Vanguard Natural Resources Q4 2008 Earnings Call Transcript

Mar. 5.09 | About: Vanguard Natural (VNR)

Vanguard Natural Resources, LLC (NYSE:VNR)

Q4 2008 Earnings Call

March 05, 2009 11:00 AM ET

Executives

Carol Coale - Investor Relations, DRG&E

Scott W. Smith - President and Chief Executive Officer

Richard A. Robert - Executive Vice President and Chief Financial Officer

Analysts

Michael Blum - Wachovia Capital Markets, LLC

Richard Roy - Citigroup

Joel Havard - Hilliard Lyons

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Vanguard Natural Resources Fourth Quarter Earnings Conference Call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be opened for questions. (Operator Instructions). This conference is being recorded today March 5, 2009.

I would now like to turn the conference over to Carol Coale with DRG&E. Please go ahead.

Carol Coale

Thanks Nicole. Good morning everyone, and welcome to the Vanguard Natural Resources fiscal year end and fourth quarter 2008 earnings conference call. We appreciate you all joining us today. And before we turn the call over to management I have a few items to go over.

First of all, if you would like to listen to a replay of today's call it will be available until March 19, 2009 and the information regarding the replay will be announced at the end of this call. Results or webcast archived will be available on the Investor Relations page of the company's website, www.vnrllc.com and will be accessible for approximately 30 days. For more information or if you want to be added to our e-mail distribution list or say future press releases, please contact Donna Washburn at our firm DRG&E at (713) 529-6600 or e-mail her at dmw@drg-e.com.

Information also provided in this morning's earnings release, and any information reported on this call speaks only as of today March 5, 2009. Therefore your advised that time sensitive information may no longer be accurate as of the time of any replay.

Before we get started, please note that some of the comments today could be considered forward-looking statements and are based on certain assumptions and expectations of management. For detailed list of all the risk factors associated with our business, please refer to the 10-K that will be filed next week or the 10-K for the calendar year 2007, both of which will be available on their website under the Investor Relations tab or on EDGAR.

Now, I'd like to turn the call over to Scott Smith, President and CEO of Vanguard Natural Resource, LLC. Scott?

Scott W. Smith

Thanks Carol, and welcome everyone and thank you for joining us today to review our accomplishments for 2008, as well as our financial results and outlook for 2009. I'm joined today by Richard Robert, our Executive Vice President and Chief Financial Officer; and Britt Pence, our Vice President of Operations.

This morning I'll start with the summary of our result for the year, briefly discuss our year-end results and operations, and then turn the call over to Richard for financial review. Then we'll open up the line for Q&A.

First of all we are proud, we have just successfully accomplished many of our goals in 2008. We completed two acquisitions, one in the Permian Basin and the other in South Texas. Due to these acquisitions we build a portfolio of assets with the balanced commodity mix and a geographic diversity.

In addition, we raised our annual distribution rate twice during the year, growing it from $1.70 at the end of 2007 to $2 where it currently stands.

In current with our acquisitions, we protected our future cash flows from these properties by establishing a hedging program that lock-in commodity prices and ensure returns. With the collapse in this commodity markets all of our hedges are significantly higher than the current market.

Based on our current drilling plans we have hedged approximately 100% of our expected 2009 gas production at a floor price of 877 per MMBtu, 81% of our 2009 oil production at a floor price of $89.37 a barrel.

We look out three years, again based on our current drilling plans for the next three year period. We've hedged approximately 84% of our expected gas production at a weighted average floor price of 850 per MMBtu, and 72% of our expected oil production at a weighted average floor price of $87.13.

Lastly, in a different difficult credit market, we expanded our credit facility in October of 2008 to provide for a borrowing base of 175 million, a $25 million increase over where it was say previously and added a new bank to our borrowing group.

With respect to reserves, we ended up 2008 with proven reserves of 108.5 Bcfe equivalent, up from 67.1% Bcfe at the end of 2007, 62% increase. The PV10 of our reserves using SEC guidelines was approximately190 million. Our year-end reserves were valued using fixed prices of 571 per MMBtu for gas and $41 per barrel of oil, which compares to the 2007 prices of 679 per MMBtu and 92.50 per barrel.

Although, we are reporting our reserves using conventional methodology, you may have seen some of our peers have reported their results in their press release as using strip pricing as of December 31, '08 and incorporating the value of their hedges and calculating PV10 value.

Every reported results using this approach in this press release, our year-end reserves would have been a 116 Bcfe and our PV10 would have been approximately 329 million, as opposed to the 190 million that we reported in our... using that conventional approach.

Operationally, in the fourth quarter we were able to see for the first time the contributions for our full quarter from our Permian Basin in South Texas acquisitions, and we saw our production increased 69% over fourth quarter of 2008 volumes, and a 10% increase over third quarter of 2008 volumes.

In our largest operating area, the Appalachian Basin, our natural gas production declined by 6% from fourth quarter 2007. However, our oil production in the quarter increased 72% over prior period numbers. So we saw net 3% decline on an Mcf equivalent basis.

During the quarter, our Appalachian operating partner Vinland Energy focused its efforts on re-completion work and on connecting previously drilled well to its gathering systems. We and Vinland have identified a substantial inventory of well that our candidates to re-complete or work over with the goal of maximizing our production from existing wells of nominal capital investments.

Then our partner believe this is the best operating strategy in the current and projected pricing environment. And we'll continue this strategy during 2009 unless market conditions improves.

In the Permian Basin, during the quarter we produced 68 million cubic feet of gas and a little over 55,000 barrels of oil, are approximately 723 BOE per day. We also participated in three gross two net wells. In South Texas, the company produced 326 Mcfe equivalent of gas, a rise at little over 3.5 million a day. We also participated in four gross two net wells.

During the quarter our production from these two areas was negatively affected by approximately 125 to 150 Mcfe per day, results of shut-ins by purchasers from certain of our casinghead gas wells in the Permian, and as a result of an election by the operator to forgo processing on all of our volumes in South Texas as a result of the collapses in the commodity prices.

With the continued erosion of the commodity markets, we are continuing to see reduced processing of our South Texas gas and have seen several instances so far this year with the gas purchases in the Permian Basin are shut-in in their gathering systems for lack of market.

The South Texas. We and our operating partner, Lewis Energy have elected to defer any additional investment of our flood inventory until the commodity prices weren't further investment.

Our current planning and forecasting include the drilling of four to five wells in the second half of 2009. Until we resume drilling operations, the Lewis team will continue to look for opportunities to add additional production through select re-completions and workovers.

We're in a very fortunate position that our extensive inventory of crude undeveloped drilling locations is on acreage that is substantially held by productions. So we aren't at risk of losing these reserves by deferring our drilling activities until such time if the commodity markets improves.

In 2009, obviously our unhedged natural gas and oil revenues would decline dramatically to the impact of lower commodity prices. However, with the positive contribution from our hedges, we should generate distributable cash flows sufficient to provide a coverage ratio in excess of 1.5 times.

On the call today, I hope our unitholders will take away the following key aspects of the company. First, as we stated earlier, we are well positioned to continue to produce strong cash flow this year and beyond due to our long life assets and our favorable hedge book. Second, until commodity prices improve, our strategy will be on maximizing the proper potential of our existing assets with nominal investment.

Lastly, although these are difficult times for the energy sector as a whole, in this market there maybe opportunities for us to acquire high quality assets that will be accretive to both near-term cash flows and provide volume growth and stability of our distributions in the future.

As a management, we will continue to look-forward and evaluate potential acquisitions where we believe we can add accretive properties at very attractive metrics. These properties could include among other things bankruptcy situations, companies need to de-leverage any bank covenants or sellers looking to rationalize assets to focus on only core operations. We've already seen the first wave of this type of opportunity in the market and expect this supply to increase as we head into the second, third quarters of this year.

Thanks again for tuning in. And I'll now turn the call over to Richard for the financial review.

Richard A. Robert

Good morning. As Scott mentioned, we're pleased with the results for 2008 and the fourth quarter.

I'll start with our full year results. We reported a net loss of $2.8 million for 2008, which includes the positive impact of net unrealized gains on our commodity and interest rate derivatives instruments and the negative impact of the non-cash impairment charge on our natural gas and oil properties.

Due to the decline in commodity prices, we were required to take a sealing test charge of $58.9 million related to the write-down of our capitalized natural gas oil property costs under full cost accounting. Needless to say the change in commodity prices impacted the carrying value of our assets. But please keep in mind that the changes, that the charge is a non-cash item and reflects the value of the assets at one point in time.

In fact, new accounting rules have been established which allow for the use of an average price for the year instead of using the year-end price, but unfortunately the application of the new rule doesn't go into effect until the end of 2009. The new rule seem to make a lot of sense. And I expect you will see few of these non-cash impairment charges once the new rules have been adopted.

Nevertheless, please remember this non-cash charge does not negatively impact the cash flow that we have available for distribution to our unitholders. Inversely, the net unrealized gains from our commodity and interest rate hedges do not positively impact the cash flow that we have available for distribution into our unitholders.

Excluding this non-cash impairment charge and the non-cash unrealized gains from our commodity interest rate hedges, we reported adjusted net income for 2008 of $19.3 million, compared to $2.6 million in 2007. The 642% increase, in addition to the increases seen in adjusted EBITDA and distributable cash flow is why we suggest that we had a record year despite of a reported net loss.

Due to the salvation related in 2008 we have built a portfolio of assets with high quality and long-like reserves that will allow us to continue to execute our business plan, design to maximize the productivity of our assets and maintain our cash distributions.

Our adjusted EBITDA were 61% in 2008, 48.8 million compared to the 30.4 million achieved in 2007. We generated distributable cash flow of $25 million in 2008, a 163% increase over the 9.5 million produced in 2007.

Now onto fourth quarter results. During the fourth quarter, adjusted EBITDA increased to 12.6 million, a 77% increase over the comparable period last year, but a 9% decline from the third quarter of 2008. The year-over-year increase was driven by higher production volumes and commodity prices as Scott just discussed and the sequential decline was primarily due to declining commodity prices on our unhedged production.

Distributable cash flow in the quarter was $6 million after consideration of 4.8 million of capital expenditures and 1.7 million in interest cost. This compares to the third quarter distributable cash flow of 5.6 million after 6.7 million in capital expenditures, and 1.5 million in interest cost.

As I suggested in the past, I believe that distributable cash flow and our resulting distribution covered ratio should be analyzed on an annual basis end of first quarter. Capital expenditures are not made even late throughout the year due to a variety of factors, including weather conditions, rig availability and the commodity price environment. And you're comparing that to a cash distribution payments that are constant.

As a result, there will be volatility in distributable cash flow on a quarter-to-quarter basis. In 2009, we anticipate our covered ratio will be above the 2008 level despite the depressed commodity price environment. This is due to our hedging program, which has been designed to protect our cash flow and support our distribution in any commodity price environment, which is particularly important in today's environment. It also helps to stay well within our debt covenants for the foreseeable future.

In our earnings press release, we included our guidance for 2009. Currently, we anticipate generating adjusted EBITDA in 2009 of 50 to 51.6 million and distribute cash flow of 38.2 to 39.3 million, which we translate into a covered ratio of approximately 1.52 to 1.57 times based on our current $2 annualized distribution level.

In 2009, we are anticipating capital expenditures in the range of 6 to $6.5 million as we focus on our developmental work and the limited amount of new drilling. These reduced capital expenditures will enhance our distribution coverage and generate a significant amount of excess cash.

Now, I'd like to shift the discussion to our leveraged and liquidity. In 2008, we expanded our credit facility to add three banks and increase our borrowing base from 110 million to 175 million during the course of two rig terminations. We were very pleased to expand this facility, particularly the $25 million expansion in the fourth quarter as everyone is aware that adding lenders and giving increased commitments in this credit crunch has been challenging.

Another good news and additional demonstration that our banks feel very capital with the Vanguard credit, the covenants of our credit facility were recently amended giving us the flexibility of the repurchase up to $5 million of our units.

From a liquidity standpoint based on our $175 million borrowing base, we currently have approximately 37 million in availability under our credit facility, in addition to approximately $4 million in cash. It is likely that we will be subject to a decrease in our borrowing base as a result from our next semi-annual borrowing base re-termination scheduled for later this month or early next month.

Banks have lowered their price tax in response to current commodity price environment and credit crunch, but based on our preliminary discussions with our lead bank we don't believe the reduction will be a material amount.

In addition as previously mentioned, our 2009 forecast anticipates generating approximately 13 to $14 million of cash, after making distribution payments at current levels and servicing our debt.

As for the better use, such as immediately accretive acquisitions of producing properties, we expect this excess cash can be used to reduce our debt level and provide an additional buffer in the event that we are subject to further borrowing base decreases in the future. We assure you that we will be very judicious on how we allocate our liquidity going forward.

This concludes my comments. We'd be happy to take any questions you might have.

Question-and-Answer Session

Operator

Thank you, sir. We will now begin the question-and-answer session. (Operator Instructions). Our first question comes from the line of Michael Blum with Wachovia. Please go ahead.

Michael Blum - Wachovia Capital Markets, LLC

Hi. Good morning.

Scott Smith

Good morning, Michael.

Richard Robert

Hi Michael.

Michael Blum - Wachovia Capital Markets, LLC

Couple of questions. Once, in terms of your hedges you said you are 100% hedged in 2009. What's the makeup of those hedges? I haven't read it. I don't know if it's in the press release. I didn't see it all. But is that puts or swaps or combination?

Richard Robert

It's a combination of swaps, collars and puts. It's about 68% swaps, 19% collars and about 14% puts.

Michael Blum - Wachovia Capital Markets, LLC

Okay. And then the other question, and then I'll get back in the queue. It looks like effectively your production would be relatively flat relative to the Q4 run-rate I just annualize it slightly lower. But you obviously spending, you're spending only about $6 million in CapEx. So, I'm just trying to reconcile is that the amount of investing CapEx you need to do to maintain production?

Scott Smith

No, no. I think if you take a closer look at the forecast you'll notice that all areas... we are forecasting less production in all areas except for South Texas because that we do intend to do a little bit amount of drilling in the second half of 2009 in that area. So, I mean we are not trying to maintain our production at current levels. And I think if you analyze those numbers, you'll see that we are anticipating decline.

Michael Blum - Wachovia Capital Markets, LLC

Okay. Thank you.

Operator

Thank you. Our next question comes from the line of Richard Dearnly (ph) with Longport Partners. Please go ahead.

Unidentified Analyst

Good morning. As I get it, you're forecasting production to be about 14.5 a day, which would be loosely speaking 22% decline. Is that what's your decline curve looks like, with relatively flat CapEx?

Richard Robert

Well, actually I'm not sure if you converting the oil to Mcfe because we're actually...

Unidentified Analyst

Well, I did it in a hurry and drew.

Richard Robert

Yeah. I mean we're actually anticipating an amount considerably higher than that. It's more in the 17.5 to 18.5 million a day range.

Unidentified Analyst

Okay.

Richard Robert

That's the forecast.

Unidentified Analyst

And is that representative of your normal decline curve?

Richard Robert

Yeah, in Appalachia I think we're forecasting about a 7% decline, which is about what our decline curve is.

Unidentified Analyst

And in South Texas?

Richard Robert

Well, again in South Texas we do anticipate drilling a number of wells in the second half of the year, which is why we actually show an increase in that area for the year. That is the only area that we anticipate an increase.

Unidentified Analyst

But in general, what's ex any CapEx in South Texas, what's your decline curve there?

Scott Smith

In South Texas, our decline is probably you look at about 15% because you do have some new wells that you drill this year that are fallen off. So that kind of makes the total on about 15%. The existing wells are on a flatter decline than that all the wells.

Unidentified Analyst

I agree. And then, your assumption on being hedged for the three years post '09 of 84% and 81 and 84, does that assume flat production at '09 rate?

Richard Robert

Actually, the 84% for natural gas and the 72% for oil it encompasses 2009, so it's three years from today, its 2009, 2010 and 2011. And it does, that does encompass, what we consider a normal drilling schedule for 2010 and 2011.

Unidentified Analyst

Which is higher than '09 I tell you.

Richard Robert

Yeah. I mean our normal drilling schedule or capital schedule have a spending in the neighborhood of 16 to $18 million.

Unidentified Analyst

Okay, great. Thank you very much.

Richard Robert

Yeah. And if we spend that kind of money you would expect to see increase from where we were, but flat to where we were this year.

Unidentified Analyst

Right. Okay, thank you.

Scott Smith

Thank you.

Operator

Thank you. Our next question comes from the line of Richard Roy with Citigroup. Please go ahead.

Richard Roy - Citigroup

My questions have been answered. Thank you.

Scott Smith

Thanks Richard.

Operator

Thank you. (Operator Instructions). Our next question comes from the line of Joel Havard with Hilliard Lyons. Please go ahead.

Joel Havard - Hilliard Lyons

Thank you. Good morning.

Scott Smith

Good morning, Joel.

Joel Havard - Hilliard Lyons

I guess your comments in the prepared statements, was there could be more acquisition opportunities? You're going to be very judicious in how you approach it. Could you help us prioritize cash flows and I'll presume that that starts with distribution coverage. But then if you could talk about debt versus the unit repurchase opportunity, versus acquisition opportunities?

Scott Smith

Okay. Obviously, we are clear on what are about our cash flow. Acquisitions, again bad times sometime that may be absolute best time strategy we think. We're fortunate I think we're going to have some liquidity if we find the right opportunity and can buy properties that fit what we want to do at the right price that again help situate the company long-term. Obviously, we'd be foolish not to pursue those. But again, you're going to have to wait through a lot of stuff in this market to find the right deal.

Again, it is a buyers market and I think it's going to continue to be the more favorable as we go forward.

But absent that, we'll say now paying down the debt we'll be looking to do, and at the same time maintaining our distributions. I mean, the reason that hedge program is in place we would... we'd look very smart in July of 2008. And I'll see the tables of turn. But just like we weren't getting the full benefit of the hedge program when prices were high, now we are getting. And the reason is there is to ensure the distributions.

Richard Robert

Yeah, just to confirm what you said. I think you are accurate in that. The number one priority is to maintain our distribution at current levels. And then utilizing excess cash flow to take advantage of the acquisition opportunities we see. And absent those acquisitions, we would use to reduce debt. We do have the flexibility to repurchase on units, but that's not something that we were looking to do. But if there is moments of weakness like we saw in the fourth quarter or last year when virtually every hedge funds sold every share they owned in us and got our price stand to a ridiculously low level, then we might see us use a limited amount to repurchase unit.

But that... we'd like to use a limited amount to fund our assets and other incentive programs that we have. But that's certainly not a focus for us. We don't... we would rather not use it for that.

Joel Havard - Hilliard Lyons

Okay. I guess I'll translate that into poker terms the acquisition opportunities are a wild card, the repurchase flexibility is your whole card, but it's really distribution defense and then incremental debt reduction if with any excess?

Richard Robert

That's correct.

Joel Havard - Hilliard Lyons

I thought so. That will make a more colorful bullet point rolling in.

Scott Smith

I like your poker analogy.

Joel Havard - Hilliard Lyons

, Thank you. The one follow-up would relate you're showing in your forecast and average higher total units, is there a trigger with Class Bs over the course of '09 or '10 that would expand it from where it finished to Q4 or is that closer to the actual Q4 finish?

Richard Robert

No, that is actually the Q4 finish. We had, it's a weighted... what you show in the financials is the weighted average for the year. And we did use units to pay for further consideration in the Lewis transaction.

Joel Havard - Hilliard Lyons

Is that now fully absorbed?

Richard Robert

That's fully absorbed.

Joel Havard - Hilliard Lyons

Okay, got it. Thank you so much guys. Good luck.

Scott Smith

Thank you.

Richard Robert

Thank you.

Operator

Thank you. Our next question is a follow-up question from the line of Michael Blum with Wachovia. Please go ahead.

Unidentified Analyst

Hi. This is actually Praneet Satish (ph). Just had one follow-up question. I guess what natural gas price would you need to see to resume kind of a normalized drilling activity, and is it significantly different in each of your segments?

Scott Smith

I think it's nearly not as much to, it's the pricing of the services and it's well as the price of the product. I mean if we can't see a 20% IRR, then it's not worth drilling. And until the service cost come down to that level then that's when it's going to make a sense to drilling and unfortunately we are not quite are looking at.

The service obviously is lagging and it's not there yet. We're relying on the Lewis Group. I mean they live and breathe this stuff every day in South Texas. And they are not seen it yet.

In strengthening in the Appalachian Basin, again, you're just still not seeing submitting, cracking those type of costs have fall to where it makes sense.

Unidentified Analyst

Okay.

Scott Smith

I think, firstly in Appalachia, it probably is going to take minimum of $6. And it probably is close to that same thing in South Texas, unless we really see rig prices collapse and steel on all the rest of it.

Unidentified Analyst

Okay. Thank you.

Scott Smith

You're welcome.

Operator

Thank you. Our next question is a follow-up question from the line of Richard Dearnly with Longport Partners. Please go ahead.

Unidentified Analyst

Well, actually the last answer answered mine as well. Thank you.

Operator

Thank you. (Operator Instructions). And there are no further questions at this time. I would like to turn the conference back over to management for any closing remarks.

Scott Smith

Thanks again everyone for listening in today. Needless to say it's going to be a challenging year for everybody. But again I think we pointed out we are well positioned to execute on our business plan, make our distributions and continue to look for opportunities to increase unitholder value going forward. So thanks again. And we look forward to the next call in May. Thanks.

Operator

Thank you, ladies and gentlemen. That does conclude our conference for today. If you would like to listen to a replay of this discussion, you may dial 303-590-3000 and entering the access code number of 11126437. Again, that telephone number is 303-590-3000 and the access number is 11126437.

Ladies and gentlemen, thank you so much for participating in the Vanguard Natural Resources fourth quarter earnings call. Thank you for your participation. You may now disconnect.

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