Legacy Reserves' Management Presents at NAPTP 2013 Master Limited Partnership Investor Conference (Transcript)

| About: Legacy Reserves (LGCY)

Legacy Reserves LP (NASDAQ:LGCY)

NAPTP 2013 Master Limited Partnership Investor Conference

May 22, 2013 4:30 p.m. ET

Executives

Dan Westcott - CFO

Analysts

Kevin Smith - Raymond James

Kevin Smith - Raymond James

All right. Next up we have Legacy Reserves, an upstream MLP that’s got a great track record in distribution growth and cash flow growth. If you have been paying attention to a lot of the news coming out of Permian, I think Pioneer even had a horizontal well, they’re really proud of this week in the Midland county. So a lot of exciting stuff going on basically in Legacy’s backyard as well as robust drilling economics of what they are doing right now. And presenting for Legacy, we have Dan Westcott, company’s CFO.

Dan Westcott

Thanks Kevin. I appreciate everybody’s patience this afternoon. We have been busy on – feel like I am too big for the stage. We have been busy working on a couple of things that we are real excited about. But wanted to welcome everybody here today. I see a lot of faces that have been following Legacy for some time. I see a few new faces. Forgive me if I am discussing things that you already know but hopefully we cover all the most salient topics. I told Kevin earlier I am really good at a 20 minute presentation and so we were kind of killing a few minutes there.

This is the forward looking statements. And I would encourage everybody to read that. This is – by the way this presentation is available on our website under the investor relations section.

So Legacy Reserves, who are we? We’re ticker LGCY, we’ve been public for about six plus years. We were the second upstream MLP behind Linn. We have a – the company itself has a predecessor formed in 1981, Cary Brown’s dad formed the company for Brothers Production, out in Midland, we are based in Midland, we have been all along. We took the company public in January of 2007 and have a great track record as a public company of steady consistent growth. We will talk about that.

Today we’re at about a $2.3 billion enterprise value, that’s $1.5 billion in market cap and just under $800 million debt. We pay a quarterly cash distribution that is – I know there is bunch of MLPs here in several different structures, ours is not the variable rate structure, ours is declared quarterly. But we have paid now in the public market 25 consecutive quarterly distributions, the last 10 of which have been growing at about $0.575 increase. That gives us about 8.5% yield. So a very attractive yield particularly in today’s environment with 2% treasuries.

We get a long-lived oil-weighted properties base that comes part and parcel with being in the Permian, about three quarters of our assets are in the Permian and then the balance is pretty evenly split between the Rockies which as you see on the map is Wyoming, Montana and North Dakota, that’s about 12.5-13% and then Oklahoma and Panhandle of Texas. I like the fact that Texas is so big, it’s actually two different regions within our company. But that’s how we think of the world.

We’ve got 83 million barrels of proved reserves equivalent, that is we are not – if you followed Legacy we are not as an MLP and kind of built within ourselves we are not focused on pudding up bunch of reserves. We have 88% PDP, that’s not proved developed, that’s proved developed producing. So we have a very high concentration of proved reserves, or producing reserves. That 68% liquids, that’s a little bit misleading, we actually in the Permian, all of our natural gas or the vast majority of our natural gas is sold wet.

So if you look at our financials, we’re realizing a premium to Henry Hub on our gas price and in Q1 it was about $1 and Q3 and Q4, the previous two quarters of about $1.25 but on an as reported basis we’re 68% liquids.

We think we do three things extremely well and better than most. One is evaluating acquisitions and our development projects, we’ve got a very intense process that holds all groups accountable to our acquisitions, it’s very rigorous, we've made -- we will talk about it here in a minute but we’ve made over 100 acquisitions as a public company and think we have developed a very stringent process.

Two, we think we do a good job of financing our capital requirements and third, we think we’re exceptional at executing our plan. We have -- we just made our largest acquisition, I will get to here in a second, Concho -- Concho properties. We think we’re really good at executing and operating oil and gas reserves.

So step back here, to take a step back for one second and talk about the Permian, the red stars is Midland, we are right in the heart of the Permian basin. The Permian basin has been around since the ‘20s. It’s produced about 30 billion barrels cumulative production. I think Pioneer is saying that there is something like 50 billion barrels to go. So we feel like we are in the heart of it all. We are in a good spot. We own just about everywhere in the basin. We don’t have significant concentrations.

If you think about us we are kind of all of that map. That is an industry map. One of the things that Cary, CEO points out that he loves so much about this map, I mean this is his go to map. It is – the colors are representing different depths and we produce in the Permian somewhere between 1500 and 15,000 feet and we own kind of all over the basin. So we’ve got lots of exposure where we have old vertical wells, we’re now drilling some horizontal wells. We just drilled one of the best wells in our corporate history at that end of last year in Q4, it was on a lease that we’ve owned since 1999. And we have seen a couple of our neighbors drilled some good horizontal wells out there. So after seeing several of them do it, we went and did it and have shown some good results. So we feel like we have a good – a great footprint and a great basin and that’s where we are really deploying all of our capital.

Acquisitions drive growth. So we’re a little bit different than some of the other upstream MLPs. Our strategy is we’re going to grow distributions through acquiring more properties. We think that provides a very balanced approach from our corporate production decline profile. If we drill more we’re going to have to drill more. And so we’re very cognizant of that as a distribution focused company and looking at things over the long term.

I mentioned earlier, we’ve made – it’s on here somewhere right, 118 acquisitions, I think we actually pulled the stat, but if you total up all those numbers I think it’s 118 acquisitions for just over $1.5 billion and the average purchase price is about 5.6 times that's a weighted average over basis we trade today at about nine times. So we think we can find – there are properties out there that fit our model, that are mature properties, that are nicely accretive to our unitholders and we will continue to pursue those.

Importantly I think I don’t think I have a laser on here, but the 2012 opportunity, I think that’s a great slide that shows that we screened about – we actively screened 135 transactions in 2012 and we closed on 19 of those. So two things I’d point out from that fact, one, we closed 19 transactions, that is by far more than our competitors. We’re looking at small deals. We think we get good value on those small deals, we have not given up on those. And then secondly is that’s 14% of the 135 deals that we actively screen. So we are being picky, we are losing quite often but we are tenacious on our approach and we stick with it.

We have just talked about the Concho acquisition, it was – what’s right – I can’t say transformative, it was landmark. There are implications to calling it transformative, it was a landmark acquisition for us, a little over $500 million, we closed at the very end of 2012. It’s about 5200 Boes a day of production to give you a sense. We produced -- in Q1 we produced 19,700. So it added almost a third to our reserve base and to our production. We thought for those of you who don’t know Concho, Concho is also a Midland based company, they are an active driller in the Permian.

Effectively what they did was sell us a big portion of their old stuff so that they could go pursue the new well drilling. If I think about them a C-corp, they are focused on period over period production growth and they can reset the bar by selling assets while we’re focused on making distributions and we can't just reset the distribution and then grow from there. And so there is a bit of an interplay there. This is the second time we bought from Concho, we think they are great operators but for their wells that are making 10 barrels a day, that doesn’t cut it for them. They want to drill 1000 barrels a day wells, and so we think we are good at taking that 10 barrel a day well and seeing how can we make it 11 barrels a day? It’s just a different focus. We feel like we have a good expertise in that and the right amount of people and the right trained people to do that efficiently.

I will note when we raised our high-yield back in November, we did that commensurate with this acquisition. We put out a number, I think we bought 1586 producing wells in the package and we look forward and said we think production in the first quarter of ’12 will be 52.38, we hit 52.50 for the quarter. So we’re really happy about setting that objective and meeting it particularly in the hottest basin in the country. This labor market is incredibly tight and we think we were in a great spot to be able to make this acquisition because of who we are and the knowledge that we have.

Page seven, I won’t read through, that’s just a more clear picture of our assets and how those are divided up on a production and reserve basis.

Page eight in an overview of our development opportunities. This year we have a $90 million capital program, about half of that program is from a one rig program in the Wolfberry. The rest of that program -- usually year-over-year about 20% to 25% of our capital comes from [Nana] and so you’re left with about 25% of the rest of the capital, which is a couple of Bone Spring wells, a couple of Cline, a very small interest in Cline wells, and of the major county work, really mattering of work throughout the basin. We have -- on the page that’s probably $1 billion worth of opportunity and we think none of it’s going away from us, we will get to it and in the meantime we think our partners will help us, will show us how to do it better.

Key investment highlights, I want to get back to and dive right into the financials, I am the CFO, I would like to get the number. So let us come back to that. Page 11 is, I think it’s our cap table, we think we have a great balance sheet. We have been working on some stuff here recently to improve that further. But today we have $1.6 billion market cap, $2.3 million TEV. Today we have over $300 million of availability, that’s twice as much availability as we’ve ever had under our borrowing base capacity. And if you think about us at Legacy as an acquisition focused company, having that $300 million of availability is really important and our ability to really go out and quickly pursue acquisitions and make deals with sellers.

I mentioned earlier we’re about an 8.5% yield, we’re at 3.1 times debt to LQA EBITDA. Our EBITDA for the quarter was $64.4 million. I think most analysts out there have us at around 270 or so. So we expect that to grow. Part of the Q1 difference was driven by differentials which we expect and I think the market expects to improve.

Page 12, I like page 12 a lot. Page 12 shows how our acquisitions have actually worked. These are not pro forma numbers, these are actual numbers. The top half of the page is the growth of our assets that’s measured by production and EBITDA. At the 25% compound annual growth rate from since 2007 we’re really proud of that accomplishment. Again that is through making accretive acquisitions. The bottom half of the page shows how we have been able to manage the balance sheet while we do that.

So if you look at debt to production or debt to EBITDA we have been able to maintain modest amount of leverage through some really tough times. You will note that today we’re at 3.1 times on an LQA basis. We talked about how the last quarter annualized doesn’t really represent our true measure of EBITDA today, but we also for the first time went out and did the high yield market. So we have 8% senior notes out there. Our view from a capital structure perspective is that we are moving from 3% money to 8% money. We should increase our leverage and so as we look forward to from here we’re looking to maintain that three-time -- in and around that three times leverage multiple.

13 is a fantastic slide, I love it. It shows 25 distributions to our public unitholders, the last 10 of which have been growing and if you overlay that with the commodity price, the WTI commodity – oil price you see we had quite a precipitous drop from 2008 to 2009 from 145, 50 down to $35, that is our (inaudible) price. We think the way that we built our balance sheet, the way that we pursue acquisitions and the way that we hedge has enabled us to be consistent throughout that volatile time period.

Our hedge strategy is a little bit different than some of the other upstream MLPs, I want to talk about that for one minute. We have about 84% of our crude oil hedged through 2014 and about 70% of our gas hedged through that period as well. Some of our competitors hedge more than that, we think that we are taking a very prudent approach to our hedging strategy and the primary reason behind that as an oil producer we can observe that our LOE is correlated to oil prices and we are afraid that if we over-hedge in the out-periods that we will actually just hedge one side of the equation and not the other. So if you guys can meet with me afterwards and tell me how to hedge our LOE, I am all ears but we’ve been maintaining this strategy of being very hedged in the first two years and tapering down thereafter.

And I think what it has shown on 15 is that it worked quite well. The top left chart here is annual revenues without hedging and the bottom left is annual revenues with hedging. You can see how hedging the top right has been up and it’s been down but it's really down what it’s supposed to do in smoothing our earnings profile.

Page 16 provides little bit more detail on our hedges specifically. We have used both swaps and three-way collars on the oil side. Those are the costs hedges, we don’t pay for our hedges as we are at the money. They are with our banks, we think that’s an important element from a risk profile, we won't have margin calls. And we also think it’s important not to be paying for your hedges. We do not use new capital to buy hedges. As an acquisition company, when we are looking and planning our existing base and our existing assets and the acquisitions we’re going to make, we’re looking at the forward curve and what is the forward curve telling us that we should be doing and we try to lock in that on the acquisition front at best we can. Really from a standpoint of if we’re out -- if we’re coming out with new dollars to fund an acquisition we want to lock in those economics.

On the gas side, we've used strictly swaps, that’s both at Henry Hub, CIG and ANR, really trying to work on minimizing basis risk. We have hedged Midland to Cushing this year, for Q2 through Q4 of this year we have about 8000 barrels of oil hedged. Unfortunately today that is out in the money but we have seen how tight that market can be. We have seen, our competitors have seen it. In Q4 that differential blew out to over $20 for a ton. And in Q1 I think our differential was -- our unhedged differential, excluding hedges was about $13.22. So we have seen that widen out and we think putting the hedge between Midland and Cushing is a judicious move as we think about planning the business and making distributions.

So we are on the appendix, and now I am going to back up to our investment highlights because I think this is the best way to finish it off. I think we’ve talked about our asset portfolio, we have a very liquids focused assets portfolio of 68% on an as reported basis. On a look through basis, so if you separated just the actual NGLs within our gas revenue stream that’s closer to 81 or 82 I believe. So a great asset base with a low decline rate. Again we are very focused on that.

We have a strong track record making 118 acquisitions as a public company with 10 consecutive quarters of distribution growth. We have a great inventory, a low risk development projects and then I want to camp out here for one more second on the experience incentivized management team, in the appendix, if you down our presentation you will see that our ownership structure is very simple. We have a general partner. The general partner doesn’t own anything different than the regular units and I believe it’s 0.3% of the regular units. The structure was put in place when we went public to not as an LLC but as a GP LP structure to try to minimize taxes. But I guess the point – the key point I want to make is a very straightforward structure, there are no incentive distribution rights, there is no synthetic incentive distribution rights. The insiders own about 18% of the total units of planning, those units are the same units that everybody else owns.

And so what that means is that – what I think that means at least is how we choose to run this business is in the best interest of our unitholders. What’s good for us is good for our unitholders and given that the vast majority of everyone’s net worth is in this company we’re not running it for the next quarter or the next fiscal year, we’re running this for long haul. And I think that underpins our strategy across-the-board whether it’s the acquisitions we pursue, the capital structure we set up, the hedges we layer on, this is our baby and that’s how we are running it.

And then lastly is the conservative financial and hedging policy but again I think that's really driven by that insiders’ straightforward ownership. I think that concludes our prepared remarks. I know we do have breakout session. We love to take Q&A afterwards. Kevin, do you know where we head?

Kevin Smith - Raymond James

(Inaudible) If you wanted you could do the breakout session here.

Dan Westcott

Is this it. There is no more. Terrific.

Question-and-Answer Session

Unidentified Analyst

[Question Inaudible]

Dan Westcott

I got that email. Thank you.

Unidentified Analyst

[Question Inaudible]

Dan Westcott

I get paid twice a month actually.

Unidentified Analyst

[Question Inaudible]

Dan Westcott

We have looked into it. We are not ready to make that step yet but it’s something we are evaluating. Ultimately that decision is made by the board. Importantly in our case our very unitholder friendly partnership agreement requires us to come back to the unitholders and get approval and that’s not something that brokers can sign off on. So I think the next time – honestly I think the next time we could do it would be next May. We just had our proxy our annual meeting on May 14. And so that effort is not for the [faint of heart] [ph] reaching out to all of our unitholders. We’ve got a pretty – a very retail focused investment base. And so if we do pursue that I think – I know we are going to need others approval.

Unidentified Analyst

[Question Inaudible]

Dan Westcott

So the question is how would we compare our hedge profile to Linn’s. Linn does hedge, I believe they are 100% hedged for five years, close to it. They use a broad mix of swaps and collars and puts. Our banks prohibit us from hedging more than 85% of our PDP, that’s a strict prohibition. We could use puts and avoid that, so we could go out in the market and buy puts. We don’t think that’s a very judicious use of capital and we think it masked the cash flow generation of our assets. And so I think we have – you can call it a dummy approach but I think we have a much more simple approach to our hedging profile. And quite honestly we’re much more oil weighted than Linn is. Gas producers have significantly lower LOE per boe or mcfe depending on however you want to look at it. On a per unit basis it just doesn’t cost nearly as much a lift, a gas as it does oil. So they don’t have that same exposure or operating leverage if you will that we do.

Unidentified Analyst

[Question Inaudible]

Dan Westcott

So the question is this, when will we see the Concho acquisition ripe and things come our way? I think you mean – if you don’t mind, if you want to talk about some of the opportunities we are pursuing today at Concho, I think what you're saying is when we get after drilling or when will –

Unidentified Analyst

[Question Inaudible]

Dan Westcott

So it sounds like more of a finance question, I think when we look at our distribution, declared distribution we are looking at that quarterly and we are looking what is sustainable over the long-term. I think we were just tickled to death with our performance with Concho given what was going on in the basin, very pleased with 5250 boes a day at the Concho. I think we are continuing to get our arms around it. If you think about and Paul can articulate this with true experience but I view it as triage. And so when we took over those properties they were just flat out wells that were offline. And so you focus on the biggest well first, and you move on down the list and so I think what we are doing now is circling back through that list. But we absolutely have more people that we want to hire, we think we have all the right field personnel but there more engineers that we want to hire. And so I would expect we will continue to make progress in that endeavor and I don't expect – I want to be clear, I don't expect that in Q3 we’re all of a sudden going to have some big pop in our distribution, and I think that’s how we run our company.

Unidentified Analyst

[Question Inaudible]

Kevin Smith - Raymond James

We just raised $250 million, what are we going to do with it? You may have seen a press release this morning that we lost the high yield market today.

Dan Westcott

And so what we can say about that is the state of the use of proceeds is to pay down our bank borrowings, that’s not – that is the use of proceeds. Kevin’s question, what are we going to do with the money, look, we make acquisition. We would love to have $635 million of acquisitions again in 2013. Obviously we’re not on a run rate for that. But acquisitions don’t crumb on our dollar per day. So we would love to be making more acquisitions in the Permian and Rockies and all throughout the middle parts of the country, we can just stay within the middle part of the country and swallow $500 million this year we would love it.

Unidentified Analyst

[Question Inaudible]

Unidentified Company Speaker

So the question is the Permian basin is incredibly hot, you’ve got all the horizontal drilling going on, that creates a lot of opportunity but are you concerned about the fact that that makes it to hot and you can't make acquisitions? Did I do that fairly?

You know Kevin, we have been buying in the Permian basin since ’81 and I would love to tell you in 1990 whatever it was really easy to make acquisitions. And what I will tell you is not one time did Cary and I look at each other and think well, this was an easy year to make acquisitions, it's always tough. The good thing about that is we are not buying acreage. As you know we’re generally making PDP acquisitions. So if we are making PDP acquisitions that have horizontal Wolfcamp underneath that or horizontal Bond Spring underneath that, are we going to have to pay for it? Yes, but remember if we are buying anything that I knew about, that I didn’t have to pay for. So I really don’t think that’s going to be a significant change. It has, two things have pushed the market up. We used to quote four to six times cash flow for acquisitions and I think we are in the five to seven range today. Part of that is due to commodity prices and part of that is due to the cost of capital. The reason then was raised the money there wasn’t because we had all these acquisitions lined up because high yields are cheap. And it sets our balance sheet up in an incredible position to where we should be able to make acquisitions, not just in 2013 but beyond.

Unidentified Analyst

[Question Inaudible]

Unidentified Company Speaker

Sure. The question was, with acquisitions when you make a $100 million acquisition how quickly do you think you will get that 100 million back and then further how many additional $100 million acquisitions do you think are out there?

Unidentified Analyst

[Question Inaudible]

Unidentified Company Speaker

Sure, sure, I always think that we’re absolutely paying too much on every acquisition we make. I am convinced that we’re paying PV 8 or 9 and we turn those acquisitions into something significantly north of that, everyone is different. But Dan mentioned the horizontal Bong Spring well that we drilled in Q3, it’s the best well in our company history on an asset that we bought in 1999. We didn't pay a dime for that 125,000 barrels of oil that we produced in the first six months or 120 or whatever it is and half million barrels of ultimate reserves. So you don’t know ultimately what your rate of return is until the end of time, what I can tell you is we do acquisition look back annually on every acquisition we’ve done, all 119 of them, or 116 of them. And what we continue to see is better rates of return than we thought we were bidding on when we bought the asset.

Unidentified Analyst

[Question Inaudible]

Unidentified Company Speaker

Well, there has been a number of things. You’ve got to be honest and say as the operations group we have the luxury that everybody in their careers behind us have not had on these assets, some of them that were drilled in the ‘40s and ‘50s and that’s $80, $90, $100 fresh bid. I have been engineering work for 30 years and things weren’t economic at $20 that worked at 80. Technology has helped, absolutely but the environment has helped as well.

Unidentified Analyst

[Question Inaudible]

Unidentified Company Speaker

Yeah depends on which play you are talking about. I think typical drilling in the Permian is in the 30 to 45% rate of return. And that’s Wolfberry, Yeso, Bong Spring, horizontal Wolfcamp, Wolf Bone, jury is out on Cline Shale, there may be a rate of return and it may be really good. I don’t know yet.

Dan Westcott

The other thing I would add is that when you look at one of these shale plays, I would take the 10,000 or $15,000 per acre that they paid and amortize that over every one of those wells. Yeah you got back on the $5 million D&C you put into the well but if you add in the $5000 per acre that you just paid for that, then that’s going to significantly prolong your return.

Any others? Thank you. Appreciate it guys. Thank you.

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