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LRR Energy (NYSE:LRE)

Q1 2013 Earnings Call

May 2, 2013 10:00 am ET

Executives

Jaime R. Casas – Vice President, Chief Financial Officer and Secretary

Eric D. Mullins – Co-Chief Executive Officer and Chairman

Charles W. Adcock – Co-Chief Executive Officer and Director

C. Timothy Miller – Vice President and Chief Operating Officer

Analysts

Kevin Smith – Raymond James

Michael Peterson – MLV & Co.,

Operator

Good morning and welcome to the 2013 First Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks there will be a question-and-answer session. (Operator Instructions)

Thank you. I’d now hand today’s call over to CFO, Mr. Jaime Casas. Please go ahead, sir.

Jaime R. Casas

Thanks operator and good afternoon everyone. Welcome to LRR Energy’s first quarter 2013 earnings conference call. Also presenting this morning will be our Co-Chief Executive Officers, Eric Mullins and Charlie Adcock; our Chief Operating Officer, Tim Miller; Chris Butta, our Chief Engineer is also with us and available for questions.

During the course of the call management will make forward-looking statements about LRE. Forward looking statements are based on current expectations and relate to future business and financial performance. Actual results and future events could differ materially from those anticipated in such statements. Forward looking statements involve certain risk and uncertainties and may not prove to be accurate. These risks and uncertainties are included in our Risk Factor section of our 2012 Form 10-K on file with the Securities and Exchange Commission.

Addition, during the course of today’s discussion, management will refer to adjusted EBITDA, distributable cash flow and distribution coverage as important metrics for evaluating LRE’s performance. Please note these metrics are non-GAAP financial measures which are reconciled to the most directly comparable GAAP measures in the earnings press release we issued yesterday.

I will now turn the call over to Eric.

Eric D. Mullins

Thanks Jaime and good afternoon everyone. We appreciate all you joining us for our earnings conference call. Charlie, Tim and Jaime will discuss our first quarter results in detail shortly but in summary we are disappointed at our first quarter operational and financial results, which were lower than our expectations. We reported first quarter 2013 average production of 5900 barrel of oil equivalents per day, which is below our internal forecast.

Average daily net production was approximately 500 barrel of oil equivalents per day lower due to third-party events; sever weather and development project delays. Tim will provide specific details on certain items in a moment. Roughly half of the 500 barrel of oil equivalents per day impacted during the quarter are back online today. Our estimated average net production for April 2013 was approximately 6500 barrel of oil equivalents per day.

For the quarter, adjusted EBITDA was $14.9 million, distributable cash flow was $8 million and our total unit distribution coverage was 0.63 times. In addition to lower than expected production adjusted EBTIDA, distributable cash flow and distribution coverage were negatively impacted by a higher Midland to Cushing oil differential, acceleration of workover activity and the issuance of common units during the quarter. We will discuss each of these items in detail shortly.

Before I turn the call over Charlie, I would like to highlight a few reason events. On April 1st, we closed our previously announced acquisition of oil and natural gas properties in the Mid-Continent region in Oklahoma and crude oil hedges from our sponsor, Lime Rock Resources for a purchase price of $38.2 million.

On March 22nd, we’ve raised approximately $60 million of net proceeds from the sale of $3.7 million common units. The net proceeds were used to fund our April acquisition and to pay down a portion of our credit facility. On April 17, we announced that our Board of Directors declared an increased cash distribution for the first quarter of 2013 of $0.4825 per outstanding unit, or $1.93 on an annualized basis. The distribution will be paid on May 15th. Notwithstanding our disappointing first quarter results, we are excited about our progress thus far into the second quarter. Production has recovered well with current rates in the 6,500 barrel of oil equivalents per day range and with our Midland to Cushing differential locked in at attractive levels due to our hedging.

With that, I’ll turn the call over to Charlie.

Charles W. Adcock

Thanks, Eric. I will review our operating results for the first quarter. Please note that everything that I will discuss pertains to actual first quarter results and does not include the effect of our recently-closed April acquisition. We’ve reported total net production of 531,000 Boe for the quarter. Our production was roughly 55% natural gas, 31% oil and 14% natural gas liquids for the quarter. Lease operating and workover expenses for the quarter were $6.2 million or $11.71 per Boe. LOE was impacted by higher than expected workover expenses.

We incurred $1.1 million of workover expenses during the quarter, which equals roughly 50% of our budgeted workover expenses for the year. As a result, we anticipate LOE cost will be lower for the remainder of the year. For the year, our revised LOE per Boe guidance $10.50 to $11 even. Production and ad valorem taxes for the quarter were $1.7 million or $3.19 per Boe and represented 7.8% of gross revenues.

I will now hand the call over to Tim Miller, who will provide more color on our operations for the period.

C. Timothy Miller

Thanks, Charlie. We experienced significant downtime during the first quarter that resulted in production of approximately 5,900 Boe per day. At our Red Lake field, our third party gas processor required us to flare approximately 75 Boe per day to plant and compressor limitations and downtime during the quarter. We’re currently flaring approximately 60 Boe per day, due to plant compression capacity limits and we expect to remain at this level into the gas compression, the plant is expanded early in the first quarter 2013. Also at Red Lake delays in our recompletion program resulted in lower production of approximately 42 Boe per day. This program is expected to be back on schedule by the end of the second quarter.

As result of a winter blizzard, our Putnam field experienced production loss of roughly 67 Boe per day for the quarter. The Putnam field has resumed normal operations. Production at our Pecos Slope field was curtailed by approximately 300 Boe per day during the quarter of which 167 Boe per day was due to previously disclosed high nitrogen content and a 133 Boe per day was due to a compressor failure. The third-party compressor resumed service on February 18. The current nitrogen content curtailment remains at approximately 1 million per day or 167 Boe per day and it expects to continue until the field-wide nitrogen rejection facility is installed in late 2013.

In tubing failure a well at our New Years Ridge field resulting in loss production of approximately 25 Boe per day during the quarter. The well repaired and is now back into service, but still cleaning up. Several other significant expense workovers were conducted to quickly return wells to production during the quarter. Overall these issues resulted in loss production of approximately 500 Boe per day and workover cost were about $800,000 higher than forecast for the quarter.

After a five month pause in drilling activity, we recommenced drilling operations in our Red Lake field in January and are beginning to see the production response. Specifically during the quarter, we drilled nine Red Lake wells and completed six of the wells, two of which were completed in late March. We also recompleted three Red Lake wells. Regarding non-operated activity, we participated in one Wolfberry well in Martin County, Texas that was not completed during the quarter. Initial results for the first quarter activity at Red Lake are meeting or exceeding our expectations and our current production rate has rebounded to approximately 6500 Boe per day.

During the second quarter, we plan to drill five wells and recomplete eight additional wells in the Red Lake area. We also plan to refrac one Red Lake well. We’re continuing to expand our Red Lake SWD system to increase capacity from 5500 to over 7000 barrels of water per day. Finally, we plan to participate in two additional non-operated Wolfberry wells and one non-operated well in our East Velma field. Our new production guidance for full year 2013 is 6250 to 6500 Boe per day. We’re also revising our planned 2013 capital expenditures to $30 million of which $20.3 million is estimated maintenance capital. The remaining $9.7 million of estimated expenditures are being invested in production growth and cost cutting projects.

I will now turn the call back to Jaime, who will walk you through our financial results.

Jaime R. Casas

Thanks, Tim. For the quarter, adjusted EBITDA was $14.9 million, distributable cash flow was $8 million and our total unit distribution coverage was 0.63 times. Excluding our subordinated units, our unit distribution coverage was 0.85 times. In addition to lower realized production, our financial results for the quarter were materially impacted by our higher Midland to Cushing oil differential. The differential averaged $7.88 per barrel for the quarter compared to the full year 2011 and 2012 average of $2.30.

We estimate the impact of the higher differential compared to the 2011 and 2012 average. Adjusted EBTIDA and distributable cash flow for the quarter was approximately $800,000. Due to the recent significant volatility of the differential, we executed basis swaps in February for March 2013 through December 2014 on roughly 85% of expected PDP production that we expect will be impacted by the differential. The average hedge prices are $1.25 and $1 per barrel for 2013 and 2014 respectively.

Our distribution coverage was further impacted by the timing of our March equity offering and the closing of our April acquisition. The majority of the net proceeds of the March equity offering were used to fund the April acquisition. Because the equity offering closed prior to the first quarter distribution record date, we will pay distribution to roughly $1.8 million on the units that were issued in the March equity offering. Since the April acquisition closed on April 1st, our first quarter financial results did not include any results related to the acquisition.

Next, I would like to provide an update on our current commodity hedge position. Assuming the midpoint of our revised 2013 production guidance has held flat through 2017. Our total estimated production is 94% hedged for the remainder of 2013, 73% in 2014, 57% in 2015, 56% in 2016 and 45% in 2017. Weighted average prices during the period are $92.85 per barrel of oil and $5.06 per MMBtu of natural gas. More specific details of our hedge position are disclosed in the earnings press release, we issued yesterday.

As Charlie and Tim mentioned, we have revised our 2013 public guidance. Take into account, our Q1 results and our recently closed acquisition, we now expect production that average 6250 to 6550 Boe per day and LOE to average between $10.50 and $11 per Boe. Total capital expenditures for 2013 are now expected to be $30 million.

I’d like to close with a few comments on our balance sheet. As mentioned in March, we have raised approximately $60 million from the sale of 3.7 million common units. The net proceeds were used to fund our April acquisition and to pay down a portion of our credit facility. Our borrowing base under our revolving credit facility was recently reaffirmed at $250 million. As of today, we have $185 million of outstanding borrowings under the credit facility and $50 million of outstanding borrowings under our term loan facility. We currently have $65 million of available borrowing capacity under our credit facility, which we believe provides ample financial flexibility to execute our 2013 capital program and distribution strategy.

Operator that concludes our formal remarks, you can now open the lines for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Kevin Smith.

Kevin Smith – Raymond James

Hi, good morning, gentlemen.

Jaime R. Casas

Good morning, Kevin.

Charles W. Adcock

Good morning, Kevin.

Kevin Smith – Raymond James

Walk me through the constraints at Red Lake. As I’m thinking about it, the majority of your drilling activity is there. Do you expect this to be a problem that we should see going forward just as you continue to grow liquids volumes and associated gas?

Charles W. Adcock

Kevin, this is Charlie. Let me do a little bit of a macro take on this first and then I can let Tim jump in on the details. When you think about the Permian right now, I think it’s sort of pretty obvious to everyone that that’s one of the harsh regions in the country, minus the shale plays and everything is running beyond the capacity. I mean all these plants, the pipelines, the trucking systems, and this is some we filed on a daily basis along with a lot of our peers, our competitors, however you want to put them in the box. We’re on the phone almost on a daily basis to Frontier and DCP as well as our haulers. And what’s ultimately going to happen and I think we all know this is a lot of these constrains are going to be alleviated which will provide more takeaway capacity and more importantly fewer these shut-ins.

The problem you have especially when these plans are running at over 100% capacity, things break. We can’t predict that. They can’t predict it. And so it’s struggling. It’s been very, very frustrating to us. I know it’s been frustrating to you guys on the analyst side as well as our investors, but we’re fighting on a daily basis, but we do believe and I think the industry as a whole believes it, a lot of this is going to start improving especially starting kind of late or third quarter of this year going through next year. So like said it’s a constant daily battle and we’re in the trenches here, along with, like I said, we know that Concho is dealing with is and Legacy and Apache and all of these guys. We’re all trying to work together and make this as livable as possible.

That’s kind of the macro picture. I’ll let Tim kind of address more of the direct Red Lake issues.

C. Timothy Miller

Yeah, Kevin, this is Tim. On the Red Lake issues, specifically, we’re sell our gas there to Frontier field services. We’re projecting going forward till the first part of the fourth quarter that we’re going to see this 60 Boe per day curtailment due to their compression capacity at their plant, where we’ve been taking with them extensively. They are planning to this, the second compression expansion project they’ve done in two years, they‘re going to be doing another one, which should be online by first part of fourth quarter.

We’re continuing to drill. We’ve seen a lot better improvement, a lot of improvement in the oil hauling takeaway and we’ve also converted a couple of our properties where oiled lined were nearby to lack sales. So on that end of it, we haven’t seen the disruptions that we saw last year. We’re thinking, projecting that the same thing will occur with gas as we move into late 2013.

Kevin Smith – Raymond James

Okay. So you don’t see additional curtailments above and beyond the 60 as you bring on new wells in Red Lake? Is that the big takeaway and hopefully that 60 will be back online sometime in late 2013?

C. Timothy Miller

Yes. The only thing we can’t predict is there are going to be another big, we had one big shut-in the first quarter of the entire plant shutdown for six days. We could see some of that. We just can’t really predict when that could occur.

Kevin Smith – Raymond James

Got you. And then I guess my next question would heavy workover expense in Q1 and then obviously you’ve got the new properties rolling in 2Q, but are you expecting on a raw dollar amount LOEs essentially to be flat to maybe even down a little bit?

C. Timothy Miller

Well, from the first quarter, yes, because the production is going to be up, I mean up higher than it was in the first quarter on the dollar per Boe basis, going forward to the year it’s going to be down on a Boe basis. We forecast our expense workovers just kind of a blended basis throughout the year, equally divided by quarter. But again, we can’t predict when those well players are going to occur and then we’ll just so happened we had quite a few occur in the first quarter. We have every reason to believe that the overall basis for the year that will be about the same as they have been in prior years which we’re forecasting came from.

Kevin Smith – Raymond James

Got you. And then lastly and I’ll jump, can you talk about how your subordination structure helps protect your distribution and whether or not the subs accrue arrears if you would like to only pay the common shareholders?

Jaime R. Casas

Yeah. Kevin, it’s Jamie. Today, approximately 25% of our total units outstanding are subordinated all are held by Fund I to Lime Rock Resources. And so, we have the ability not to pay those distributions. For example, in this specific order, if we have not paid those distributions to the subordinate units, our coverage would have been 0.85 times. And so, we do have that structure, obviously, the purpose of that is to protect the distributions to the common unit holders.

Kevin Smith – Raymond James

Gotcha. All right. Thank you very much.

Operator

Your next question comes from the line of Michael Peterson.

Michael Peterson – MLV & Co.,

Hi, good morning, everyone.

Eric D. Mullins

Good morning.

Michael Peterson – MLV & Co.,

Charlie, I have a follow-up question. I appreciate the detail you provided on the accelerated workover activity and the associated LOE impacts both for first quarter, as well as balance of the year. My question regards the catalyst for the increase on full-year LOE guidance by $0.50 a barrel. Is this a function of cost inflation? What insight might you be able to share with us?

C. Timothy Miller

Yes, this is Tim Miller. The biggest reason for that is the acquisition we did at East Velma, acquisition effective April 1st that acquisition had a higher per unit LOEs in our current portfolio, so that should grow some of that increase or most of that increase, and just the lower production that we did have in the first quarter, so those two factors where the reason for that guidance increase.

Michael Peterson – MLV & Co.,

Okay. Thank you, Tim. A follow-up to Kevin's question a minute ago, additional insight, if you can reconcile your accelerated workover activity with takeaway constraints, I suspect the answer may be specific wells, specific parts of the system. Is that a correct assumption, or how do you reconcile those big picture for those of us that can’t see some of the specific operating issues that you’re facing?

C. Timothy Miller

Yeah, the term accelerated for those workover expenses is probably not the right term. We did intentionally accelerate those. Those are well failures that that we had to address to get keep production up. And yes all the major ones were outside of the Red Lake area.

Michael Peterson – MLV & Co.,

Okay, okay thanks for that, Tim and those are the only two questions that I have. I appreciate your help.

C. Timothy Miller

Okay.

Operator

Your next question comes from the line of [Punet Pradesh].

Unidentified Analyst

Hi, good morning, just two quick questions for you. I guess the first, I was just wondering why the proceeds from the equity offering weren’t used to pay down some of the term loan. I guess what’s the thinking there, and do you expect to pay that down sometime this year, or how should we think about that?

C. Timothy Miller

Well, the term loan is in place. We just decided that we wanted to keep it in place at least for the time being, paying down the revolver. We can always go back and pull that back down. It maintains our liquidity for us, which we were interested in doing. So, we look at that every quarter but for now it keeps our liquidity very attractive and very comfortable. And the term loan even with the higher interest rates still very attractive rate and we certainly don’t mind keeping it in place for at least for the time being.

Unidentified Analyst

Okay. And if I could ask, just to get an update on fund raising at the sponsor and also as it relates to the MLP, whether you expect this to decrease LRE’s share of G&A expense at all?

C. Timothy Miller

The first part of your question, you’re right, we are fund raising for our third fund. We have had two closings so far. We’ve closed on just over a half of what our target is. Our target was to raise $600 million. We’ve closed on $335 million. The fund raising process is going very well. We have another closing coming up in about two weeks. And then our expectation is we would have one additional and probably final close coming up at the end of June. And our expectation is, right now, we’re oversubscribed in terms of what our target is for $600 million. We have quite a few investors who are completing their work. So we do expect to get to our target and actually beyond our target and probably we’ll be in a position where we have to allocate people back.

So that fund raising process is going very well. I think you know that we use about 50% debt to win our acquisition. So that will give us at or above $1.2 billion of additional acquisition capacity at the sponsor. Our investment period is five years. So we’ll put that capital workover five years and just increase the inventory and the property base that potentially becomes available for sales over time and potential drop-down transactions for LRR Energy. Now, the second part of your question, I didn’t quite understand as it related to the G&A.

Unidentified Analyst

Yes, I was just wondering with the pool getting bigger at the parent, whether that’s going to impact at all the G&A expense that the MLP incurs?

Jaime R. Casas

Yeah, Punet, it is Jaime. On that specific question, I think initially you won’t see much of reduction, because Fund III is going get closed, is going to take a while for it to get ramped up in terms of people spending time looking at deals. But once that happens and – you know, they bring assets and deals under management. And we’re spending more time or they’re spending more time operating those assets. Over time, yes, I would expect LRE to get a specific G&A benefit from having Fund III raised – that capital put to work given the size of it.

Unidentified Analyst

Okay great thank you.

Operator

(Operator Instructions) Your next question comes from the line of Michael Gayden.

Unidentified Analyst

Good morning, gentlemen.

Eric D. Mullins

Good morning

Unidentified Analyst

If I could please ask – are there any notable items that we should think about as far as production trajectory quarter-to-quarter over the balance of the year?

Eric D. Mullins

Michael, this is Eric. Obviously we have some volatility as it relates to that but we certainly are confident that we’re going to meet our guidance targets for production over the course of 2013. The little of flaring that Tim’s spoke about is built into that in those assumptions. All the things that we have talked about, we do have some downtime built-in to that. So, and we have a range around what we expect to do. So we have built that into what our expectations are for the year.

Unidentified Analyst

Great. Thank you. And can I lastly ask about LOE as well? Accepting the higher expense this quarter from greater-than-expected workovers, you talked about some saltwater disposal that you were working on in the Permian. Are there other operational items that you are currently tackling now that we could see bring some benefit to LOE over the balance of the year or into next?

C. Timothy Miller

This is Tim Miller, again. We are looking at a couple of compressor projects and attempting to get into lower pressure lines in a couple of areas outside of the Red Lake area, those could reduce our compression cost in specifically at our Putnam field and New Years Ridge field. It’s not going to be major, but it could have some impact both on LOE and assistant production.

Unidentified Analyst

Great. Thank you. I'll hop back in the queue.

Operator

Thank you. At this time there are no further questions.

Eric D. Mullins

Okay. Thank you. I really appreciate everybody’s time and your participation on the call, and will be in touch with you soon. Thanks again.

Operator

This concludes the 2013 first quarter earnings conference call. Thank you for participating. You may now disconnect.

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