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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

Ethan Bellamy - Robert W. Baird

Michael Peterson - MLV & Co.

Praneeth Satish - Wells Fargo

John Ragozzino - RBC Capital

LRR Energy, L.P (LRR) Q2 2013 Earnings Conference Call August 2, 2013 10:00 AM ET

Operator

Good morning my name is Chris and I will be your conference operator today. At this time I would like to welcome to the 2013 Second Quarter Earnings 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’ll now turn the call over to Chief Financial Officer, Jaime Casas. Please go ahead.

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; and our Chief Operating Officer, Tim Miller.

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 the Risk Factor section of our 2012 Form 10-K on file with the Securities and Exchange Commission.

Additionally 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 everybody. We appreciate everybody joining us for the second quarter earnings conference call. Charlie, Tim and Jaime are going to discuss the second quarter results in greater detail but in summary we’re very pleased with our second quarter. It included strong operating and financial results along with the closing of our second acquisition this year.

Second quarter financial results benefited from higher reduction, higher oil price realizations and lower operating costs compared to the first quarter. For the quarter production averaged 6,484 Boes per day, adjusted EBITDA was 21.3 million, distributable cash flow was $14.1 million and our total unit distribution coverage was 1.11 times.

Before I turn the call over to Charlie I would like to highlight a few recent events on April 1st we did close our acquisition in the mid-Continent region of properties in Oklahoma from our sponsor Lime Rock Resources for a purchase price of $38.2 million. That transaction added mostly liquids weighted low declining, producing assets that are well suited for LRE. We continue to evaluate additional acquisitions of various sizes and are excited about the current backlog of transactions we have to evaluate. We never know exactly about the timing of acquisitions or whether we’re going to be successful or not but we are excited given the deal flow that we are seeing today.

Finally our Board of Directors declared an increase in our per unit distribution for the second quarter bringing our current distribution to $0.485 per outstanding unit or $1.94 on an annualized basis. Distribution will be paid on August 14, 2013. Consistent with our distribution strategy, the second quarter distribution is the fourth consecutive quarter with a distribution increase.

With that I will turn it over to Charlie.

Charles W. Adcock

Thanks, Eric. I’ll review the operating results for the second quarter. Please note that everything that I will discuss includes the effect of recasting our April acquisition to January 1st of this year. Yesterday we reported total net production of 590,000 Boe for the quarter, an increase of approximately 30,000 Boe over a re-casted first quarter production.

Our production was roughly 52% natural gas, 36% oil and 12% natural gas liquids for the quarter. Oil production increased for the quarter primarily due to our liquids focused drilling program at our Red Lake field along with closing our oil-weighted acquisition in April. Lease operating and workover expenses for the quarter were $5.3 million or $8.93 per Boe compared with $6.8 million or $12.11 per Boe in the first quarter. The 26% decrease was primarily due to a fewer number of workovers and lower saltwater disposal cost during the quarter.

For full year 2013 and on a re-casted basis our LOE per Boe guidance remains at $10.50 to $11 per Boe. Production ad valorem taxes for the second quarter were $2.2 million or $30.72 per Boe and represented 7.6% of gross revenue. This compared to the production ad valorem taxes for the first quarter of $1.8 million or $3.29 per Boe. I will now hand the call over to Tim Miller who will provide more detail on our operations for the period.

C. Timothy Miller

Thanks Charlie. We continue to successfully execute our 2013 drilling program which is focused on oil weighted projects in the Red Lake field in the Mexico. During the second quarter we successfully drilled eight and completed nine wells at Red Lake. We also recompleted four and re-fracced one Red Lake well during the quarter. For the quarter our average daily production was 6,484 Boe per day. Second quarter production benefited from the closing of our April acquisition and the development work at Red Lake, which continues to meet or exceed our expectations.

Unfortunately production during the quarter continued to be negatively impacted by flaring at the Red Lake field for approximately 90 Boe per day and curtailment at the Pecos Slope field of 1 million cubic feet per day or 167 Boe per day.

At our Red Lake field we are currently flaring approximately 90 Boe per day due to third party plant compression limits and expect that we will continue to flare at this level until a new compression station at the plant is put into service. This is expected to occur in mid-fourth quarter 2013. We expect the Pecos Slope curtailment to remain at the previous mentioned level until late 2013 when a field wide nitrogen rejection facility is installed.

As Charlie mentioned second quarter results benefited from lower operating cost. Expense workovers which can vary significantly from quarter-to-quarter were $800,000 lower than in the first quarter. Through July 25th we estimate that our average net production for July was approximately 6,550 Boe per day. Our updated recasted production guidance range for full year 2013 is 6,300 to 6,550 Boe per day. Our current guidance takes the flaring and curtailment that I mentioned above into consideration.

We are also revising our planned 2013 capital expenditures by 2 million to $32 million. The additional capital will be used to accelerate the drilling of 2 gross, 1 net Red Lake well and 11 recompletions that were originally scheduled for 2014. The additional drill wells are possible with the same one rig drilling program due to progress we have made in reducing drill times at Red Lake. The additional capital will allow us to retain the rig, the rig contract without interruption and accomplish the recompletions earlier than originally planned.

Including the activity just mentioned our plan for the third quarter is to drill a total of eight wells, five of which are at Red Lake. Three others are low interest non-operated wells and to recomplete 11 wells.

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 21.3 million. Distributed cash flow was 14.1 million and our total unit distribution coverage was 1.11 times. Excluding our subordinated units our unit distributed coverage was approximately 1.5 times. In addition to higher production and lower operating cost the second quarter results benefited from a narrower Midland differential and lower G&A expenses. The Midland to Cushing average oil deferential potential narrowed dramatically from approximately $8 in the first quarter to approximately $0.15 in second quarter. This positively impacted our realized oil price which was up 9% over the first quarter.

Turning to G&A our expenses during the second quarter were lower than the first quarter primarily due to an advisory transaction fee and year-end accounting and tax related cost incurred during the first quarter.

Next I would like to provide an update on our current commodity hedge position. It is important to note that LRE's hedge portfolio consists almost entirely of swaps. These are [costly] derivative instrument that we entered into at market prices. Assuming the midpoint of our revised 2013 production guidance is held flat through 2017 our total estimated production is 96% hedged for the remainder of 2013, 80% in 2014, 57% in 2015, 55% in 2016 and 44% in 2017. Weighted average prices during the period are $92.73 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. Taking into account the recasting of our April acquisition we now expect production average 6,300 and 6,550 Boe per day and LOE to average $10.50 and $11 per BOE. Total capital expenditures for 2013 are now expected to be $32 million.

I would like to close with a few comments on our balance sheet. As of today we have $188 million of outstanding borrowings under our revolving credit facility and $50 million of outstanding borrowings under our term loan facility. We currently have 62 million available borrowing capacity under our revolving credit facility and we believe it provides ample financial flexibility to execute our 2013 capital program and distribution strategy.

Operator that concludes our comments. You can now open up the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first comes from the line of Kevin Smith with Raymond James.

Kevin Smith – Raymond James

Hi, good morning gentlemen.

Eric D. Mullins

Morning, Kevin.

Kevin Smith – Raymond James

Congrats on the nice quarter. Your level workover activity clearly declined in 2Q and I think you mentioned in your prepared remarks, was that correct, was it about 800,000 less in 2Q versus 1Q?

C. Timothy Miller

Yes, that expense was over, those were kind of unplanned maintenance workovers.

Kevin Smith – Raymond James

Got you. So that was the primary driver why LOE decreased and that, it pretty much hit the -- that was the vast majority of it, right?

C. Timothy Miller

That was about half. I think a little bit more than half. I think we went down from 6.7 to 5.3. So the other part was lower operating cost, due to saltwater disposal cost and saltwater disposal income as our system there the upgrades, we have been putting in place there have helped us reduce that LOE.

Kevin Smith – Raymond James

Got you. And then as I think back to the Q1 call you mentioned that about half of your workover activity you budget for the year happened in Q1. What’s the outlook for the next few quarters as far as your workover activity and expense showing up in LOE?

Jaime R. Casas

Given the second quarter and kind of what we know through July of this year it looks like we are going to be back on trend with our original budget levels which were in the $2.2 million range for the year.

Kevin Smith – Raymond James

Got you. Okay so should we expect about 500,000 a quarter for second half of the year as far as above and beyond your kind of base level?

Jaime R. Casas

Yes, slightly less than that.

Kevin Smith – Raymond James

Got you. Okay, and then you know one more question, if I may. The 2 million that you are adding to capital spending for this year, the one net well in Red Lake and more recompletions, should we think about that adding production more in Q1 of 2014 or should we see some boost, maybe in the fourth quarter this year from those activities?

C. Timothy Miller

Yeah that’s why we didn't increase the production guidance much. A lot of that is just to continue to program throughout the end of the year. So a lot of it happens in the fourth quarter. So that impact 2014 production more.

Kevin Smith – Raymond James

Got you. Okay, that’s all I had. Thank you.

Operator

Your next question comes from the line of Ethan Bellamy with Robert W. Baird.

Ethan Bellamy – Robert W. Baird

Good morning, gentlemen. Congrats on a solid quarter. I have two questions for you. The first kind of specific, we were a little heavy on our NGL expectations, NGL price realizations. Was there anything specific negative in terms of NGL prices or was it just sort of the broad ethane rejection that we are seeing?

C. Timothy Miller

Yeah nothing that we could tell you Ethan in terms of why our NGL prices came in a little bit lower, nothing specific.

Ethan Bellamy – Robert W. Baird

Okay and then in big picture perspective, obviously a more solid quarter than what we saw at the beginning of the year but we and at least the Street as of the last estimates have you guys in sort of the 0.9 the 1.0 times coverage range, does that square with your own expectations about, do you see up coverage going forward and if so what’s it going to take to expand coverage and potentially get to a point where you can see material distribution increases again?

Eric D. Mullins

Yeah, this is Eric. [Technical Difficulty] …second quarter relative to first quarter, you know, we don't really develop quarterly forecasts for that coverage. But I will reiterate that you are right, our expectations and our goal is to get our coverage in line with our peer group which in our minds is more like 1.2 times. In addition to, obviously this was a strong quarter in terms of coverage, but in addition to that to get over the course of 12 months or four consecutive quarters in that range our plan is still the same, which to make acquisitions to increase our distributable cash flow on a per unit basis very methodically and slowly until we get our coverage in line with what we want and which is in that 1.2 times range.

Ethan Bellamy – Robert W. Baird

Is that going to be a function of acquisitions or there are further cost control measures like we saw this quarter that we will fit about there.

Eric D. Mullins

A quick answer is that it is going to be a little bit of both but I think the majority of it is going to be acquisitions. So you should look for us to continue to make acquisitions in order to strengthen that. But the impact of the cost cutting as well as a solid production quarter certainly helps.

Ethan Bellamy – Robert W. Baird

Okay, and so you handicap the probability of an acquisition in the balance of year is really high.

Eric D. Mullins

Well, we are always looking. The backlog is very busy right now. We have a lot to look at which always helps. It is very unpredictable. It seems to be pretty lumpy. So I hesitate to predict when we are going to make and be successful with acquisitions but the market is certainly helping us right now in terms of the opportunity set.

Ethan Bellamy – Robert W. Baird

Okay, thanks guys.

Eric D. Mullins

Welcome.

Operator

Your next question comes from the line of Michael Peterson with MLV and Company.

Michael Peterson – MLV & Co.

Good morning, everyone. I would like to discuss the non-organic growth and I have two questions on that topic. First can you get us an update regarding the pipeline for sponsor dropdowns, either Eric or Charlie?

Eric D. Mullins

Yeah, you may have seen some of our numbers, we have substantial amounts of assets still in our fund, primarily our Fund II. Right now they are in various stages of development. We have been spinning quite a bit of our cash flow back on the properties and exploiting the development opportunities there. As we get through that program which is happening, continuing to happen, those properties, some of those properties will be attractive candidates for dropdowns.

So I don't have a schedule for you in terms of anything specific but again we do have a huge inventory of properties that would be potential candidates for those kind of dropdowns.

Michael Peterson – MLV & Co.

It sounds like maybe some of the maturity of those assets isn’t quite where you would like it to be for a dropdown. Would a majority of those prospective assets be 2014 events do you think, or is it too much specificity?

Eric D. Mullins

Yeah, that’s a little too much specificity. I wouldn’t necessarily assume that I think we look at it every quarter. And we are spending capital on those properties, we are getting results and the different properties kind of progressed on that front at different paces. But we look at that all the time.

Michael Peterson – MLV & Co.

Okay. Second question with regards to third party acquisitions. Given some of the efficiencies that you have captured this quarter, which are certainly a solid turnaround from what we’ve seen in the last couple, would you be more interested in bolt-ons or would you entertain entry into a new basin, and start the efficiency process yet again?

Charles W. Adcock

This is Charlie, yeah, I think we would be interested in either of those. We look at stuff all over, the lower 48 and we have looked at lot of Rockies deals we have looked at lot of Appalachian deals. We have just been more successful in the areas where we are concentrated right now, the Permian and the Mid-Continent but we look at deals over. Very obviously we like bolt-ons. Bolt-ons tend to come to you at pretty attractive prices. Part of the issue there is they tend to be smaller.

So going back to the other question about increase in our distribution coverage, I mean, we would like to do some more sizeable acquisitions in order to create that increase in the distribution coverage over the short term. But we look at everything. I mean it’s pretty all the time when you look at the number of deals we churn through on an annual basis with the staff we have. So we throw a pretty broad net and we try to capture everything we can.

Michael Peterson – MLV & Co.

That’s helpful. Thank you, Charlie. Nice quarter, guys.

Charles W. Adcock

Thanks.

Operator

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

Praneeth Satish – Wells Fargo

Hey guys, good morning. Just wondering if you could update us on the average cash returns or IRRs that you are seeing on your Red Lake drilling program. I think you said the program is meeting or exceeding expectation so far?

Eric D. Mullins

This is Eric, Praneeth, good morning. What we are seeing are returns in the 30% to 50% type range and I would say that we’re still seeing that is if anything maybe towards the higher end of that. The cash-on-cash returns that we’re getting on these properties are also very attractive. So I would say they are very much consistent with that.

Charles W. Adcock

Yeah this is Charles. I’ll just add a little bit to that in that we continue in order to kind of keep the cost inline in a rising cost environment. We continue to modify our [mud] programs, our bid programs. Tim mentioned in the text of the conversation that we have seen some cost reductions there. So that also enhances the returns to the bottom line.

Praneeth Satish – Wells Fargo

Okay, great. I was wondering if you could comment on where you see the liquids mix going towards the end of the year, do you see crude continuing to grow as a percentage of total production or any guidance there would be helpful.

Jaime R. Casas

Praneeth, this is Jaime you should see kind of a very minor increase in terms of the oil percentage increase the rest of the year just given the fact that our capital program is liquids weighted and more specifically oil weighted. And I think NGLs will stay relatively flat the rest of the year and you will see probably 1% or 2% change from gas to oil.

Praneeth Satish – Wells Fargo

Okay, thanks. Congrats on the good quarter.

Jaime R. Casas

Thanks.

Operator

(Operator Instructions). Your next question comes from the line of John Ragozzino with RBC Capital.

John Ragozzino - RBC Capital

Good morning, gentlemen.

Eric D. Mullins

Good morning, John.

John Ragozzino - RBC Capital

Just a couple of quick ones for me. Going back to last quarter outside of the ongoing layering and containment issues that we’ve seen for a while can you comment on the handful of operating issues that obviously caused a pretty depressed level of coverage last quarter and basically how those things came to be resolved and whether or not there was any specific impact that trailed into the second quarter number?

Charles W. Adcock

John this is Charlie. Yeah we are facing a lot of the same things that we’re seeing other operators. We’re in constant contacts with other guys. This is mostly third-party related and a lot of times you don’t have a lot of control over. The processing capacity in the Permian has been stretched and it’s filtering over into the Texas side now. And a lot of these guys are on top of it. We saw some, I am not going to mention the name of the group but we saw some pretty severe shake ups at one of the groups because the CEO was not happy with their performance and their progress in getting projects done. And we’ve seen as a result of that we’ve seen better performance just in the last few months as a matter of fact and a better response on to some of these projects.

We feel pretty comfortably that a lot of these issues are going to work themselves out by mid next year. And that’s pretty much the consensus pretty much from the other operators. There is a lot of capacity coming on. There is lot of retrofits being done. And I think as we go forward we’re going to see some better run times and a lot less flaring over the next six to 12 months.

C. Timothy Miller

John, this is Tim Miller. I would add when we have a quarter with a lot of expense workovers like we did in first quarter that’s associated with wells going down and us getting on to repair them. There was a couple of significant wells that went down in that first quarter that we did get back on and repaired, one was a significant well was a ESP that failed and another one was a well in our New Years Ridge field that loaded up and had a tubing -- due to a tubing failure. So once those wells are repaired due the workover expenses that production is back on.

John Ragozzino - RBC Capital

Okay, great. That’s really helpful it’s glad to hear that someone is cracking heads to get things done out there. Looking on to 2015 and considering the shape of the forward curve specifically with crude price how are you thinking about hedging going forward and is that changed the way that you are implementing your strategy?

Eric D. Mullins

Yeah John we obviously noticed the increase in at least in the front end of the curve on the oil and as a result of that post the end of the quarter, we get out on some incremental hedges on the oil side the remainder of this year as well as 2014. But once you get to kind of end of ‘15 and outer the curve drops-off pretty significantly. And so we will continue to monitor it and whenever we think it makes sense we will continue to take advantage of increases that we have seen for example on the oil side recently.

On the gas side we are even better hedged than oil and so we feel very good where we are now on the gas side at least out the next three to four years.

John Ragozzino - RBC Capital

Okay. And just one or two more the start of the workover expense which obviously was much lower this quarter you mentioned the salt water disposal savings due to some of the investments you have made in that area. Is there any further cost savings to be had in that regard or should we kind of use this quarter’s number as a good run rate going forward?

Eric D. Mullins

I think for the next couple of quarters we probably won’t see much in terms of additional savings there, but we are working on those lines and such takes time to get right of way et cetera. We are working on some things that could impact few quarters out.

John Ragozzino - RBC Capital

All right. And just one more and you may or may not feel like you want to answer this one. But we have been hearing about the installation of this compression facility and the nitrogen reinjection facility for some time now and I am just wondering if it gives you guys any benefit to actually specify a targeted day of the fourth quarter? And then could you kind of handicap what your confidence levels are in terms of having that actually be done because I know it’s out of your hands?

Charles W. Adcock

John this Charlie. Yeah I think we feel much better about it now the facility actually is in place now and the last item is the electrical connection to it. They have to run 10 or 12 miles of electrical. It took them much longer than anticipated to get right of ways for that because a lot it's cross BOM land. They have those right of ways, the poles are in place and they actually started stringed wire last week. So I think at this point in time you have to handicap it pretty strong because they have made the investment and it’s very obvious that they want to get it on as quick as possible.

They are still saying fourth quarter. I don’t know if they are hedge their bets just to be safe or what but they have got a lot of money invested here and they don’t start capturing anything till they start flowing gas through it. So you have to assume that they are working as hard as fast as possible. But it very positive to us that we do see them out there stringing wire. So we know that they have got that going.

Jaime R. Casas

And John this is Jaime, what probably Charlie was talking about as it related to the Pecos Slope field but it’s also important to note that both of these issues we expect and hope to have resolved in during the fourth quarter but neither one of those in terms of production coming back online is embedded in our 2013 guidance. And so we are assuming that it just comes on in 2014 but there is possibility that it will come in during the fourth quarter.

John Ragozzino - RBC Capital

All right. That’s all I got. Nice work guys keep it up.

Eric D. Mullins

Thanks John.

Operator

(Operator Instructions) At this time you have no further questions. I will now turn the call back over to management for closing remarks.

Eric D. Mullins

Thanks Chris. Well that concludes our call this morning. We appreciate everybody participating. If you have any additional follow-up questions, don't hesitate to call. Thanks a lot.

Operator

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.

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