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Legacy Reserves LP (NASDAQ:LGCY)

Q1 2013 Earnings Conference Call

May 7, 2013 10:00 a.m. ET

Executives

Dan Westcott – Chief Financial Officer

Cary Brown – Chief Executive Officer

Paul Horne – Chief Operating Officer

Kyle McGraw – Chief Development Officer

Micah Foster – Chief Accounting Officer

Analysts

Kevin Smith – Raymond James & Associates

Ethan Bellamy – Robert W. Baird

Michael Peterson – MLV & Co.

Praneeth Satish – Wells Fargo

Abhishek Sinha – Bank of America

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the first-quarter 2013 for Legacy Reserves LP. At this time, all participants are in a listen only mode. Following the call there will be a question-and-answer session. As a reminder this call is being recorded today May 7, 2013.

I will now turn the conference over to Dan Westcott, Legacy's Chief Financial Officer.

Dan Westcott

Good morning. I appreciate everyone in dialing to Legacy's Q1 2013 earnings call.

Before we begin, we like to remind everybody that during the course of this call, legacy Management will make certain statements concerning future performance of Legacy and other statements that will be forward-looking statements as defined by Securities laws.

These statements reflect our current views with regard to future events and are subject to various risk, uncertainties and assumptions. Actual results may materially differ from those discussed in these forward-looking statements and you should refer to the additional information contained in Legacy 10-Q, which we released tomorrow, May 8th, as well as subsequent reports as filed with the Securities and Exchange Commission.

For those of you unfamiliar with Legacy, we're a matched limited partnership headquartered in Midland, Texas, focused on the acquisition and development of and natural gas properties primarily in Permian basin, mid-town and Rocky Mountain region WS(ph).

This morning Cary Brown, Legacy's CEO, and I will provide commentary on the quarter and the year. We'll then open the call for Q&A to the entire Management team.

At this time, I'd like to turn the call over to Cary.

Cary Brown

Thanks, Dan, and we appreciate our friends and unit holders joining us today.

We're very pleased with our first-quarter results. After purchasing the Concho properties for $500 million at the end of December, our first quarter was focused on the integration of those assets.

This ongoing integration is going very smoothly, as we met our first-quarter production goal for the Concho assets, despite third-party infrastructure issues in the Permian that curtailed some of our production.

I couldn't be more pleased with the great work our employees have done this quarter. We purchased nearly 1600 gross producing wells, and have been incredibly busy getting those wells under our control and within our systems. We continue to go through the well list methodically assessing current performance and seeing what we can do to economically enhance these wells.

The game is not a sprint, it's a marathon, but we're off to a great start.

In addition to our integration, I'm impressed with our quarterly results. Despite record Permian and higher Rockies crude oil differentials as well as constrained natural gas and NGL production in the Permian basin and Texas Panhandle, we posted record production of over 19,700 barrels a day and adjusted EBITDA of $64.4 million, both of which are up 25% relative to last quarter.

We weren't alone in seeing production curtailments. Industry-wide, Permian Basin production has increased from less than 1 million barrels a day and 4.5 BCF a day in January 2011 to about 1.25 million barrels a day and 4.8 BCF a day currently.

It's fun having 75% of our assets in the hottest basin in the country, but as we see takeaway capacity constraints, there are some challenges to this growth.

The good news is there's tremendous amount of third-party capital commitments by midstream players, and we're seeing these infrastructure issues being addressed.

As we look forward, we're seeing great opportunities within our newly expanded asset base. Our Wolfberry drilling is going well as our other development opportunities, most of which are in the Permian.

We're also continuing to actively pursue acquisitions. Since the beginning of the year, we made four small bolt-on acquisitions in the Permian for approximately $12 million, all of which were completed at attractive metrics.

We also continue to evaluate acquisitions of various sizes and are pleased with our current pipeline in all of our core areas. You never know about acquisitions whether they're going to come or not, but I’m happy with what I'm seeing in this area.

Based on our first quarter results and our promising outlook, we increased our distribution to $0.575 a unit. This marks our 10th consecutive quarterly increase, an accomplishment of which we’re very proud of.

In closing, I just want to say I'm really blessed to be part of a great team that's putting together these results.

We've got a great group of employees, and I think they've done just a fantastic job of growing our company by about a third in terms of production and meeting their numbers and this first quarter, so it's been a great result.

And with that, I'll turn it over to Dan to talk a few more specifics about the quarter.

Dan Westcott

Thanks, Cary. As Cary mentioned, we had a great quarter. We generated a record production of 19,711 barrels a day, EBITDA is $64.4 million, and distributable cash flow per unit of $0.61 covering our $0.575 distribution by 1.06 times.

Our differential support this quarter, driven by Midland-to-Cushing crude oil price spread widening to $7.70, and a Rockies crude oil differential averaging over $22 a barrel.

We've seen Midland-to-Cushing differentials narrow considerably lately, but are well aware of the tight capacity constraints in the Permian, and are pleased to have 8,000 barrels per day hedged at $1.47 for Q2 through Q4.

As noted in our earnings release, our natural gas price realizations were lower this quarter. This was driven by significant infrastructure issues in the Permian, as more of our wet natural gas volumes were constrained, thereby reducing the amount of pricing uplift we normally receive over Henry Hub.

Within our daily operations, we’re pleased that our LOE was down 7% to $18.26 per BOE from $19.59 per BOE last quarter. As the added Concho properties, our lower cost per BOE, and we had less of the one-time work over expenses that we've talked about in the last two quarters.

G&A, excluding LTIP expense for the quarter was $5.3 million.

From a personnel perspective, we've hired all the necessary field employees to manage the Concho assets, and we continue to recruit additional employees to help us more efficiently manage our now larger asset base. We expect our G&A to increase somewhat in subsequent quarters.

Cary previously mentioned that we're continuing our acquisition pursuits. From a financial standpoint; we're very well positioned to do so. Our balance sheet is in better shape than ever, our current 20-member bank group recently reaffirmed our $800 million volume base, and today, we have $325 million of availability. In addition, our $300 million 8% notes have traded very nicely and currently yielding about 6.7%, which provides another sensible financing source.

In conclusion, we're pleased with our first quarter results and are excited about our Outlook. We plan to file our 10-Q tomorrow and encourage everybody to read the risk factors and other detailed disclosures.

At this time, Cary and I, as well as the other management teams and other members of our senior management would like to take questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from the line of Ethan Bellamy with Baird. Your line is open.

Ethan Bellamy – Robert W. Baird

Hi guys, good morning. What's going on in the Cline, Carry, and with FireWheel specifically?

Cary Brown

I will let Kyle -- well, I will also about that one. They're drilling some wells. We've got– the early results are definitely got oil. It's not a problem making oil; it's a matter of how to complete them effectively.

We've got three wells. I'd say one is okay. One is not very good. And then, one is pretty good.

So, it's early to know those results, but they're – technically, they're pretty encouraged with what they're seeing and – but it's going to be a challenge to figure that one out to get a lot of running room, but you've got to figure out how to complete and where to actually land that lateral.

Ethan Bellamy – Robert W. Baird

So, it's the– we're not quite at the point where we can declare it five times the Eagleford yet?

Cary Brown

No, we are not.

Ethan Bellamy – Robert W. Baird

Okay, good. Your NGL realizations continue to be excellent relative to your peers. Where is that strength coming from?

Dan Westcott

You know– Ethan, this is Dan. Our NGL realizations are primarily out of the Mid-Con. When we – the NGLs we sell in the Permian are sold within our natural gas stream.

So, that's why we saw a significant reduction in the dollar per MCF realization, but the NGLs that we report separately are primarily out of Panhandle and Oklahoma.

Ethan Bellamy – Robert W. Baird

I mean is that risk coming in favor or something? I just– I mean, there’s like a $20 delta to some of your peers. I'm just trying to understand.

Cary Brown

Yes. But those are very heavy relative to Permian NGLs.

Ethan Bellamy – Robert W. Baird

Got it. Okay. Thanks.

Operator

Our next question comes from the line of Kevin Smith with Raymond James. And your line is open.

Cary Brown

Good morning, Kevin.

Kevin Smith – Raymond James & Associates

Nice results. Happy to see the Concho acquisition integrations going so smoothly.

Dan Westcott

Thank you.

Cary Brown

Thank you.

Kevin Smith – Raymond James & Associates

So, I guess in that line, now that you've got several months under your belt, any change in –how do you feel about production guidance? I think you, I guess, picked it right at the beginning?

Dan Westcott

We do feel like we did a good job with our guidance. We – you'll notice in our reports, we have not updated that. We feel like our current guidance remains in effect. And so that's – I guess is the best we could say on that one.

Kevin Smith – Raymond James & Associates

Got you. Any changes in thought of the Lower Abo play? I know you're going to – you're supposed to take a look at it, I guess, since the beginning of the year. Any, I guess, chance to mess around with it this year?

Paul Horne

Yes, Kevin. This is Paul Horne. We have looked at the Abo a good bit. You know that – we really have got two pieces of Abo in the Concho acquisition – one, the core area where the PDP existing production came from. There are some pud opportunities there that we believe we will develop.

We have not moved those up into 2013 at this point, but we definitely believe there's some opportunities there that still fit our model and that we will likely drill.

There was also a good bit of acreage through the North and East of that core area, which I believe someone will want to drill. I'm not sure that that will fit in an MLP model.

It's a little more exploratory in nature, so I would anticipate that we would probably look for either a farm out or a partner-type arrangement that would take a look at that more risky acreage, kind of where we're at today, Kevin.

Kevin Smith – Raymond James & Associates

Got you. And then lastly...?

Cary Brown

Kevin, let me give a little more color on that. As you – as we told you guys early, there's some flush production coming out of Abo that we're not going to chase. And so, I would expect a little bit of decline, not major, but I'm not expecting to be able to chase that peak production that we had in the first quarter.

Kevin Smith – Raymond James & Associates

Okay. That makes sense. Are you guys pretty straight in an non-op horizontal Wolfcamp wells? I know there's a ton of activity right around your acreage.

Kyle McGraw

Yes, Kevin. This is Kyle McGraw. We have some proposals right now; we are not currently participating in any, but yes, there's– we're near pioneering some of that. There's some discussions right now about some acreage we have and how we might could either trade or share with them or participate at some level.

So, we're watching some of that activity that sure is enjoyable from the New York OGIS requiring discussion about that, and we are looking across the finish line to see what's happening.

Cary Brown

With our historical Spraberry footprint and our Wolfberry footprint, we've got a lot of that acreage, and looking forward to seeing how that develops, because that could be a real driver resource for us in the future if it looks like what everybody's talking about.

Kevin Smith - Raymond James & Associates

Got you. You're still pretty comfortable with your CapEx guidance?

Cary Brown

Yes.

Kevin Smith – Raymond James & Associates

Okay. All right. That's all I had. Thanks.

Paul Horne

Thanks, Kevin.

Operator

(Operator Instructions). Our next question comes from the line of Michael Peterson with MLV & Co. Your line is open.

Michael Peterson – MLV & Co.

Hey. Good morning, gentlemen.

Cary Brown

Good morning, Michael

Dan Westcott

Good morning, Michael

Michael Peterson – MLV & Co.

Paul, my first question is for you, Sir. Integration of the Concho acquisition appears to have been a success. If you were to repeat the process knowing what you know now, are there any notable items you would do differently?

Paul Horne

Well, I hadn't done a postmortem. I've been in the process of this one. So, off the top of my head, immediately, Mike, I would say no. We're thrilled with the way the integration is going.

As you know and as we had discussed, we had a very short period of time to take over operations of those assets closing on December 20th and taking over on January 1, but I cannot tell you what a phenomenal job the operations folks did in hiring all of the field employees necessary to manage those assets.

They were on the ground working for Legacy on January 1st. We're thrilled with the new employees that we've brought in. And, obviously, the results show that they were a great addition and knew what they were doing and plugged into our team well, so very pleased there.

Ask me that question in six months, and I'll circle back with you. But as of today, no, I don't know of anything that we would do differently to be in this place.

Michael Peterson – MLV & Co.

Okay. That's helpful. I may very well ask you in six months, and I may be asking you about a different acquisition altogether in six months, so hence the question.

DD&A expenses during the period approximated $23.50, a little bit higher than I expected. Are those results reflective of a normalized run rate or what would you say in terms of going forward with the new portfolio?

Micah Foster

Michael, this is Micah Foster; Chief Accounting Officer.

Michael Peterson – MLV & Co.

Hey, Micah.

Micah Foster

No. Those rates were a little higher with Concho acquisition in a large well count. We had a large ARO liability and also a corresponding ARO asset that came on in those depletion rates early on with a number of shut-in wells that had kind of stuff. Those get depleted a little quicker in a normal run rate. So, I would anticipate in the future quarters for that rate to come down.

Michael Peterson – MLV & Co.

Come down by a $1 or $2. Is it 10% high? Can you give me any bit of a tolerance? I mean, previous to the integration, we were kind of at the $16, $17, $18 range.

Micah Foster

Yes. As you add these properties at kind of higher costs, depletion rate is a little bit higher, but I would say 10% is probably a reasonable number.

Michael Peterson – MLV & Co.

Okay, okay. That's helpful. Lastly, gentlemen, can you give us a sense in terms of the infrastructure constraints; how much volume you had available that was constrained in the first quarter?

Cary Brown

Yes. That's probably the million-dollar question around here, Mike. The situation is it wasn't in places where entire lines were shut down. And so, I can say we had exactly a $0.5 million a day here and $2 million a day there and it's more of pressure issues, just holding back pressure on existing wells and it was pervasive across most of the Permian, so we have not nailed that number down for our sales. I'm sure not comfortable throwing the number out that I'm not– I have it nailed down. It was not insignificant.

Obviously, that put us on the lower end of our guidance range, and so you can probably look at the midpoint are a little higher of our guidance and know that's probably where we were anticipating being to where we came out and the majority of that.

In fact, more than a majority of that we offset some of the lost production by increases in other areas, some good capital projects that we did, as well some real good operational efficiencies on the Concho acquisitions.

While I'm mentioning that, I would like to come back to your original question, after having a few seconds to think about it and say, one of the things that really helped us in this acquisition is that we've got a very good relationship with Concho.

As you know, we made an acquisition from them two years ago. We're right here in Midland. We know those guys well and they were very helpful. And the integration and getting us information that we needed and giving us access to their employee base to not only pick their brain but to offer jobs too.

And that sure helped us a lot and we appreciate that not just from Leach but from his entire crew. They're a very good company and one that we feel very comfortable buying from and hope to do deals from in the future.

Michael Peterson – MLV & Co.

I appreciate the color, Sir. Thank you, gentlemen. All I have this morning.

Cary Brown

Thanks, Mike.

Operator

Our next question comes from the line of Praneeth Satish with Wells Fargo. Your line is open.

Praneeth Satish – Wells Fargo

Good morning. Good morning.

Cary Brown

Hi, Praneeth.

Praneeth Satish – Wells Fargo

One or two quick questions like I guess just following up on Mike's question with the infrastructure constraints. I mean, I guess, what steps are you taking to resolve that This is more on the gap side in the Permian and Panhandle. And I guess how soon can you see some relief? Are you just waiting on the midstream guys to build infrastructure at this point?

Dan Westcott

Yes. Praneeth, this is Dan Westcott. I think across the Permian, we have many different purchasers, as a broader player with broad geographic spread. Obviously, we have more exposure to the bigger players but we see DCP and target specifically pursuing a couple of big projects that should help the basin and its entirety that will help on the driest volumes as well as the wet gas volumes. I think they've got a project to Mont Bellevue that DCP has that the last I looked was anticipated at the end of Q2. But if the earlier question was a million-dollar question, I think your question is the $10 million question.

Praneeth Satish – Wells Fargo

Okay. Thanks. And then, I guess, just following up on that, is it fair to assume then that your gas price realizations for the second quarter will also be a little bit lower because of the takeaway constraints but them picked up in the third quarter?

Dan Westcott

Yes, I think that's fair.

Praneeth Satish – Wells Fargo

Okay, great. Thank you.

Dan Westcott

You bet.

Operator

Our next question comes from the line of Abhishek Sinha with Bank of America. Your line is open.

Abhishek Sinha – Bank of America

Hey. Good morning, everybody. Just wanted to quickly ask on the differential. Last time, you guys showed (inaudible) in terms of 7.5 to 9 books (ph) for the differential. And I think– I mean the Cushing, Midland-to-Cushing has narrowed down. Will that still remain the same? Or do you think a little better differential in– going forward?

Dan Westcott

Hi. This is Dan Westcott. Thanks for the question. So, if you look back at our guidance that we gave in February, I think footnote 1 showed $11.75 to $13.50 per Q1 and we were at $13.22, so we were just inside our guidance there for our crude oil differential.

For the year, we rent $7.50 to $9. I think we see ourselves within that guidance consistent with our general comment at the beginning.

Obviously, if Midland-to-Cushing stays really low, then we would expect to be on the bottom end of that but I think our general comment this morning is we feel very comfortable with our full year guidance.

Abhishek Sinha – Bank of America

Sure. Thank you. Can you add some color on basically that position landscape in a broad nature and in a one kind of cap growth (inaudible) you have in mind investment acquisition looking at M&A?

Kyle McGraw

This is Kyle McGraw. Coming on the landscape overall, it's a very active markets. There are a number of deals being marketed. We're responding to those.

Our statistic– or liquidation and looked and screened about 70 deals so this year. So, that's about a deal every other day that we're looking at– and that's at that the screening level.

We've got a number of those that we're doing full evaluation, so I would say the acquisition pipeline markets, it was slow in January and then the number of deals came on the market.

So, since it's been in a very good pace probably slightly ahead of our last year pace I would say. But we get our fair share of those, where we land another big one. Only time will tell on that but we are working diligently.

They mentioned four little bolt-on acquisitions and we've got a couple two or three probably to add to that in the near future. But at this point, where– it's a good-looking market for acquisitions.

Abhishek Sinha – Bank of America

Yes. I mean to mine (ph) like was compared to last year what you spend?

Kyle McGraw

No. We're opportunities driven, more so we would love to see another big one come along but we'll respond to what's available.

Just based on our past history, it would be surprising if we ever saw a year like last year with that big but yet we are going– it's because of what opportunities come available because as good as the operations guys did with integrating from this Concho, I think we're ready to go onto the next one.

Paul is looking at me like I'm crazy but we'll do as many as we can. We always have a value mindset and so anything we can buy within our value metrics, we're going to buy.

I don't think we're constrained by capital. There is some constrained in how fast we can grow people life but I we've shown that we can grow faster than we have in the past with people.

So, I would say it the opportunities are there, could we have year like last year?

Absolutely.

Are we expecting that?

Probably not but I am seeing some things that the deal flow looks good and the metrics that I'm seeing I feel pretty good about. So, I'm real hopeful for a really good year.

Abhishek Sinha – Bank of America

Sure. Thank you. That's all I have. Thank you very much.

Kyle McGraw

Thank you.

Operator

I'm not showing any further questions at this time. I'd like to turn the call back over to Mr. Carry Brown for closing remarks.

Carry Brown

I just want to thank everybody for joining us today and say, I'm really excited about where we are. I think we've got a great balance sheet, got a good operational handle on our assets now and where we're going and the oil price looks good.

So, from what I expect in the future it's about as good as I have ever seen it and the acquisition market looks good as well.

So, I'm really excited about what the future holds for Legacy.

I can't tell you how proud I am of the group of employees and the people I get to work with and the job they did. I know you guys just the numbers, I see all the work that goes into making those numbers and I think we've got the best team in the business to do what we do, and I'm real proud to be a part of those.

So, appreciate you guys and we'll be back with you next quarter.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone, have a great day.

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