is organized under Delaware law, we currently conduct business in Oklahoma and may in the future conduct business in other states. A unitholder could be liable for our obligations as if it was a general partner if:

 

   

a court or government agency determined that we were conducting business in a state but had not complied with that particular state’s partnership statute; or

 

   

a unitholder’s right to act with other unitholders to remove or replace the general partner, to approve some amendments to our partnership agreement or to take other actions under our partnership agreement constitute “control” of our business.

Please read “The Partnership Agreement—Limited Liability” for a discussion of the implications of the limitations of liability on a unitholder.

Our unitholders may have liability to repay distributions.

Under certain circumstances, unitholders may have to repay amounts wrongfully returned or distributed to them. Under Section 17-607 of the Delaware Revised Uniform Limited Partnership Act, we may not make distributions to unitholders if the distribution would cause our liabilities to exceed the fair value of our assets. Liabilities to partners on account of their partnership interests and liabilities that are non-recourse to us are not counted for purposes of determining whether a distribution is permitted. Delaware law provides that for a period of three years from the date of an impermissible distribution, limited partners who received the distribution and who knew at the time of the distribution that it violated Delaware law will be liable to the limited partnership for the distribution amount. A purchaser of common units who becomes a limited partner is liable for the obligations of the transferring limited partner to make contributions to us that are known to such purchaser of common units at the time it became a limited partner and for unknown obligations if the liabilities could be determined from our partnership agreement.

Our unitholders may have limited liquidity for their common units, a trading market may not develop for the common units and our unitholders may be unable to resell their common units at the initial public offering price.

Prior to this offering, there has been no public market for the common units. After this offering, there will be publicly traded common units. We do not know the extent to which investor interest will lead to the development of a trading market or how liquid that market might be. Our unitholders may not be able to resell their common units at or above the initial public offering price. Additionally, a lack of liquidity would likely result in wide bid-ask spreads, contribute to significant fluctuations in the market price of the common units and limit the number of investors who are able to buy the common units. All of the              common units that are issued to affiliates of our general partner, or     % of our outstanding common units, will be subject to resale restrictions under a 180-day lock-up agreement with the underwriters. Each of the lock-up agreements with the underwriters may be waived by              in its sole discretion. Sales by affiliates of our general partner of a substantial number of our common units in the public markets following this offering, or the perception that such sales might occur, could have a material adverse effect on the price of our common units or could impair our ability to obtain capital through an offering of equity securities. In addition, we have agreed to provide registration rights to our general partner and its affiliates. Under our partnership agreement, our general partner and its affiliates have registration rights relating to the offer and sale of any units that they hold, subject to certain limitations.

If our common unit price declines after the initial public offering, our unitholders could lose a significant part of their investment.

The initial public offering price for the common units will be determined by negotiations between us and the representatives of the underwriters and may not be indicative of the market price of the common units that will

 

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prevail in the trading market. The market price of our common units could be subject to wide fluctuations in response to a number of factors, most of which we cannot control, including:

 

   

changes in commodity prices;

 

   

changes in securities analysts’ recommendations and their estimates of our financial performance;

 

   

public reaction to our press releases, announcements and filings with the SEC;

 

   

fluctuations in broader securities market prices and volumes, particularly among securities of oil and natural gas companies and securities of publicly traded limited partnerships and limited liability companies;

 

   

changes in market valuations of similar companies;

 

   

departures of key personnel;

 

   

commencement of or involvement in litigation;

 

   

variations in our quarterly results of operations or those of other oil and natural gas companies;

 

   

variations in the amount of our quarterly cash distributions to our unitholders;

 

   

future issuances and sales of our common units; and

 

   

changes in general conditions in the U.S. economy, financial markets or the oil and natural gas industry.

In recent years, the securities market has experienced extreme price and volume fluctuations. This volatility has had a significant effect on the market price of securities issued by many companies for reasons unrelated to the operating performance of these companies. Future market fluctuations may result in a lower price of our common units.

Our unitholders will experience immediate and substantial dilution of $         per unit.

The assumed initial offering price of $         per common unit (the midpoint of the price range set forth on the cover of this prospectus) exceeds our pro forma net tangible book value after this offering of $         per common unit. Based on the assumed initial offering price of $         per common unit, our unitholders will incur immediate and substantial dilution of $         per common unit. This dilution will occur primarily because the assets contributed by affiliates of our general partner are recorded, in accordance with GAAP at their historical cost, and not their fair value. The impact of such dilution would be magnified upon any conversion of the incentive distribution rights into common units. Please read “Dilution.”

We have the right to borrow to make distributions. Repayment of these borrowings will decrease cash available for future distributions, and covenants in our new revolving credit facility may restrict our ability to make distributions.

Our partnership agreement allows us to borrow to make distributions. We may make short-term borrowings under our new revolving credit facility to make distributions. The primary purpose of these borrowings would be to mitigate the effects of short-term fluctuation in our working capital that would otherwise cause volatility in our quarter-to-quarter distributions.

The terms of our new revolving credit facility will restrict our ability to pay distributions if we do not satisfy the financial and other covenants in the facility.

 

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Our partnership agreement requires that we distribute all of our available cash, which could limit our ability to grow our reserves and production.

Our partnership agreement provides that we will distribute all of our available cash each quarter. As a result, we may be dependent on the issuance of additional common units and other partnership securities and borrowings to finance our growth. A number of factors will affect our ability to issue securities and borrow money to finance growth, as well as the costs of such financings, including:

 

   

general economic and market conditions, including interest rates, prevailing at the time we desire to issue securities or borrow funds;

 

   

conditions in the oil and natural gas industry;

 

   

the market price of, and demand for, our common units;

 

   

our results of operations and financial condition; and

 

   

prices for oil, NGLs and natural gas.

The NYSE does not require a publicly traded limited partnership like us to comply with certain of its corporate governance requirements.

We intend to apply to list our common units on the NYSE. Because we will be a publicly traded limited partnership, the NYSE does not require us to have a majority of independent directors on our general partner’s board of directors or to establish a compensation committee or a nominating and corporate governance committee. Accordingly, unitholders will not have the same protections afforded to certain corporations that are subject to all of NYSE corporate governance requirements. Please read “Management—Management of New Source Energy Partners L.P.”

Tax Risks to Unitholders

In addition to reading the following risk factors, please read “Material Tax Consequences” for a more complete discussion of the expected material federal income tax consequences of owning and disposing of common units.

Our tax treatment depends on our status as a partnership for U.S. federal income tax purposes, as well as our not being subject to a material amount of entity-level taxation by individual states. If the IRS were to treat us as a corporation for federal income tax purposes or we were to become subject to material additional amounts of entity-level taxation for state tax purposes, then our cash available for distribution to you could be substantially reduced.

The anticipated after-tax economic benefit of an investment in our common units depends largely on our being treated as a partnership for U.S. federal income tax purposes.

Despite the fact that we are organized as a limited partnership under Delaware law, it is possible in certain circumstances for a partnership such as ours to be treated as a corporation for federal income tax purposes. Although we do not believe, based upon our current operations, that we will be so treated, a change in our business (or a change in current law) could cause us to be treated as a corporation for federal income tax purposes or otherwise subject us to taxation as an entity.

If we were treated as a corporation for federal income tax purposes, we would pay federal income tax on our taxable income at the corporate tax rate, which is currently a maximum of 35%, and would likely pay state income tax at varying rates. Distributions to you would generally be taxed again as corporate distributions, and no income, gains, losses, deductions or credits would flow through to you. Because a tax would be imposed upon

 

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us as a corporation, our cash available for distribution to you would be substantially reduced. Therefore, treatment of us as a corporation would result in a material reduction in the anticipated cash flow and after-tax return to the unitholders, likely causing a substantial reduction in the value of our common units.

Our partnership agreement provides that if a law is enacted or existing law is modified or interpreted in a manner that subjects us to taxation as a corporation or otherwise subjects us to entity-level taxation for federal, state or local income tax purposes, the minimum quarterly distribution amount and the target distribution amounts may be adjusted to reflect the impact of that law on us.

The tax treatment of publicly-traded partnerships or an investment in our units could be subject to potential legislative, judicial or administrative changes and differing interpretations, possibly on a retroactive basis.

The present U.S. federal income tax treatment of publicly-traded partnerships, including us, or an investment in our common units may be modified by administrative, legislative or judicial changes or differing interpretations at any time. For example, members of Congress have recently considered substantive changes to the existing federal income tax laws that affect publicly-traded partnerships. Any modification to the U.S. federal income tax laws may be applied retroactively and could make it more difficult or impossible to meet the exception for certain publicly-traded partnerships to be treated as partnerships for U.S. federal income tax purposes. Although the considered legislation would not appear to have affected our treatment as a partnership, we are unable to predict whether any of these changes, or other proposals will be reintroduced or will ultimately be enacted. Any such changes could negatively impact the value of an investment in our common units.

You will be required to pay taxes on your share of our income even if you do not receive any cash distributions from us.

Because our unitholders will be treated as partners to whom we will allocate taxable income that could be different in amount than the cash we distribute, you will be required to pay federal income taxes and, in some cases, state and local income taxes on your share of our taxable income whether or not you receive cash distributions from us. You may not receive cash distributions from us equal to your share of our taxable income or even equal to the actual tax liability that results from that income.

The sale or exchange of 50% or more of our capital and profits interests during any twelve-month period will result in the termination of our partnership for federal income tax purposes.

We will be considered to have terminated as a partnership for federal income tax purposes if there is a sale or exchange of 50% or more of the total interests in our capital and profits within a twelve-month period. Immediately following this offering, New Source Energy will directly and indirectly own more than 50% of the total interests in our capital and profits. Therefore, a transfer by New Source Energy of all or a portion of its interests in us could result in a termination of us as a partnership for federal income tax purposes. Our termination would, among other things, result in the closing of our taxable year for all unitholders and could result in a deferral of depreciation deductions allowable in computing our taxable income. In the case of a unitholder reporting on a taxable year other than the calendar year, the closing of our taxable year may also result in more than twelve months of our taxable income or loss being includable in his taxable income for the year of termination. Our termination currently would not affect our classification as a partnership for federal income tax purposes, but instead, after our termination we would be treated as a new partnership for federal income tax purposes. If treated as a new partnership, we must make new tax elections and could be subject to penalties if we are unable to determine that a termination occurred. Please read “Material Tax Consequences—Disposition of Units—Constructive Termination” for a discussion of the consequences of our termination for federal income tax purposes.

 

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Tax gain or loss on the disposition of our common units could be more or less than expected.

If you sell your common units, you will recognize a gain or loss equal to the difference between the amount realized and your tax basis in those common units. Because distributions in excess of your allocable share of our net taxable income result in a decrease in your tax basis in your common units, the amount, if any, of such prior excess distributions with respect to the units you sell will, in effect, become taxable income to you if you sell such units at a price greater than your tax basis in those units, even if the price you receive is less than your original cost. Furthermore, a substantial portion of the amount realized, whether or not representing gain, may be taxed as ordinary income due to potential recapture of depreciation and depletion deductions and certain other items. In addition, because the amount realized includes a unitholder’s share of our nonrecourse liabilities, if you sell your units, you may incur a tax liability in excess of the amount of cash you receive from the sale. Please read “Material Tax Consequences—Disposition of Units—Recognition of Gain or Loss” for a further discussion of the foregoing.

Tax-exempt entities and non-U.S. persons face unique tax issues from owning common units that may result in adverse tax consequences to them.

Investments in common units by tax-exempt entities, such as employee benefit plans and individual retirement accounts (or “IRAs”), and non-U.S. persons raises issues unique to them. For example, virtually all of our income allocated to organizations that are exempt from federal income tax, including IRAs and other retirement plans, will be unrelated business taxable income and will be taxable to them. Distributions to non-U.S. persons will be reduced by withholding taxes, and non-U.S. persons will be required to file U.S. federal tax returns and pay tax on their shares of our taxable income. If you are a tax-exempt entity or a non-U.S. person, you should consult your tax advisor before investing in our common units.

If the IRS contests the federal income tax positions we take, the market for our common units may be adversely impacted and the cost of any IRS contest will reduce our cash available for distribution to you.

The IRS may adopt positions that differ from the positions we take. It may be necessary to resort to administrative or court proceedings to sustain some or all of the positions we take. A court may not agree with some or all of the positions we take. Any contest by the IRS may materially and adversely impact the market for our common units and the price at which they trade. Our costs of any contest by the IRS will be borne indirectly by our unitholders and our general partner because the costs will reduce our cash available for distribution.

We will treat each purchaser of our common units as having the same tax benefits without regard to the actual common units purchased. The IRS may challenge this treatment, which could adversely affect the value of the common units.

Because we cannot match transferors and transferees of common units, we will adopt depreciation and amortization positions that may not conform to all aspects of existing Treasury Regulations. A successful IRS challenge to those positions could adversely affect the amount of tax benefits available to you. It also could affect the timing of these tax benefits or the amount of gain from your sale of common units and could have a negative impact on the value of our common units or result in audit adjustments to your tax returns. Please read “Material Tax Consequences—Tax Consequences of Unit Ownership—Section 754 Election” for a further discussion of the effect of the depreciation and amortization positions we adopt.

We will prorate our items of income, gain, loss and deduction between transferors and transferees of our units each month based upon the ownership of our units on the first day of each month, instead of on the basis of the date a particular unit is transferred. The IRS may challenge this treatment, which could change the allocation of items of income, gain, loss and deduction among our unitholders.

We generally prorate our items of income, gain, loss and deduction between transferors and transferees of our common units each month based upon the ownership of our common units on the first day of each month,

 

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instead of on the basis of the date a particular common unit is transferred. Nonetheless, we allocate certain deductions for depreciation of capital additions based upon the date the underlying property is placed in service. The use of this proration method may not be permitted under existing Treasury Regulations, and although the U.S. Treasury Department issued proposed Treasury Regulations allowing a similar monthly simplifying convention, such regulations are not final and do not specifically authorize the use of the proration method we have adopted. Accordingly, our counsel is unable to opine as to the validity of this method. If the IRS were to successfully challenge our proration method, we may be required to change the allocation of items of income, gain, loss, and deduction among our unitholders.

A unitholder whose common units are the subject of a securities loan (e.g., a loan to a “short seller” to cover a short sale of common units) may be considered as having disposed of those common units. If so, he would no longer be treated for tax purposes as a partner with respect to those common units during the period of the loan and may recognize gain or loss from the disposition.

Because there is no tax concept of loaning a partnership interest, a unitholder whose common units are the subject of a securities loan may be considered as having disposed of the loaned units. In that case, he may no longer be treated for tax purposes as a partner with respect to those common units during the period of the loan and the unitholder may recognize gain or loss from such disposition. Moreover, during the period of the loan, any of our income, gain, loss or deduction with respect to those common units may not be reportable by the unitholder and any cash distributions received by the unitholder as to those common units could be fully taxable as ordinary income. Unitholders desiring to assure their status as partners and avoid the risk of gain recognition from a loan to a short seller should modify any applicable brokerage account agreements to prohibit their brokers from borrowing their common units.

You will likely be subject to state and local taxes and return filing requirements in states where you do not live as a result of investing in our common units.

In addition to U.S. federal income taxes, you will likely be subject to other taxes, including state and local taxes, unincorporated business taxes and estate, inheritance or intangible taxes that are imposed by the various jurisdictions in which we conduct business or own property now or in the future, even if you do not live in any of those jurisdictions. We will initially own assets and conduct business in the state of Oklahoma. Oklahoma currently imposes a personal income tax and also imposes income taxes on corporations and other entities. You may be required to file state and local income tax returns and pay state and local income taxes in Oklahoma. Further, you may be subject to penalties for failure to comply with those requirements. As we make acquisitions or expand our business, we may own assets or conduct business in additional states or foreign jurisdictions that impose a personal income tax. It is your responsibility to file all U.S. federal, foreign, state and local tax returns. Our counsel has not rendered an opinion on the foreign, state or local tax consequences of an investment in our common units.

 

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USE OF PROCEEDS

We intend to use the estimated net proceeds of approximately $         million from this offering, based upon the assumed initial public offering price of $         per common unit (the midpoint of the price range set forth on the cover of this prospectus), after deducting underwriting discounts, structuring fees, fees and expenses associated with our new revolving credit facility and offering expenses, together with $         of borrowings under our new revolving credit facility, as consideration (together with our issuance to New Source Energy of              common units and             subordinated units) for the contribution by New Source Energy of the Partnership Properties and the commodity derivative contracts described in “Summary—Our Hedging Strategy,” and to pay fees and expenses associated with such contribution, our new revolving credit facility and this offering. We anticipate that we will assume approximately $         million of New Source Energy’s indebtedness that currently burdens the Partnership Properties, and we will use $         million of borrowings under our new revolving credit facility, in addition to a portion of the net proceeds from this offering, to repay in full such assumed debt at the closing of this offering.

The following table illustrates our use of the proceeds from this offering and our borrowings under our new credit facility.

 

Sources of Cash (in millions)

    

Uses of Cash (in millions)

 

Gross proceeds from this offering(1)

   $                       

Consideration for the Partnership Properties and commodity derivative contracts

   $     

Borrowings under our new credit facility

   $        

Repayment of debt assumed from New Source Energy

   $     
     

Underwriting discounts, structuring fees and other expenses

   $     

Total

   $        

Total

   $                    
  

 

 

       

 

 

 

 

(1) If the underwriters exercise their option to purchase additional common units in full, the gross proceeds would be $         million and the amount borrowed under our new revolving credit facility would be approximately $         million.

We will use any net proceeds from the exercise of the underwriters’ option to purchase additional common units to reduce outstanding borrowings under our new revolving credit facility. If the underwriters exercise in full their option to purchase additional common units, the ownership interest of the public unitholders will increase to              common units representing an aggregate         % limited partner interest in us and the ownership interest of our general partner will increase to              general partner units representing a 2.0% general partner interest in us. Please read “Underwriting.”

Our estimates assume an initial public offering price of $         per common unit (the midpoint of the price range set forth on the cover of this prospectus) and no exercise of the underwriters’ option to purchase additional common units. An increase or decrease in the initial public offering price of $1.00 per common unit would cause the net proceeds from the offering, after deducting underwriting discounts and structuring fees, to increase or decrease by $         million, and would result in a corresponding increase or decrease in the amount paid to New Source Energy as partial consideration for the Partnership Properties contributed to us.

 

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CAPITALIZATION

The following table shows our capitalization as of September 30, 2012:

 

   

on a historical basis;

 

   

on a pro forma basis, reflecting our conversion to a non-taxable partnership and the payment to be made to New Source Energy for the Partnership Properties; and

 

   

on a pro forma basis, as adjusted to reflect the issuance and sale of common units to the public at an assumed initial offering price of $         per common unit (the midpoint of the price range set forth on the cover of this prospectus), the other formation transactions described under “Summary—Our Partnership Structure and Formation Transactions,” and the application of the net proceeds from this offering as described under “Use of Proceeds.”

We derived this table from, and it should be read in conjunction with and is qualified in its entirety by reference to, the historical financial statements and the accompanying notes included elsewhere in this prospectus. You should also read this table in conjunction with “Summary—Our Partnership Structure and Formation Transactions,” “Use of Proceeds” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

     As of September 30, 2012  
     Historical      Pro Forma      Pro Forma
As  Adjusted
 
     (in thousands)  

Distribution payable to New Source Energy for Partnership Properties

   $ —         $         $     

Long-term debt(1)

   $ 68,000       $ 68,000       $ 40,000   
  

 

 

    

 

 

    

 

 

 

Partners’ capital/net equity(2):

        

Parent net investment

     15,322         

Common units held by purchasers in this offering

     —           —        

Common units held by New Source Energy

     —           —        

Subordinated units held by New Source Energy

     —           —        

General partner interest

     —           —        
  

 

 

    

 

 

    

 

 

 

Total parent net investment/net equity

     15,322         
  

 

 

    

 

 

    

 

 

 

Total capitalization

   $ 83,322       $         $     
  

 

 

    

 

 

    

 

 

 

 

(1) We intend to enter into a $         million credit facility, approximately $         million of which will be available for borrowing upon the completion of the transactions described under “Summary—Our Partnership Structure and Formation Transactions.” After giving effect to the transactions described under “Summary—Our Partnership Structure and Formation Transactions,” including our expected borrowing of $40 million under our new revolving credit facility, we will have approximately $         million of borrowing capacity. Please read “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—New Revolving Credit Facility.”
(2) The pro forma as adjusted partners’ capital/net equity amounts reflect the removal of $1.7 million of deferred loan fees associated with New Source Energy’s credit facility. This amount will be reflected as a charge to earnings in the quarter in which the offering is completed.

This table does not reflect the issuance of up to an additional              common units that may be sold to the underwriters upon exercise of their option to purchase additional common units.

 

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DILUTION

Dilution is the amount by which the offering price paid by the purchasers of common units sold in this offering will exceed the pro forma as adjusted net tangible book value per unit after this offering. Net tangible book value is our total tangible assets less total liabilities. Assuming an initial offering price of $         per common unit (the midpoint of the price range set forth on the cover of this prospectus), on a pro forma as adjusted basis as of September 30, 2012, after giving effect to the transactions described under “Summary—Our Partnership Structure and Formation Transactions,” including this offering of common units and the application of the related net proceeds and assuming the underwriters’ option to purchase additional common units is not exercised, our pro forma as adjusted net tangible book value was $         million, or $         per unit. Purchasers of common units in this offering will experience substantial and immediate dilution in net tangible book value per common unit for accounting purposes, as illustrated in the following table:

 

Assumed initial offering price per common unit

   $                

Pro forma net tangible book value per unit before this offering(1)

   $     

Increase in net tangible book value per unit attributable to purchasers in this offering

  
  

 

 

 

Pro forma as adjusted net tangible book value per unit after this offering(2)

  
  

 

 

 

Immediate dilution in net tangible book value per unit to purchasers in this offering(3)

   $     
  

 

 

 

 

(1) Determined by dividing the pro forma net tangible book value of our net assets immediately prior to the offering by the number of units (         common units and          subordinated units) to be issued to New Source Energy as partial consideration for their contribution of the Partnership Properties to us and the              general partner units to be issued to our general partner.
(2) Determined by dividing our pro forma net tangible book value, after giving effect to the application of the expected net proceeds of this offering, by the total number of units to be outstanding after this offering (         common units, subordinated units, and          general partner units).
(3) If the assumed initial offering price were to increase or decrease by $1.00 per common unit, then dilution in pro forma as adjusted net tangible book value per unit would equal $         or $        , respectively. The information discussed above is illustrative only and will be adjusted based on the actual public offering price and other terms of this offering determined at pricing.

The following table sets forth the number of units that we will issue and the total consideration contributed to us by our general partner and its affiliates, including New Source Energy, in respect of their units and by the purchasers of common units in this offering upon the completion of the transactions contemplated by this prospectus:

 

     Units Acquired     Total Consideration  
     Number    Percent     $      Percent  
                (in millions)         

General partner and its affiliates(1)(2)

               $               

Purchasers in this offering(3)

                        
  

 

  

 

 

   

 

 

    

 

 

 

Total

        100   $                      100
  

 

  

 

 

   

 

 

    

 

 

 

 

(1) Upon the completion of the transactions contemplated by this prospectus, and assuming the underwriters do not exercise their option to purchase additional common units, our general partner and its affiliates will own              common units, subordinated units, and              general partner units.
(2) The assets contributed by New Source Energy were recorded at historical cost in accordance with GAAP. Total consideration provided by affiliates of our general partner is equal to the pro forma net tangible book value of such assets as of September 30, 2012 and does not include the $         million cash distribution to be made to New Source Energy as partial consideration for their contribution of the Partnership Properties to us.
(3) Total consideration is after deducting underwriting discounts and estimated offering expenses.

 

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OUR CASH DISTRIBUTION POLICY AND RESTRICTIONS ON DISTRIBUTIONS

You should read the following discussion of our cash distribution policy in conjunction with specific assumptions included in this section. For more detailed information regarding the factors and assumptions upon which our cash distribution policy is based, please read “—Estimated Adjusted EBITDA for the Year Ending December 31, 2013” below. In addition, you should read “Forward-Looking Statements” and “Risk Factors” for information regarding statements that do not relate strictly to historical or current facts and certain risks inherent in our business.

For additional information regarding our historical operating results, you should refer to the audited financial statements attributable to the Partnership Properties as of December 31, 2010 and 2011 and for the years then ended and the unaudited financial statements attributable to the Partnership Properties for the nine months ended September 30, 2011 and 2012, all included elsewhere in this prospectus.

General

Rationale for Our Cash Distribution Policy

Our partnership agreement requires us to distribute all of our available cash on a quarterly basis. Our available cash is our cash on hand at the end of a quarter after the payment of our expenses and the establishment of reserves for future capital expenditures, operational needs and certain future distributions, including cash from borrowings. We intend to fund any acquisitions and growth capital expenditures with additional borrowings or issuances of additional units. We may also borrow to make distributions to unitholders, for example, in circumstances where we believe that the distribution level is sustainable over the long term, but short-term factors have caused available cash from operations to be insufficient to pay the distribution at the current level. Our cash distribution policy reflects a basic judgment that our unitholders will be better served by us distributing our available cash, after expenses and reserves, rather than retaining it. Also, because we are not subject to an entity-level federal income tax, we will have more cash to distribute to our unitholders than would be the case if we were subject to federal income tax.

Restrictions and Limitations on Cash Distributions and Our Ability to Change Our Cash Distribution Policy

There is no guarantee that unitholders will receive quarterly distributions from us. We do not have a legal obligation to pay the minimum quarterly distribution or distributions at any other rate except as provided in our partnership agreement. Our distribution policy is subject to certain restrictions and may be changed at any time, including:

 

   

Our cash distribution policy may be subject to restrictions on distributions under our new revolving credit facility or other debt agreements that we may enter into in the future. Specifically, we anticipate that the agreement related to our new revolving credit facility will contain financial tests and covenants that we must satisfy. These financial ratios and covenants are described under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—New Revolving Credit Facility.” Should we be unable to satisfy these restrictions, or if a default occurs under our new revolving credit facility, we would be prohibited from making cash distributions to our unitholders notwithstanding our stated cash distribution policy.

 

   

Our general partner will have the authority to establish reserves for the prudent conduct of our business and for future cash distributions to our unitholders, and the establishment of or increase in those reserves could result in a reduction in cash distributions to our unitholders from levels we currently anticipate under our stated distribution policy. Any determination to establish or increase reserves made by our general partner in good faith will be binding on the unitholders. We intend to reserve a portion of our cash generated from operations to fund our maintenance capital expenditures. Over a

 

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longer period of time, if our general partner does not set aside sufficient cash reserves or make sufficient cash expenditures to maintain our asset base, we will be unable to pay the minimum quarterly distribution from cash generated from operations and would therefore expect to reduce our distributions. We are unlikely to be able to sustain our current level of distributions without making capital expenditures that maintain the current production levels of our oil and natural gas properties. Decreases in commodity prices from current levels will adversely affect our ability to pay distributions. If our asset base decreases and we do not reduce our distributions, a portion of the distributions may be considered a return of part of our unitholders’ investment in us as opposed to a return on our unitholders’ investment.

 

   

Although our partnership agreement requires us to distribute all of our available cash, our partnership agreement, including the provisions requiring us to make cash distributions contained therein, may be amended. Our partnership agreement may not be amended during the subordination period without the approval of our public common unitholders, other than in certain limited circumstances where no unitholder approval is required. However, our partnership agreement can be amended with the consent of our general partner and the approval of the holders of a majority of our outstanding common units (including common units that are held by New Source Energy) after the subordination period has ended. Upon the closing of this offering, New Source Energy and certain of its affiliates will own our general partner, and New Source Energy will control the voting of an aggregate of approximately     % of our outstanding common and subordinated units. Assuming we do not issue any additional common units and New Source Energy does not transfer its common units, New Source Energy and certain of its affiliates will have the ability to amend our partnership agreement without the approval of any other unitholder once the subordination period ends.

 

   

Even if our cash distribution policy is not modified or revoked, the amount of distributions we pay under our cash distribution policy and the decision to make any distribution is determined by our general partner, taking into consideration the terms of our partnership agreement, our new revolving credit facility and any other agreements we may enter into in the future.

 

   

Under Section 17-607 of the Delaware Revised Uniform Limited Partnership Act, we may not make a distribution to our unitholders if the distribution would cause our liabilities to exceed the fair value of our assets.

 

   

We may lack sufficient cash to pay distributions to our unitholders due to a number of factors, including reductions in commodity prices, reductions in our oil and natural gas production, increases in our general and administrative expenses, principal and interest payments on our outstanding debt, tax expenses, working capital requirements and anticipated cash needs. For a discussion of additional factors that may affect our ability to pay distributions, please read “Risk Factors.”

 

   

If and to the extent our cash available for distribution materially declines, we may reduce our quarterly distribution in order to service or repay our debt or fund growth capital expenditures.

 

   

All available cash distributed by us on any date from any source will be treated as distributed from operating surplus until the sum of all available cash distributed since the closing of this offering equals the cumulative operating surplus from the closing of this offering through the end of the quarter immediately preceding that distribution. We anticipate that distributions from operating surplus will generally not represent a return of capital. However, operating surplus, as defined in our partnership agreement, includes certain components that represent non-operating sources of cash, including a cash basket equal to $         million and working capital borrowings. Consequently, it is possible that distributions from operating surplus may represent a return of capital. For example, the $         million cash basket would allow us to distribute as operating surplus cash proceeds we receive in the future from non-operating sources such as asset sales, issuances of securities and long-term borrowings, which would represent a return of capital. Distributions representing a return of capital could result in a corresponding decrease in our asset base. Additionally, any cash distributed by us in excess of operating surplus will be deemed to be capital surplus under our partnership agreement. Our

 

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partnership agreement treats a distribution of capital surplus as the repayment of the initial unit price from this initial public offering, which is similar to a return of capital. Distributions from capital surplus could result in a corresponding decrease in our asset base. We do not anticipate that we will make any distributions from capital surplus. Please read “Provisions of Our Partnership Agreement Relating to Cash Distributions—Operating Surplus and Capital Surplus” and “Provisions of Our Partnership Agreement Relating to Cash Distributions—Distributions from Capital Surplus—Effect of a Distribution from Capital Surplus.”

Our Ability to Grow Depends on Our Ability to Access External Growth Capital

Our partnership agreement requires us to distribute all of our available cash to unitholders on a quarterly basis. As a result, we expect that we will rely primarily upon external financing sources, including commercial bank borrowings and the issuance of debt and equity interests, rather than cash reserves established by our general partner, to fund our growth capital expenditures and any acquisitions. To the extent we are unable to finance our growth externally, our cash distribution policy will significantly impair our ability to grow. In addition, because we will distribute all of our available cash, our growth may not be as fast as that of businesses that reinvest their available cash to expand their ongoing operations. To the extent we issue additional units in connection with any growth capital expenditures, the payment of distributions on those additional units may increase the risk that we will be unable to maintain or increase our quarterly per unit distribution level. There are no limitations in our partnership agreement or our new revolving credit facility on our ability to issue additional units, including units ranking senior to the common units. The incurrence of additional commercial borrowings or other debt to finance our growth strategy would result in increased interest expense, which in turn may impact the available cash that we have to distribute to our unitholders.

Our Minimum Quarterly Distribution

Upon the closing of this offering, the board of directors of our general partner will establish a minimum quarterly distribution of $         per unit per whole quarter, or $         per unit per year on an annualized basis, to be paid no later than 45 days after the end of each fiscal quarter beginning with the quarter ending March 31, 2013. This equates to an aggregate cash distribution of approximately $         million per quarter or $         million per year, in each case based on the number of common units, subordinated units and general partner units outstanding immediately after the closing of this offering, including the common units we expect to issue under the long-term incentive plan that our general partner plans to adopt at the closing of this offering. If the underwriters exercise their option to purchase additional common units in full,              common units, subordinated units and              general partner units will be outstanding, which equates to an aggregate cash distribution of approximately $         million per quarter or $         million per year. Our ability to make cash distributions at the minimum quarterly distribution will be subject to the factors described above under the caption “—General—Restrictions and Limitations on Cash Distributions and Our Ability to Change Our Cash Distribution Policy.”

As of the date of this offering, our general partner will be entitled to 2.0% of all distributions of available cash that we make prior to our liquidation. Our general partner’s initial 2.0% interest in these distributions may be reduced if we issue additional units in the future and our general partner does not contribute a proportionate amount of capital to us to maintain its initial 2.0% general partner interest. Our general partner is not obligated to contribute a proportionate amount of capital to us to maintain its current general partner interest. Our general partner will also hold the incentive distribution rights, which entitle the holder to additional increasing percentages, up to a maximum of 23.0%, of the cash we distribute in excess of $         per common unit per quarter.

 

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The table below sets forth the assumed number of outstanding common (assuming no exercise and full exercise of the underwriters’ option to purchase additional common units), subordinated and general partner units upon the closing of this offering and the aggregate distribution amounts payable on such units during the year following the completion of this offering at our minimum quarterly distribution of $         per unit per quarter, or $         per unit on an annualized basis.

 

     No Exercise of the Underwriters’ Option to
Purchase Additional Common Units
   Full Exercise of the Underwriters’ Option to
Purchase Additional Common Units
          Distributions         Distributions
     Number of Units    One Quarter    Four Quarters    Number of Units    One Quarter    Four Quarters

Common units held by purchasers in this offering

                 

Common units held by New Source Energy(1)

                 

Subordinated units

                 

General partner units

                 

 

(1) Includes common units that we expect to issue to members of our management and the board of directors of our general partner under the long-term incentive plan that our general partner plans to adopt at the closing of this offering.

If the minimum quarterly distribution on our common units is not paid with respect to any quarter, the common unitholders will not be entitled to receive such payments in the future except that, during the subordination period, to the extent we distribute cash in any future quarter in excess of the amount necessary to make cash distributions at the minimum quarterly distribution to holders of our common units, we will use this excess cash to pay any of these arrearages related to prior quarters before any cash distribution is made to holders of subordinated units. Please read “Provisions of Our Partnership Agreement Relating to Cash Distributions—Subordination Period.”

We do not have a legal obligation to pay the minimum quarterly distribution or distributions at any other rate except as provided in our partnership agreement. Our distribution policy is consistent with the terms of our partnership agreement, which requires that we distribute all of our available cash quarterly. Under our partnership agreement, available cash is defined to generally mean, for each fiscal quarter, cash generated from our business in excess of expenses and the amount of reserves our general partner determines is necessary or appropriate to provide for the prudent conduct of our business (including payments to our general partner for reimbursement of expenses it incurs on our behalf), to comply with applicable law, any of our debt instruments or other agreements or to provide for future distributions to our unitholders for any one or more of the next four quarters. Please read “Provisions of our Partnership Agreement Relating to Cash Distributions—Distributions of Available Cash—Definition of Available Cash.”

Our partnership agreement provides that any determination made by our general partner in its capacity as our general partner must be made in good faith and that any such determination will not be subject to any other standard imposed by our partnership agreement, the Delaware limited partnership statute or any other law, rule or regulation or imposed at equity. Holders of our common units may pursue judicial action to enforce provisions of our partnership agreement, including those related to requirements to make cash distributions as described above; however, our partnership agreement provides that our general partner is entitled to make the determinations described above without regard to any standard other than the requirement to act in good faith. Our partnership agreement provides that, in order for a determination by our general partner to be made in “good faith,” our general partner must have an honest belief that the determination is in our best interests. Please read “Conflicts of Interest and Fiduciary Duties.”

 

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Our cash distribution policy, as expressed in our partnership agreement, may not be modified or repealed without amending our partnership agreement. The actual amount of our cash distributions for any quarter is subject to fluctuation based on the amount of cash we generate from our business and the amount of reserves our general partner establishes in accordance with our partnership agreement as described above. Our partnership agreement, including provisions contained therein requiring us to make cash distributions, may be amended by a vote of the holders of a majority of our common units after the expiration of the subordination period. Upon the closing of this offering, New Source Energy and certain of its affiliates will own our general partner and approximately     % of our outstanding common and subordinated units. Assuming we do not issue any additional common units and New Source Energy does not transfer a controlling portion of its equity interests in our general partner or its common units, New Source Energy and certain of its affiliates will have the ability to amend our partnership agreement without the approval of any other unitholders once the subordination period ends.

We will pay our distributions on or about the 15th of each of February, May, August and November to holders of record on or about the first day of each such month. If the distribution date does not fall on a business day, we will make the distribution on the business day immediately preceding the indicated distribution date. For our initial quarterly distribution, we will adjust the quarterly distribution for the period from the closing of this offering through March 31, 2013 based on the actual length of the period. We expect to pay this initial quarterly cash distribution on or before May 15, 2013.

In the sections that follow, we present in detail the basis for our belief that we will be able to fully fund our minimum quarterly distribution of $         per unit for the year ending December 31, 2013. In those sections, we present two tables, consisting of:

 

   

“Unaudited Pro Forma Available Cash for the Year Ended December 31, 2011 and Twelve Months Ended September 30, 2012,” in which we present the amount of cash we would have had available for distribution to our unitholders and our general partner for the year ended December 31, 2011 and the twelve months ended September 30, 2012, based on unaudited pro forma amounts. Our calculation of unaudited pro forma available cash in this table should only be viewed as a general indication of the amount of available cash that we might have generated had the transactions contemplated in this prospectus occurred in an earlier period.

 

   

“Estimated Adjusted EBITDA for the Year Ending December 31, 2013,” in which we demonstrate our ability to generate the minimum Adjusted EBITDA necessary for us to have sufficient cash available for distribution to pay the full minimum quarterly distribution on all the outstanding units, including our general partner units, for the year ending December 31, 2013.

Unaudited Pro Forma Available Cash for the Year Ended December 31, 2011 and Twelve Months Ended September 30, 2012

If we had completed the formation transactions contemplated in this prospectus and the acquisition of all of the Partnership Properties on January 1, 2011, our unaudited pro forma available cash generated during the year ended December 31, 2011 would have been approximately $22.4 million. Assuming the underwriters do not exercise their option to purchase additional common units, this amount would have been sufficient to make a cash distribution for the year ended December 31, 2011 at the minimum quarterly distribution of $         per unit per quarter (or $         per unit on an annualized basis) on all of our common units, general partner units and subordinated units. Assuming the underwriters exercise in full their option to purchase additional common units, this amount would have been sufficient to make a cash distribution for the year ended December 31, 2011 at the minimum quarterly distribution of $         per unit per quarter (or $         per unit on an annualized basis) on all of our common units, general partner units and subordinated units. The number of outstanding common units on which we have based such belief includes the restricted common units that we expect to issue to members of our management and the board of directors of our general partner under the long-term incentive plan that our general partner plans to adopt at the closing of this offering.

 

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If we had completed the formation transactions contemplated in this prospectus and the acquisition of all of the Partnership Properties on October 1, 2011, our unaudited pro forma available cash generated during the twelve months ended September 30, 2012 would have been approximately $17.9 million. Assuming the underwriters do not exercise their option to purchase additional common units, this amount would have been sufficient to make an average cash distribution for the twelve months ended September 30, 2012 at the minimum quarterly distribution of $         per unit per quarter (or $         per unit on an annualized basis) on all of our common units, general partner units and subordinated units. Assuming the underwriters exercise in full their option to purchase additional common units, this amount would have been sufficient to make an average cash distribution for the twelve months ended September 30, 2012 at the minimum quarterly distribution of $         per unit per quarter (or $         per unit on an annualized basis) on all of our common units, general partner units and subordinated units. The number of outstanding common units on which we have based such belief includes the restricted common units that we expect to issue to members of our management and the board of directors of our general partner under the long-term incentive plan that our general partner plans to adopt at the closing of this offering.

Unaudited pro forma available cash also includes general and administrative expenses, which were calculated on a different basis as compared to historical periods. Unaudited pro forma cash available for distribution gives effect on a pro forma basis to the quarterly fee of $675,000 for operating services our general partner will pay to the New Source Group pursuant to the omnibus agreement with our general partner. Please read “Certain Relationships and Related Party Transactions—Agreements Governing the Transactions—Omnibus Agreement.” In historical periods, the general and administrative expenses reflect an allocation of New Source Energy’s general and administrative expenses based on the proportion of historical production. Please read Note 1 to our audited financial statements included elsewhere in this prospectus.

We based the pro forma adjustments upon currently available information and specific estimates and assumptions. The pro forma amounts below do not purport to present our results of operations had the transactions contemplated in this prospectus and the acquisition of all of our properties actually been completed as of the dates presented. In addition, cash available to pay distributions is primarily a cash accounting concept, while our financial statements have been prepared on an accrual basis. As a result, you should view the amount of unaudited pro forma available cash only as a general indication of the amount of cash available to pay distributions that we might have generated had we been formed in an earlier period. The pro forma amounts below are presented on a twelve-month basis, and there is no guarantee that we would have had available cash sufficient to pay the full minimum quarterly distribution on all of our outstanding common units and subordinated units for each quarter within the twelve-month periods presented.

 

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The following tables illustrate, on an unaudited pro forma basis, for the year ended December 31, 2011, the twelve months ended September 30, 2012 and for each of the four quarters in each respective period, the amount of available cash that would have been available for distribution to our unitholders, assuming that the formation transactions (including the acquisition of all of the Partnership Properties) and this offering had been consummated on January 1, 2011 and October 1, 2011, respectively and that the underwriters did not exercise their option to purchase additional common units. Each of the pro forma adjustments presented below is explained in the footnotes to such adjustments.

 

    Pro Forma
(on a quarterly basis)
 
    Three Months Ended     Year Ended
December 31,
2011
 
     March 31,
2011
    June 30,
2011
    September 30,
2011
    December 31,
2011
   
    (in thousands, except per unit data)  

Net income (loss)

  $ 1,375      $ 4,870      $ (5,709   $ (1,613   $ (1,077

Unrealized (gain) loss on derivatives

    3,041        (1,394     (3,906     2,109        (150

Non-cash compensation expense

    —          —          1,402        3,069        4,471   

Accretion expense

    14        13        14        14        55   

Interest expense

    656        789        1,509        781        3,735   

Depreciation, depletion and amortization

    3,041        3,586        4,140        3,971        14,738   

Income tax expense

    —          —          11,555        (1,053     10,502   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA(1)

    8,127        7,864        9,005        7,278        32,274   

Less:

         

Cash interest expense(2)

    363        363        363        363        1,452   

General and administrative expense adjustment(3)

    513        110        (232     (148     243   

Estimated average maintenance capital expenditures(4)

    2,050        2,050        2,050        2,050        8,200   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Pro forma available cash

  $ 5,201      $ 5,341      $ 6,824      $ 5,013      $ 22,379   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Pro forma annualized distributions per unit(5)

         

Pro forma estimated annual cash distributions:

         

Distributions on common units held by purchasers in this offering(5)

  $        $        $        $        $     

Distributions on common units held by New Source Energy and affiliates(5)

         

Distributions on subordinated units(5)

         

Distributions on general partner units(5)

         
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total estimated annual cash distributions(5)

  $        $        $        $        $     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Excess(5)

  $        $        $        $        $     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Percent of minimum quarterly distributions payable to common unitholders

                                            

Percent of minimum quarterly distributions payable to subordinated unitholders

                                            

 

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    Pro Forma
(on a quarterly basis)
 
    Three Months Ended     Twelve Months
Ended September 30,
2012
 
    December 31,
2011
    March 31,
2012
    June 30,
2012
    September 30,
2012
   
    (in thousands, except per unit data)  

Net income (loss)

  $ (1,613   $ (108   $ 2,920      $ (799   $ 401   

Unrealized (gain) loss on derivatives

    2,109        (740     (6,466     6,317        1,220   

Non-cash compensation expense

    3,069        3,149        3,149        1,107        10,474   

Accretion expense

    14        28        29        29        100   

Interest expense

    781        811        787        824        3,203   

Depreciation, depletion and amortization

    3,971        3,944        3,700        3,409        15,023   

Income tax expense

    (1,053     (144     1,872        (562     113   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA(1)

    7,278        6,940        5,991        10,325        30,534   

Less:

         

Cash interest expense(2)

    363        363        363        363        1,452   

General and administrative expense adjustment(3)

    (148     (502     (302     (722     (1,674

Estimated average maintenance capital expenditures(4)

    2,050        2,050        2,050        2,050        8,200   

Early termination of derivative contracts(5)

    —          —          —          4,609        4,609   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Pro forma available cash

  $ 5,013      $ 5,029      $ 3,880      $ 4,025      $ 17,947   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Pro forma annualized distributions per unit(5)

         

Pro forma estimated annual cash distributions:

         

Distributions on common units held by purchasers in this offering(5)

  $        $        $        $        $     

Distributions on common units held by New Source Energy and affiliates(5)

         

Distributions on subordinated units(5)

         

Distributions on general partner units(5)

         
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total estimated annual cash distributions(5)

  $        $        $        $        $     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Excess(5)

  $        $        $        $        $     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Percent of minimum quarterly distributions payable to common unitholders

                                            

Percent of minimum quarterly distributions payable to subordinated unitholders

                                            

 

(1) Adjusted EBITDA is defined in “Summary—Non-GAAP Financial Measure.”
(2) In connection with this offering, we intend to enter into a new $         million revolving credit facility, under which we expect to borrow approximately $40.0 million upon the closing of the offering. The pro forma cash interest expense is based on $40.0 million of borrowings at an assumed weighted average interest rate of 3.63%, which equals New Source Energy’s weighted average interest rate on its revolving credit facility as of September 30, 2012.
(3) Reflects the difference between historical cash general and administrative expenses and the aggregate quarterly fee we will pay the New Source Group for the provision of management and administrative services under our omnibus agreement following the closing of this offering through December 31, 2013.
(4)

Historically, we did not make a distinction between maintenance and growth capital expenditures. For purposes of the presentation of Unaudited Pro Forma Available Cash, we have estimated that approximately $8.2 million of our capital expenditures were maintenance capital expenditures for the Partnership

 

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  Properties for the respective period, which reflects our estimate of the average annual capital expenditures necessary to at least maintain our production at 3,200 Boe/d through December 31, 2016.
(5) Reflects the allocated net proceeds of settlements of derivative contracts closed out before scheduled production date settlement. New Source Energy realized $4.9 million upon early termination of derivative contracts, of which $4.6 million was allocated to the Partnership Properties for the three months ended September 30, 2012.

Estimated Adjusted EBITDA for the Year Ending December 31, 2013

The cumulative amount that we would distribute for the year ending December 31, 2013, if we made distributions on all our common units, subordinated units and general partner units at the minimum quarterly distribution rate of $         per unit during that period, would be $         million if the underwriters do not exercise their option to purchase additional common units and $         million if the underwriters exercise in full their option to purchase additional common units. Based upon the assumptions and considerations set forth in “—Assumptions and Considerations,” in order to fund distributions on all our common units, subordinated units and general partner units at the minimum quarterly distribution rate for the year ending December 31, 2013, we estimate that our minimum Adjusted EBITDA for that period must be at least $         million if the underwriters do not exercise their option to purchase additional common units and at least $         million if the underwriters exercise in full their option to purchase additional common units. The number of outstanding common units on which we have based such belief includes the restricted common units that we expect to issue to members of our management and the board of directors of our general partner under the long-term incentive plan that our general partner plans to adopt at the closing of this offering.

Based on the assumptions set forth in “—Assumptions and Considerations,” and as set forth in the table below, we believe that we will be able to generate approximately $         million in Adjusted EBITDA during the year ending December 31, 2013, which amount we refer to as our “estimated Adjusted EBITDA.” We can give you no assurance, however, that we will generate this amount of Adjusted EBITDA during that period. There will likely be differences between our estimated Adjusted EBITDA and our actual results for the year ending December 31, 2013, and those differences could be material. In addition, Adjusted EBITDA may not represent actual cash generated during an applicable period because of, among other things, timing differences between the incurrence and actual payment of accounts payable and accounts receivable. If the amount of Adjusted EBITDA that we actually generate during the year ending December 31, 2013 is less than our estimated Adjusted EBITDA, we may not be able to pay the minimum quarterly distribution on all of our units.

Our management has prepared the prospective financial information that is the basis of our estimated Adjusted EBITDA below to substantiate our belief that we will have sufficient cash to pay the minimum quarterly distribution on all outstanding common, subordinated and general partner units for the year ending December 31, 2013. This prospective financial information is a forward-looking statement and should be read together with the historical financial statements and the accompanying notes included elsewhere in this prospectus and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” This prospective financial information was not prepared with a view toward complying with the published guidelines of the SEC or the guidelines established by the American Institute of Certified Public Accountants with respect to prospective financial information, but, in the view of our management, was prepared on a reasonable basis, reflects the best currently available estimates and judgments, and presents, to the best of our management’s knowledge and belief, the assumptions and considerations on which we base our belief that we can generate sufficient Adjusted EBITDA to pay the minimum quarterly distribution to all of our common unitholders and subordinated unitholders, as well as in respect of our general partner units, for the year ending December 31, 2013. However, this prospective financial information is not fact and may not be necessarily indicative of our actual results of operations, and readers of this prospectus are cautioned not to place undue reliance on this prospective financial information. Please read “—Assumptions and Considerations.”

 

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The forecast has been prepared by and is the responsibility of management. Our forecast reflects our judgment as of the date of this prospectus of conditions we expect to exist and the course of action we expect to take during the year ending December 31, 2013. While the assumptions disclosed in this prospectus are not all-inclusive, the assumptions listed below are those that we believe are material to our forecasted results of operations and any assumptions not discussed below were not deemed to be material. We believe we have a reasonable objective basis for these assumptions; however, there will likely be differences between our forecast and the actual results and those differences could be material. If the forecast is not achieved, we may not be able to pay cash distributions on our common units at the minimum quarterly distribution rate or at all.

Neither BDO USA LLP nor any other independent accountant has compiled or performed any procedures with respect to the accompanying prospective financial information and, accordingly, BDO USA LLP and any other accounting firm do not express an opinion or any other form of assurance with respect thereto. The BDO USA LLP report included in the registration statement relates to historical financial information. Such report does not extend to the prospective financial information and should not be read to do so.

When considering this prospective financial information, you should keep in mind the risk factors and other cautionary statements under “Risk Factors.” Any of the risks discussed in this prospectus, to the extent they are realized, could cause our actual results of operations to vary significantly from those that would enable us to generate the estimated Adjusted EBITDA sufficient to pay the minimum quarterly distributions to holders of our common, subordinated and general partner units for the year ending December 31, 2013.

We do not undertake any obligation to release publicly the results of any future revisions we may make to this prospective financial information or to update this prospective financial information to reflect events or circumstances after the date of this prospectus. Therefore, you are cautioned not to place undue reliance on this information.

As a result of the factors described in “—Our Estimated Adjusted EBITDA” and “—Assumptions and Considerations,” we believe we will be able to pay cash distributions at the minimum quarterly distribution of $         per unit on all outstanding common, subordinated and general partner units for each full calendar quarter in the year ending December 31, 2013. The number of outstanding common units on which we have based such belief includes the restricted common units that we expect to issue to members of our management and the board of directors of our general partner under the long-term incentive plan that our general partner plans to adopt at the closing of this offering.

Our Estimated Adjusted EBITDA

Adjusted EBITDA is a supplemental non-GAAP financial measure that is used by management and external users of our financial statements, such as industry analysts, investors, lenders and rating agencies, and is not a measure of net income or cash flows as determined by United States generally accepted accounting principles, or GAAP.

We define Adjusted EBITDA as earnings before interest expense, income taxes, depreciation, depletion and amortization, accretion expense, non-cash compensation expense and unrealized derivative gains and losses.

 

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Our management believes Adjusted EBITDA is useful because it allows us to more effectively evaluate our operating performance and compare the results of our operations from period to period without regard to our financing methods or capital structure. We exclude the items listed above from net income in arriving at Adjusted EBITDA because these amounts can vary substantially from company to company within our industry depending upon accounting methods and book values of assets, capital structures and the method by which the assets were acquired. Adjusted EBITDA should not be considered as an alternative to, or more meaningful than, net income or cash flows from operating activities as determined in accordance with GAAP or as an indicator of our operating performance or liquidity. Certain items excluded from Adjusted EBITDA are significant components in understanding and assessing a company’s financial performance, such as a company’s cost of capital and tax structure, as well as the historic costs of depreciable assets, none of which are components of Adjusted EBITDA. Our computations of Adjusted EBITDA may not be comparable to other similarly titled measures of other companies. We believe that Adjusted EBITDA is a widely followed measure of operating performance and may also be used by investors to measure our ability to meet debt service requirements.

 

    Forecasted(1)  
    Three Months Ending     Twelve  Months
Ending

December 31,
2013
 
    March 31,
2013
    June 30,
2013
    September 30,
2013
    December 31,
2013
   
    ($ in millions, except for per unit amounts)  

Annual Production

         

Oil (Mbls)

    12.9        13.6        14.7        15.8        57.0   

Natural Gas (Mmcf)

    557.5        566.7        578.0        583.9        2,286.1   

NGLs (Mbls)

    192.6        193.7        194.0        192.0        772.3   

Total (Mboe)

    298.4        301.8        305.0        305.1        1,210.3   

Boe/d

    3,316        3,316        3,316        3,316        3,316   

Realized Commodity Prices(2)

         

Oil ($/Bbl)

    $91.53      $ 92.10      $ 91.74      $ 91.44      $ 91.70   

Natural Gas ($/Mcf)

    $3.85      $ 3.85      $ 3.85      $ 3.85      $ 3.85   

NGLs ($/Bbl)

    $35.94      $ 35.94      $ 35.94      $ 35.94      $ 35.94   

Operating revenue and realized commodity derivative settlements

    $10.3      $ 10.4      $ 10.5      $ 10.6      $ 41.8   

Less:

         

Lease operating expenses

    2.0        2.0        1.9        2.0        7.9   

Production and ad valorem taxes

    0.3        0.3        0.4        0.4        1.4   

General and administrative expenses

    0.7        0.7        0.7        0.6        2.7   

Depreciation, depletion and
amortization

    3.8        3.8        3.9        3.9        15.4   

Interest expense

    0.4        0.4        0.3        0.3        1.4   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income and realized commodity derivative settlements excluding unrealized derivative settlements and non-cash compensation
expense

  $ 3.1      $ 3.2      $ 3.3      $ 3.4      $ 13.0   

Adjustments to reconcile net income and realized commodity derivative settlements excluding unrealized derivative settlements to estimated Adjusted EBITDA:

         

Add:

         

Depreciation, depletion and amortization

    $3.8      $ 3.8      $ 3.9      $ 3.9      $ 15.4   

Interest expense

    0.4        0.4        0.3        0.3        1.4   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Estimated Adjusted EBITDA

    $7.3      $ 7.4      $ 7.5      $ 7.6      $ 29.8   

 

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    Forecasted(1)  
    Three Months Ending     Twelve  Months
Ending

December 31,
2013
 
    March 31,
2013
    June 30,
2013
    September 30,
2013
    December 31,
2013
   
    ($ in millions, except for per unit amounts)  

Adjustments to reconcile estimated Adjusted EBITDA to estimated available cash:

         

Estimated Adjusted EBITDA

  $ 7.3      $ 7.4      $ 7.5      $ 7.6      $ 29.8   

Less:

         

Cash interest expense(3)

  $ 0.4      $ 0.4      $ 0.3      $ 0.3      $ 1.4   

Estimated average maintenance capital expenditures(4)

    2.1        2.1        2.0        2.0        8.2   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Estimated available cash

  $ 4.8      $ 4.9      $ 5.2      $ 5.3      $ 20.2   

Estimated annualized minimum quarterly distribution per unit

  $        $        $        $        $     

Estimated annual cash distributions:

         

Distributions on common units held by purchasers in this offering

  $        $        $        $        $     

Distributions on common units held by New Source Energy and affiliates(5)

         

Distributions on subordinated units

         

Distributions on general partner units

         
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total estimated annual cash distributions

  $        $        $        $        $     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Excess cash available for distribution

  $        $        $        $        $     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Minimum estimated Adjusted EBITDA:

         

Estimated Adjusted EBITDA

  $ 7.3      $ 7.4      $ 7.5      $ 7.6      $ 29.8   

Less:

         

Excess cash available for distributions

         
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Minimum estimated Adjusted EBITDA

  $        $        $        $        $     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Assuming no exercise of the underwriters’ option to purchase additional common units.
(2) Includes the forecasted effect of cash settlements of commodity derivative instruments and certain commodity derivative contracts held by New Source Energy as of September 30, 2012, which New Source Energy intends to contribute to us at the closing of this offering.
(3) In connection with this offering, we intend to enter into a new $         million revolving credit facility, under which we expect to borrow approximately $40.0 million upon the closing of the offering. The forecasted cash interest expense is based on $40.0 million of borrowings upon the close of the offering and an assumed weighted average interest rate of 3.63%, which equals New Source Energy’s weighted average interest rate on its revolving credit facility as of September 30, 2012.
(4) In calculating the estimated cash available for distribution, we have included our estimated maintenance capital expenditures for the twelve months ending December 31, 2013. To maintain our targeted average net production from our assets of 3,200 Boe/d through December 31, 2016, we expect to incur, on average approximately $8.2 million of annual capital expenditures for the twelve months ending December 31, 2012 based on our reserve reports as of June 30, 2012.
(5) Includes distributions on              restricted common units to be granted to certain members of our management team and the board of directors of our general partner upon the closing of this offering.

 

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    Forecasted(1)  
    Three Months Ending      Twelve  Months
Ending

December 31,
2013
 
    March 31,
2013
     June 30,
2013
     September 30,
2013
     December 31,
2013
    
    ($ in millions, except for per unit amounts)  

Annual Production

             

Oil (Mbls)

    12.9         13.6         14.7         15.8         57.0   

Natural Gas (Mmcf)

    557.5         566.7         578.0         583.9         2,286.1   

NGLs (Mbls)

    192.6         193.7         194.0         192.0         772.3   

Total (Mboe)

    298.4         301.8         305.0         305.1         1,210.3   

Boe/d

    3,316         3,316         3,316         3,316         3,316   

Realized Commodity Prices(2)

             

Oil ($/Bbl)

  $ 91.53       $ 92.10       $ 91.74       $ 91.44       $ 91.70   

Natural Gas ($/Mcf)

  $ 3.85       $ 3.85       $ 3.85       $ 3.85       $ 3.85   

NGLs ($/Bbl)

  $ 35.94       $ 35.94       $ 35.94       $ 35.94       $ 35.94   

Operating revenue and realized commodity derivative settlements

  $ 10.3       $ 10.4       $ 10.5       $ 10.6       $ 41.8   

Less:

             

Lease operating expenses

    2.0         2.0         1.9         2.0         7.9   

Production and ad valorem taxes

    0.3         0.3         0.4         0.4         1.4   

General and administrative expenses

    0.7         0.7         0.7         0.6         2.7   

Depreciation, depletion and amortization

    3.8         3.8         3.9         3.9         15.4   

Interest expense

    0.3         0.3         0.2         0.2         1.0   
 

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net income and realized commodity derivative settlements excluding unrealized derivative settlements and non-cash compensation expense

  $ 3.2       $ 3.3       $ 3.4       $ 3.5       $ 13.4   

Adjustments to reconcile net income and realized commodity derivative settlements excluding unrealized derivative settlements to estimated Adjusted EBITDA:

             

Add:

             

Depreciation, depletion and amortization

  $ 3.8       $ 3.8       $ 3.9       $ 3.9       $ 15.4   

Interest expense

    0.3         0.3         0.2         0.2         1.0   
 

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Estimated Adjusted EBITDA

  $ 7.3       $ 7.4       $ 7.5       $ 7.6       $ 29.8   

Adjustments to reconcile estimated Adjusted EBITDA to estimated available cash:

             

Estimated Adjusted EBITDA

  $ 7.3       $ 7.4       $ 7.5       $ 7.6       $ 29.8   

Less:

             

Cash interest expense(3)

    0.3         0.3         0.2         0.2         1.0   

Estimated average maintenance capital expenditures(4)

    2.1         2.1         2.0         2.0         8.2   
 

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Estimated available cash

  $ 4.9       $ 5.0       $ 5.3       $ 5.4       $ 20.6   

Estimated annualized minimum quarterly distribution per unit

             

 

71


Table of Contents
Index to Financial Statements
    Forecasted(1)  
    Three Months Ending      Twelve Months
Ending
December 31,
2013
 
    March 31,
2013
     June 30,
2013
     September 30,
2013
     December 31,
2013
    
    (In millions, except for per unit amounts)  

Estimated annual cash distributions:

             

Distributions on common units held by purchasers in this offering

  $         $         $         $         $     

Distributions on common units held by New Source Energy and affiliates(5)

             

Distributions on subordinated units

             

Distributions on general partner units

             
 

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total estimated annual cash distributions

  $         $         $         $         $     
 

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Excess cash available for distribution

  $         $         $         $         $     
 

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Minimum estimated Adjusted EBITDA:

             

Estimated Adjusted EBITDA

  $ 7.3       $ 7.4       $ 7.5       $ 7.6       $ 29.8   

Less: