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Linn Energy, LLC (NASDAQ:LINE)

Q1 2010 Earnings Call

April 29, 2010 11:00 a.m. ET

Executives

Clay Jeansonne - VP, IR

Mark Ellis - President and CEO

Kolja Rockov - EVP and CFO

Arden Walker - SVP and COO

Analysts

Mark Levin - Davenport & Company

Leo Mariani - RBC

Adam Leight - RBC Capital

Jeff Robertson - Barclays Capital

Richard Dearnley - Longport Partners

Operator

Good morning, everyone, and welcome to Linn Energy's first quarter 2010 earnings conference call. (Operator Instructions) At this time, I would like to turn the call over to Clay Jeansonne, Linn Energy's Vice President of Investor Relations, for some opening remarks.

Clay Jeansonne

Good morning and thank you for joining our first quarter 2010 earnings conference call. In a moment, I'll introduce Mark Ellis, our President and Chief Executive Officer. But first, I need to provide you with disclosure regarding forward-looking statements that will be made during this call.

The statements describing our beliefs, goals, plans, strategies, expectations, projections, forecasts and assumptions are forward-looking statements. Please note that the company's actual results may differ from those anticipated by such forward-looking statements for a variety of reasons, many of which are beyond our control. Additional information concerning certain risk factors relating to our business, prospects and results is available in the company's filings with the SEC, including our Form 10-Q for the quarter ended March 31, 2010, which will be filed later today; and any of the public filings and press releases.

Additionally, during the course of today's discussion, management will refer to adjusted EBITDA as an important metric for evaluating the company's performance. Please note that adjusted EBITDA is a non-GAAP financial measure, which is reconciled to the most directly comparable GAAP measure in our earnings press release issued this morning.

Following management's prepared remarks, we'll take your questions.

With this in mind, I'll now turn the call over to Mark.

Mark Ellis

Thank you, Clay, and good morning to everyone joining us on the call. Also with us today in Houston is Kolja Rockov, Linn Energy's Executive Vice President and Chief Financial Officer; and Arden Walker, Linn's Senior Vice President and Chief Operating Officer.

During the first quarter, Linn again delivered excellent operating and financial results that exceeded guidance across the board. On Tuesday, we announced that on May 14 we will pay our 17th consecutive cash distribution of $0.63 per unit, which offers our investors a current annualized yield of approximately 9.5%. And since Linn's initial public offering in January of 2006, our total return to unitholders has been approximately 90%.

Now, March and April were extremely busy months for Linn, and we accomplished a great deal. We've already announced two major acquisitions this year. One marks our entry into a new operating area in Northern Michigan. And the other is a bolt-on acquisition that will double our production reserves in the Permian Basin.

We also raised approximately $1.7 billion of net proceeds through equity and senior notes offerings. We will use the proceeds of these offerings to fund our recently announced acquisition and pay down bank debt under our credit facility. This also positions us to take full advantage of future acquisition opportunities as they become available. We appreciate the support of our investors and believe the positive response to our offerings is a testament to our performance and the strength of our business model.

We've also opportunistically increased and extended our commodity hedges through 2015. Our net hedged portfolio combined with other actions noted provides more certainty to our cash flow and the sustainability of future distribution.

I would now like to highlight some of the first quarter results. Production was 213 million cubic feet equivalent per day, which was at the high end of our guidance range. And lease operating expenses were $1.63 per Mcfe, much lower than anticipated due to cost control initiatives implemented by the company in 2009. We also generated stronger than expected cash flow and achieved distribution coverage of 1.26 times for the first quarter.

Turning to our guidance for 2010, we included a guidance table in our first quarter earnings release, addressing our expectations for the second quarter and full year 2010. The guidance includes the impact of our pending acquisitions.

Second quarter production is projected to be in the range of 235 to 245 million cubic feet equivalent per day. And for the full year, we anticipate production will be in the range of 245 to 255 million cubic feet equivalent per day.

Now, we expect LOE to increase from the levels seen during the first quarter, which will include increased workover activity as well as costs associated with the integration of pending acquisitions. And it is typical to see higher costs within the first few quarters following the integration of acquired asset. For the second quarter, we project LOE to be approximately $1.92 per Mcfe; and for the full year, we expect LOE to be approximately $1.80 per Mcfe.

Now we have increased the 2010 capital program to approximately $200 million to reflect additional capital expenditures associated with developing properties acquired in the recent and pending acquisitions.

We now plan to drill a total of more than 170 wells and complete more than 400 workover recompletion and optimization projects during the year, with more than 70% of outstanding on liquids rich and oil-focused projects, which includes our horizontal Granite Wash program.

Now I'm pleased to report our first operated horizontal well in the Granite Wash area, the McMahon 22-2H, was drilled and cased in 36 days, which was ahead of schedule and below our estimated cost. Completion operations will soon begin and we anticipate testing in late May.

On Tuesday, we spud our second operated well, the Black 50-1H, which should be completed late in the second quarter. We'll increase our operating Granite Wash rig count to two during the third quarter 2010 and keep the balance of our 2010 Granite Wash drilling program, which includes seven operated and three non-operated wells.

As these are liquids content, we believe that Granite Wash is one of the most economic, conventional play in United States. And we have identified more than 100 future locations in the Texas Panhandle area alone. Expansion of this play into Western Oklahoma will dramatically increase this inventory of opportunities. Now we anticipate the results of organic activities and the closing of pending acquisitions will provide for a yearend production exit rate of between 270 and 280 million cubic feet equivalent per day.

In closing, Linn began the year with a strong start and a goal to acquire at least $500 million of oil and natural gas properties. We've exceeded that goal. Year-to-date we have closed or announced acquisitions totaling approximately $800 million and we are poised to acquire additional assets as they become available. We also have the organizational depth and ability to effectively integrate future acquisitions and employees.

And with the actions taken thus far, we believe we are well positioned both operationally and financially to continue implementing our balanced strategy of growth through organic activity and accretive acquisitions. Now I'd like to thank our entire Linn team for their hard work, which allowed the company to achieve outstanding results for the quarter and positioned the company for the future.

I'll now turn the call over to Kolja for his financial report.

Kolja Rockov

Thanks, Mark. I would like to address the following topics in my discussion today: excellent results for the first quarter 2010; guidance to the second quarter and full year 2010; recent successful capital market transactions, raising approximately $1.7 billion; new five-year $1.5 billion credit facility amendment; improved balance sheet with pro forma liquidity of approximately $1 billion; and recent commodity hedging through 2015.

For the first quarter, we generated strong cash flow ahead of guidance. We generated adjusted EBITDA of approximately $152 million for the first quarter compared to midpoint guidance of $138 million.

On a per unit basis, our distributable cash flow was $0.79 per unit. When compared to our cash distribution of $0.63 per unit, we achieved a strong distribution covered ratio of 1.26 times for the first quarter 2010, well exceeding our guidance of 1.06 times.

Looking forward through the remainder of 2010, at the midpoint of our guidance range is we expect to generate adjusted EBITDA of approximately $165 million in the second quarter and approximately $660 million for the full year.

Distributable cash flow is estimated to be approximately $100 million for the second quarter and $410 million for the year, which implies a distribution covered ratio of 1.06 times for the second quarter and 1.13 times for fiscal year 2010.

As Mark indicated, our guidance for 2010 includes the impact of our pending acquisitions in Michigan and the Permian Basin. Our guidance also includes the positive impact of our new drilling activity in the Granite Wash. Along with an active acquisition program, we view our Granite Wash acreage as a key element of our future growth strategy. We believe our strong performance and attractive growth prospects through both acquisitions and Granite Wash development helped drive our very successful capital market transactions.

In total, we raised approximately $1.7 billion in public equity and 10-year bonds. The additional equity and debt financing dramatically repositioned our balance sheet between bank debt and bonds and greatly improves our ability to complete large acquisitions.

Due to strong retail demand, we're able to upsize the equity offering by 25% to $431 million, including the full over-allotment option. Our bond offering was significantly oversubscribed, and due to tremendous demand, we were able to upsize the deal by 160% to $1.3 billion. Approximately 80% of the orders were from new investors, which we believe indicates a rapidly growing confidence in the performance and strategy of the company.

These notes have a (8.625%) coupon and were priced to yield 9%. The notes have performed well in the aftermarket and are currently trading at approximately 103 with a yield of 8.2%. This offering is by far the largest MLP bond offering and is among the top five largest E&P bond offerings. Mark and I and our entire team appreciate the confidence of all of our investors who made these offerings such a success.

In addition to these capital market financings, we recently amended our credit facility to a five-year deal, extending the maturity through April 2015. As a result, Linn had no debt maturities for the next five years. Our new facility also has a lower pricing grid from 200 to 300 basis points over LIBOR, which is an improvement over our prior facility which had a grid of 250 to 325 basis points over LIBOR.

Pro forma for the pending acquisitions, our liquidity is approximately $1 billion, which positions Linn to continue growing organically and through acquisitions.

Now I'd like to update you on our hedging program. We recently hedged natural gas volumes for 2012 through 2015 and added to oil positions for 2011 through 2013. On the natural gas side, we are hedged at weighted average prices per MMBtu of $8.66 for 2010 and $9.25 for 2011. Consistent with our strategy of hedging several years out, we have added natural gas hedges for 2012 through 2015 at weighted average price of $6.25 per MMBtu.

We maintain a significant percentage of our hedges in the form of puts that allow us to capture upside beyond the strike prices and commodity prices rally over the next several years. Puts comprise between 31% and 45% of our hedged natural gas volume for 2010 through 2013.

On the oil side, we are hedged at weighted average prices per barrel of $99.68 for 2010, $83.46 for 2011, $89.51 for 2012 and $89.51 for 2013. Our oil puts make up between 39% and 48% of our hedged oil volume for 2010 through 2013.

As a result of our hedging activities, we now have a six-year hedged book with approximately 90% of our current expected production hedged on an equivalent basis through 2013. This provides more certainty to our cash flow and support future distribution. We believe we are well positioned both financially and operationally to continue to grow, and we are glad that we're pursuing additional acquisitions to capitalize on our momentum.

On April 27, we announced the cash distribution of $0.63 per unit for the first quarter 2010, which will be paid on May 14 to unitholders of record as of the close of business on May 7. This distribution represents our 17th consecutive quarterly distribution.

At yesterday's closing price of $26.51 per unit, our yield was approximately 9.5% based on our current annualized distribution rate of $2.52 per unit. Combined with our enhanced stability and significant growth credential, we believe our yield represents an attractive investment in the current market.

We appreciate your time this morning. And I will now turn the call over to the operator for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Mark Levin of Davenport & Company.

Mark Levin - Davenport & Company

Guys, great quarter and certainly very good guidance. Two quick questions. One, can you guys provide an update on the Puryear well? And then secondly, in the course of your discussion, I think you mentioned you're still aggressively looking for M&A opportunities. Can you maybe delineate where exactly you find the most attractive opportunities? Thanks.

Mark Ellis

Yes, Mark, real quick of the Puryear well. I think if you listened earlier, the current operator of the drilling operations, Questar, is now starting this week. They do have that well back on production now. They still have a bit of a compromised completion, but it's producing quite well. I think the splits were about 7 million a day, gas went up 1,600 barrels a day of natural gas liquids based on the Btu content, and I think 600 barrels a day of compensate the (inaudible) wellhead.

So all of that combined, I think it's about 19 million a day equivalent type well. So performing pretty well. And again, we have around a 30% interest in that well.

Mark Levin - Davenport & Company

And then on the acquisition?

Mark Ellis

Yes, on the acquisition front, we continue to be looking at a lot of different things there. Market still seems to be pretty active. And so we're well positioned, as we've said, financially to participate in that market and will continue to use those as one of the vehicles for growth for sure.

Mark Levin - Davenport & Company

And then just one last question on the LOE rise. Again, a terrific quarter from an LOE perspective, 1Q. And then your Q2 guidance is a little higher. Can you maybe talk about what was going on in the first quarter and then what you're expecting in the second quarter on the LOE side?

Mark Ellis

Sure, Mark. I'm going to turn it to Arden here real quick, and then he'll give you a little more depth. The guys have done a great job from an operational standpoint of monitoring the costs and initiating some things last year that have driven our cost down a bit. So I'm going to let him give you more details on that.

Arden Walker

Yes, in addition to the comments Mark had on the call around cost reduction program, that was a concerted effort on our part, and we're starting to use some dividends from that. In addition, we have about $1 million of reimbursement from insurance proceeds for California buyers in the first quarter. That's a non-recurring thing. And then we also had slightly fewer walkovers in the field who were not in the first quarter due to weather conditions.

So we would see those continuing to ramp back up as we move into the second quarter in addition to the acquisition integrations that will be underway.

Operator

Our next question comes from Leo Mariani of RBC.

Leo Mariani - RBC

Just trying to get a sense of when we can expect first production from your operating Granite Wash well program.

Mark Ellis

Yes, Leo, completion and frac work is planned right now for mid-May. And so after a flow back period, probably testing that well late May, stabilize production hopefully in the month of June, early June.

Leo Mariani - RBC

I guess that's on your first well, and I guess your second well would follow shortly thereafter, I imagine?

Mark Ellis

Yes, second well, I figure about 60 days, I guess, total cycles times. So we just spud that well. So look for that one out into the July timeframe.

Leo Mariani - RBC

And in terms of your production guidance, you guys mentioned that you are baking some into your guidance here for the Granite Wash. Just trying to get a sense of kind of magnitude of that there. Do you guys think you're being conservative on those volumes? It looked like that Questar-operated well was pretty damn good. Just trying to get a sense of whether or not there could be upsides to the Granite Wash here?

Mark Ellis

Leo, we do our business planning, we think, about 8 million a day, first 30-day stabilized rate, which comparatively speaking to the wells in the general area that looks pretty conservative. But that's on an [8-8] basis, of course. And our net ownership on our program is probably around 50% is probably a good way to think of our business going forward. So yes, there is upside in our volumes in terms of a well perform better than that 8 million a day average 30-day rate.

Leo Mariani - RBC

In the past, you guys have curtailed gas volumes in low-price environments. Have you done any of that yet or are there potentially any plans to do so if gas weakens?

Mark Ellis

We've not done any of that at this point in time. We're watching that pretty closely. We typically won't be exposed to that until prices for the foreseeable future, let's say, for a six-month window or something drop a little about 350, that's when we start getting sensitive. And we really have a very few wells that have the variable costs that it makes sense for us to show in that price.

Operator

Our next question comes from Adam Leight of RBC Capital.

Adam Leight - RBC Capital

A couple of quick financial questions. Can you give us an idea how much did you incur to put costs in the first quarter? Was it a second quarter event, and how much outlay that involved?

Kolja Rockov

Yes, Adam, most of it is going to be in the second quarter. It's hopefully another incremental 15 in the first quarter and then another 76 total through the balance of that will be in the second quarter.

Adam Leight - RBC Capital

To get to that pro forma liquidity number, maybe you can work with real numbers, how much cash was drawn on revolver?

Kolja Rockov

Yes, cash is a pretty minimal number. What will be drawn on the revolver pro forma for all the pending acquisitions will be roughly about $300 million. But I will point out as well that the borrowing base was reduced as a result of the bond offering. And when we looked at what our true borrowing base was even before we did any of these acquisitions it was $1.75 billion. We think that number is probably north of $2 billion. So I think at some point we will return back to $1.5 billion borrowing base against our $1.5 billion credit facility. So we'll be between $1.1 billion and $1.2 billion of available at that point. That's significant.

Adam Leight - RBC Capital

It looked a little different. How much pro forma cash flow from the pending acquisitions are you including in the second quarter guidance?

Kolja Rockov

Well, this is going to be adjusted for the time of close. I think the annualized rate on the two acquisitions was $45 million and $60 million respectively. And we're anticipating to close end of April.

Mark Ellis

We'll close tomorrow the first transaction.

Adam Leight - RBC Capital

If you can sort of give us a breakdown of the $224 million of cash flow from investing, how much of that was drilling and completion and how much was acquisition and other?

Mark Ellis

Adam, the $200 million development is going to be probably development 22 and then you got purchases of another 2. So it's $200 million roughly from acquisitions and the balance would be CapEx.

Adam Leight - RBC Capital

So most of the drilling CapEx will be weighted throughout the rest of the year?

Mark Ellis

Correct, yes. Correct.

Operator

Our next question comes from Jeff Robertson with Barclays Capital.

Jeff Robertson - Barclays Capital

In the Granite Wash play, do you all have any transportation issues or processing issues, and how are you dealing with the liquids rich gas up there?

Mark Ellis

All of our acreage there in the Texas Panhandle is dedicated to Enbridge. And right now there is faith on Enbridge system. And I think you might have noticed recently Enbridge made an announcement of expanding their cryo plant by, I believe, 150 million a day. So we're closely working with them to make sure that we have space available to move our commodity.

Operator

Our final question comes from Richard Dearnley from Longport Partners.

Richard Dearnley - Longport Partners

Good morning. I actually have two. The Ozona unit, what horizons are you producing from there? And does the second acquisition up in the Permian, the Wolfcamp Spraberry continue down into that area?

Mark Ellis

Obviously, the Wolfberry well on the westernmost margin of the Wolfberry trans. So if you were to look at the map there, I mean it's pretty extensible on that western side of that base. I don’t have a map in front of me to see exactly where that unit is.

Arden Walker

I am not aware of that either. I am not familiar of even that name.

Richard Dearnley - Longport Partners

It's on your slide six of the IPAA presentation.

Mark Ellis

If you don’t mind, I'd be happy to take your number and we can call you and give you the more color on that.

Richard Dearnley - Longport Partners

I'll give you a call. The second question is two or so years ago you had an organic growth target of 2% or 5%. And if I remember correctly, you guessed that the CapEx -- you would have to spend 20% or 30% of your cash flow to achieve maintaining production and then growing 2% or 5%. And if I remember that correctly, you'd have to spend 20% or 30% of your cash flow to maintaining production and then growing 2% or 5%. Do I remember that correctly? And then how was that changed over the next, say, three years with the special focus to the spending on the Granite Wash?

Mark Ellis

Initially, our targeted growth rates were anywhere from 3% to 5% range is what we typically targeted. And that was based on the inventory we had in place, our access to real growth through transactional activity. That's kind of what we targeted from an organic standpoint.

Right now, that inventory setting is far richer in terms of its productivity. And so what is moving our organic growth a bit is the fact that the wells that we're pursuing in the Granite Wash are obviously much more rate-efficient than what they were in the past.

So that will a tendency to push organic growth a little bit higher and level this out significantly higher than that 3% to 5% range. But we will balance that organic growth, again, I want to say, with some active acquisitions of more mature assets that have a very, very low decline rates.

Richard Dearnley - Longport Partners

And given your portfolio as it stands today, what would you guess the percentage of your cash flow is needed to just maintain production?

Mark Ellis

Prior to the acquisitions, it was in high-60s like $66 million I think is what we estimated. Right now, we're in the mid-80s with the addition of the two acquisitions that pushes our maintenance capital up in the 80s. But it's about 12% of EBITDA.

Operator

Thank you. That concludes our question-and-answer session. I will now turn the call back over to Mark Ellis for closing remarks.

Mark Ellis

Thanks, everyone. We appreciate your time today. And again, I just want to close by saying that Linn Energy continues to be very financially sound, operationally strong, and we're looking forward to another successful quarter. Thank you.

Operator

Thank you for participating in today's call. You may now disconnect.

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Source: Linn Energy, LLC Q1 2010 Earnings Call Transcript
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