Vanguard Natural Resources, LLC Q1 2009 Earnings Call Transcript

| About: Vanguard Natural (VNR)

Vanguard Natural Resources, LLC (NYSE:VNR)

Q1 2009 Earnings Call

May 8, 2009 11:00 am ET


Carol Coale - IR, DRG&E

Scott Smith - President and CEO

Richard Robert - EVP and CFO

Britt Pence - VP of Engineering


Joel Havard - Hilliard Lyons

Steven Black - Jefferies & Company


Ladies and gentlemen, thank you for standing by and welcome to the Vanguard Natural Resources first 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 Friday May 8 of 2009.

I would now like to turn the conference over to Carol Coale. Please go ahead Ma’am.

Carol Coale

Thanks, Britney. Good morning, everyone and welcome to the Vanguard Natural Resources, LLC first quarter 2009 earnings conference call. We appreciate you joining us today. Before I turn the call over to management I have a few items to go over.

If you would like to be on our e-mail distribution list to receive future news releases or if you experience a technical problem and did not get this one this morning, please call us at 713-529-6600. If you'd like to listen to a replay of today’s call, it will be available via webcast by going to the Investor Relations section of the company’s website, at or via recorded into replay until May 15, 2009.

Information was also provided in this morning’s earnings release. Information reported on this call speaks only as of today May 8, 2009. Therefore, you are 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 2008 10-K which is available on the website under the Investor Relations tab or on EDGAR.

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

Scott Smith

Thanks, Carol. Welcome, everyone, and thanks for joining us today. I’m joined here 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 the first quarter results then move on to a brief discussion of operations. Richard will then take you through review the financials and then we’ll open up the line for Q&A.

First of all, our results were in line with expectations as we benefited from the hedging program we put in place last year. In addition, our strategy to preserve capital and suspend our drilling program, given the low commodity price environment, resulted in record high Distributable Cash Flow and distribution coverage in the first quarter.

Our favorable hedge positions on our oil and gas production help to mitigate the volatility of energy prices during the quarter when we saw oil and gas pricing fall to levels not seen since the 2002, 2003 timeframe.

Based on our forecast, we have hedged approximately 100% of our expected gas production for the balance of 2009 at a minimum average price of 869 per MMBtu and 82% of our expected oil production at a minimum average price of just over $89 a barrel. It’s important to remember that a substantial portion of our gas production has a high Btu content. So our reported pricing on Mcf basis will be 15 to 20% higher than the 869 floor price.

Hedge program supports our ability to maintain our distribution payments. As we announced last month on May 15, 2009, the company will pay a first-quarter cash distribution of $0.50 per unit to unitholders of record on April 30th, which is the same distribution that we made for the fourth quarter of 2008. In our press release this morning and the 10-Q we expect to file on Monday, we set out our hedge positions through 2011.

Based on our current drilling plans, we believe we’ve hedged approximately 84% of our expected gas production at a weighted average floor price of 850 per MMBtu; 72% of our expected oil production at a weighted average floor price of just over $87.

Fortunately for all of us in the business are producing oil and gas, it appears we have seen in the bottom and the commodity price markets, as both the oil and natural gas pricing have rallied nicely over the past 30 days.

We hope the markets continue to improve. We are looking for opportunities to layer in additional hedges in the 2011 to 2013 timeframe when we see attractive pricing that is sufficient to ensure our desired cash flow during those periods.

During the first quarter, our average daily production rose 19% to 17,815 million Mcfe from 15,016 Mcfe produced in the first quarter of 2008. This reflects a full quarter contribution from our Permian and South Texas properties that we acquired in 2008.

Looking at our total production, our year-over-year natural gas production rose 25% to 1.14 Bcf and our oil production rose 49%, just little over 77,000 barrels. Sequentially, oil production was 8% higher than the 71,570 barrels we produced in the fourth quarter of 2008. Our gas production was 11% lower, partially reflecting our curtailed drilling program. Including the positive impact of our hedges in the first quarter, we realized a net price of 10.65 per Mcf of natural gas and $70.53 per barrel of crude oil.

In our largest operating area, the Appalachian basin, our oil production in the quarter increased 50% over prior period numbers. However, our natural gas production declined by 7%. The net decline was 3% on Mcfe basis.

During the quarter, our Appalachian operating partner, Vinland Energy, continued to focus their efforts on recompletion of work, connecting previously drilled wells and installing pumping units on wells to enhance oil production. This program has obviously been successful as evidenced by the nice increase we see in oil production in this area.

We'll continue to work with Vinland to identify wells that are candidates to recomplete or workover, with a goal of maximizing the production from existing wells with nominal investment. Together we believe, this the best operating strategy in the current uncertain commodity price environment.

In the Permian, during the quarter, we produce 59 million cubic feet of gas and 60,680 barrels of oil, or approximately 784 BOE per day. In South Texas, we produce 276 Mcf million cubic feet equivalent, or a little less than 3.1 million a day. During this quarter, our production in Permian was negatively affected by one unsuccessful workover. In South Texas, we saw a decrease in volumes as our operating partner, Lewis Energy, elected to forgo processing because of negative processing margins.

Virtually, the market in the NGO markets improved and we have resumed processing this quarter. It should see the benefits in our second quarter results.

In addition, although service and drilling cost have dropped considerably, we and Lewis have elected to defer any additional investment in our PUD inventory in South Texas until commodity prices improved further. Our current forecast includes the drilling of four wells in the second half of 2009. This may change if the gas markets don’t recover to a level that justifies additional drilling.

In summary, although we've seen a nice rally in both the stock market and commodity markets, we are still significantly below levels we saw last year and believe there will be difficult times ahead for those companies with significant exposure to natural gas pricing.

During this quarter, we have seen, what I would characterize as the first wave of situations where properties have hit the market as a result of distress conditions, such as bankruptcies or debt covenant compliance.

We expect this trend to continue as borrowing base redeterminations are concluded and companies find the need to right size their balance sheets to comply with their credit facilities, or elect to monetize select mature assets to fund higher return projects.

In this environment, we’ll continue to look for opportunities to acquire high quality reserves at attractive metrics that would be accretive to near term cash flows and produce stable production volumes to support our distributions in the future.

With that, I am finished and I'll turn the call over to Richard for his financial review.

Richard Robert

Good morning. As Scott mentioned, we are pleased with our first quarter results, while we reported a net loss of 50 million for the quarter compared to a net loss of 15.9 million in the 2008 first quarter.

The recent quarter contain a number of special items, a largest of which was a 63.8 million non-cash impairment charge to our oil and gas assets, which we incurred under our full-cost accounting method.

In addition, we incurred $1.3 million of non-cash unrealized compensation charge related to the fair value of phantom units granted to management pursuant to their employment agreements. Offsetting these charges was a 9.8 million non-cash unrealized net gain in our commodity and interest rate derivative contracts.

Excluding the net impact of these specific non-cash items, our adjusted net income was 5.1 million in the first quarter of 2009, or $0.43 per unit, as compared to the adjusted net income of 4.3 million, or $0.38 per unit, in the first quarter of 2008.

A continued decline in gas prices throughout the quarter required us to take another ceiling test charge related to the write-down of our capitalized natural gas and oil costs under full-cost accounting. Please keep in mind that it is a non-cash charge and it reflects the value of our assets at one point in time.

As I mentioned in a last call, there are some new accounting rules that will allow for the use of an average price instead of a period end price when measuring expected future revenues against our cost-full, but unfortunately the application of the new rule doesn’t go into effect until the end of 2009. Once this rule is adopted, I except you will see fewer of these non-cash impairment charges on the quarterly basis.

Nevertheless, this impairment charge has no impact on our cash flow than we have available for distribution to our unitholders nor do the unrealized losses or gains from our commodity and interest rate hedges have any impact on our Distributable Cash Flow.

Our adjusted EBITDA rose 21% in the 2009 first quarter to 12.7 million compared to the 10.4 million achieved in first quarter of 2008. We generated Distributable Cash Flow of $10 million in the 2009 first quarter, after a 1.3 million in capital expenditures and 1.3 million in interest costs including realized losses on our interest rate derivatives.

This amount of Distributable Cash Flow represents a 43% increase over the $7 million generated in the same period last year and a 67% rise over the $6 million generated in the fourth quarter of 2008.

I have suggested in the past that I believe that Distributable Cash Flow and our resulting distribution coverage ratio should be analyzed on an annual basis as opposed to a quarterly basis. However, this was principally due to the inconsistent timing of capital expenditures. As a result of our current attention to spend less capital, I would expect our Distributable Cash Flow to be more consistent quarter-to-quarter until we resume our drilling program.

Now I would like to take a look at our expenses during the quarter. Our lease operating expenses were a little higher than we wanted increasing by 1.1 million to 3.1 million for the three months ended March 31, 2009 over last year's first quarter.

All in all, it wasn’t that significant in increase when you considered that about 1 million of the 1.1 million increase was related to having the Permian and South Texas acquisitions included in the full 2009 quarter.

Our positive note, we’ve seen a 0.3 million reduction in our production taxes for the three months ended March 31, 2009 as compared to the same period in 2008, because of the drop in gas and oil revenues.

Like segmented to discus the increase in our SG&A, which rose 1.5 million in the recent quarter from the first quarter of 2008, due principally to non-cash stock-based incentive compensation. 2009 first quarter results included a $2.2 million non-cash compensation charge compared to 0.9 million a year ago. A 2.2 million charge this quarter consisted of a 1.3 million charge related to the grant of phantom units on January 1 and $0.9 million, which was the same as last year, was related to the amortization of Common and Class B units as they vest.

In accordance with previously negotiated employment agreements, phantom units were granted to two officers in amount equal to 1% of our units outstanding at January 1, 2009 and the amount paid in either cash or units will equal the appreciation in value of the units, if any, from the date of the grant, which was January 1, until the determination date, which is the end of the year December 31, plus cash distributions paid on the units, less an 8% hurdle rate. The fair value of the phantom units at March 31, 2009 of 1.3 million was determined using a Black Scholes model and will be recalculated at each quarter end until the final value is known at December 31, 2009.

Since our units substantially appreciated the value over the quarter, the expense recognized was significant.

Now I would like to shift the discussion to our leverage and liquidity. At March 31, 2009, our borrowings under our reserve-based credit facility were 136.5 million and our cash on hand was 2.9 million. We had 38.5 million in availability under the facility based on the 175 million borrowing based at that time or in other words, we were 76% drawn net of cash. As of May 5, our indebtedness under facility had declined to 134 million and our cash on hand has increased to 5.4 million.

Unfortunately, our semi-annual borrowing base redetermination has taken longer than expected and therefore I can’t currently provide a specific amount of availability remaining on facility. However, based on my discussions with our lead bank and the borrowing base recommendation that they’ve recently made to the other participating banks, we do anticipate a reduction to the borrowing base, which would put our drawn percentage net of cash somewhere in the low 80% range.

I expect the redetermination process will be completed in the next couple of weeks. We will issue our press release at that time to confirm the final borrowing base amount.

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

Question-and-Answer Session


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

Joel Havard - Hilliard Lyons

Could you go back over the pace of activity in the field. I was recalling I believe that this was kind of an all workover season. Could you touch on the three regions individually?

Scott Smith

Britt, I'll let you kind of address this.

Britt Pence

Yeah, in the first quarter, we have not done any drilling. We completed or we did some major capital workovers in the Permian Basin. Few of them have been successful, where we increase the productions on two wells about 40 barrels a day to 60 barrels a day.

We had one well that was an unsuccessful fishing job at the Permian Basin, where we lost about 20 barrels a day. So there has been some capital spin on that kind of work, that kind of give you a flavor for what’s going on in Permian Basin. Then, we haven’t spend any significant capital in South Texas.

Appalachian, we are continuing to spend some capital as we finish up on the completion of some new wells and some small type workovers as we clean wells out thinks like that. So that’s what we've done so far. We still have some recompletion ideas in the Permian Basin as well as in Appalachian. Then later in the year, we have budgeted…

Richard Robert

Four wells.

Britt Pence

…four wells in South Texas. With the gas price increase that we’ve seen recently, we ran some numbers and it's starting to look like those might became favorable. We may want to do that later this year.

Joel Havard - Hilliard Lyons

I'll kind of mix a double follow-up here if you don’t mind. Let me review quickly. So no new wells in Q1, not really planning for Q2, let's say Q3, you have got four on the books in the second half.

Scott Smith

That’s four gross wells not…

Britt Pence


Scott Smith

…four net. It's only two net wells.

Joel Havard - Hilliard Lyons

Two net, okay. All right. Good. Actually, that’s what I had originally. Should we anticipate anything new in Appalachian this year, yet?

Scott Smith

With respect to drilling, no.

Joel Havard - Hilliard Lyons

Okay. Again, pace of workover sort of act is paced then, I don’t know, call this 5 or 10, what you are describing.

Richard Robert


Scott Smith

I mean just historically, we spend $150,000 amount a month or something like that. Again, its rod jobs, its tubing jobs, its putting in pumping unit, and again a lot of it is been associated with our oil production, which again has more than double. So that’s money well spent, especially, now with the wells almost $60. We encouraged those projects.


Thank you. Our next question is from the line of Steven Black with Jefferies & Company. Please go ahead.

Steven Black - Jefferies & Company

I think you mentioned about seeing properties coming to the market and so forth. I was wondering, are you seeing those across the Board? Is that regional nature where you are seeing more of that? What kind of properties or what locations might you be interested in, if they where to come to market?

Scott Smith

Well, there is a lot of properties in the market. We've seen Appalachian, Mid-Continents, South Texas, California, I mean it's a broad base, distressed. It's not geographic, it's everywhere. I mean we're looking at properties that fit the profile of what we're looking for, more matured properties with decent, modest decline curves, some degree of upside, good correlation to the commodity markets, ability to hedge the bases.

Richard Robert

Predictable operating costs.

Scott Smith

Predictable operating costs and...

Steven Black - Jefferies & Company


Scott Smith

We are not necessarily just looking at things in one particular geographic area. I mean in our business model, you have to be opportunistic. Again, we have to be creative if we are going to try to make a transaction happen. So, again, we're seeing things, again, all over. So we are not really focusing on one any particular area.

Steven Black - Jefferies & Company

Would you say that you might have a more of a bias towards areas that you're already operating in versus stepping out into a whole new area?

Scott Smith

I mean obviously, I think our Permian Basin, since we have a platform there, if we could find something that would fit, although that’s been the area that we haven’t seen any kind of distress deals yet. So far, the things that we’ve seen are Mid-Continent and Appalachian based, for one circumstance or another.

Richard Robert

Generally speaking, yeah, I mean, certainly the areas that we operate in, we know best. So, it would be preferable to add on to those positions.

Britt Pence

We have looked at two Permian basin deals this quarter. I mean, they are out there.

Scott Smith

We're very, very competitive, especially if it's primarily oil-based and you have seen the oil prices come back substantially.

Steven Black - Jefferies & Company


Scott Smith

Much more so than the gas.


Thank you. (Operator Instructions). There are no further questions in the queue at this time. I would like to turn the call back to management at this time.

Scott Smith

Again, thanks, everybody for joining us today. We look forward to talking to you again in August. Enjoy your Friday and have a great weekend. Thanks.


Thank you. Ladies and gentlemen, this concludes the Vanguard Natural Resources first quarter earnings conference call.

This conference will be available for replay after 1:00 p.m. Eastern Standard Time today through May 22, 2009 at midnight Eastern Standard Time. You may access the replay system at anytime by dialing 1-303-590-3030 or 1-800-406-7325 and entering the access code of 4058441 followed by the pound sign.

Thank you for your participation. You may now disconnect.

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