Vanguard Natural Resources, LLC. Q1 2010 Earnings Call Transcript

May. 3.10 | About: Vanguard Natural (VNR)

Vanguard Natural Resources, LLC (NASDAQ:VNR)

Q1 2010 Earnings Call

May 3, 2010 11:00 am ET

Executives

Lisa Godfrey - IR Manager

Scott Smith - President and CEO

Richard Robert - EVP and CFO

Britt Pence - VP of Operations

Analysts

Eli Kantor - Jefferies

Joel Havard - Hilliard Lyons

Ethan Bellamy - Wunderlich Securities

Richard Dearnley- Longport Partners

Operator

Good day, ladies and gentlemen. Welcome to the Vanguard Natural Resources, LLC first quarter 2010 earnings conference call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions. (Operator Instructions) This conference is being recorded today, Monday, May 3, 2010.

I would now like to turn the conference over to Investor Relations Manager, Ms. Lisa Godfrey.

Lisa Godfrey

Good morning, everyone and welcome to the Vanguard Natural Resources, LLC first quarter 2010 earnings conference call. We appreciate you joining us today. Before I introduce Scott Smith, our President and Chief Executive Officer, I have some information to provide you. If you would like to listen to a replay of today's call, it will be available through June 2, 2010 and may be accessed by calling 303-590-3030 and using the pass code 4286946. A webcast archive will also be available on the Investor Relations page of the company's website at www.vnrllc.com and will be accessible for approximately 30 days. For more information or if you would like to be on our e-mail distribution list to receive future news releases, please contact me at 832-327-2234 or via e-mail at lgodfrey@vnrllc.com.

This information was also provided in this morning's earnings release. Please note, the information reported on this call speaks only as of today, May 3, 2010 and therefore you're advised that time sensitive information may no longer be accurate as of the time of any replay.

Before we get started, please note that some of the comments today could be considered forward-looking statements and are based on certain assumptions and expectations of management. For a detailed list of all the risk factors associated with our business, please refer to our 2009 10-K that is available on our website under the Investor Relations tab or on EDGAR.

Now, I would like to turn the call over to Scott Smith, President and Chief Executive Officer of Vanguard Natural Resources, LLC.

Scott Smith

Thank you, Lisa and welcome everyone and thanks for joining us today on this conference call to review our results for the first quarter of the year. I am joined today by Richard Robert, our Executive Vice President and Chief Financial Officer and Britt Pence, Vice President of Operations.

This morning, I'll start with a summary of our results for the quarter, briefly discuss that we accomplished in the field and then we will review the acquisition we announced this morning. I will then turn the call over to Richard for a financial review and then we will open the line up for Q&A.

First of all, our results were in line with expectations as we benefited from a full quarters contribution from the Permian acquisition in Ward County that we completed in December of last year. Our asset base in total continued to perform at projected levels.

From a capital perspective, we didn’t complete any drilling during the quarter on our major properties, but we did spend 1.6 million on initial drilling activities to be completed in the second quarter, workovers, pumping units and other projects. In addition, this quarter we prepaid drilling cost of 1.1 million for some of the drilling activity we expect to occur this quarter.

During 2010 first quarter, our average daily production rose 46% to approximately 26.1 million cubic equivalents per day from the 17.8 million cubic feet equivalent per day produced in the first quarter of 2009 and rose 8.3% over fourth quarter 2009 volumes. This increase reflects a full quarter contribution from both the recent Permian acquisition and the South Texas properties we acquired in August of last year.

Looking at our production on individual product basis, our year-over-year natural gas production rose 12% to 1.2 Bcf, oil production rose 72% to 132,000 barrels and NGL production increased [437,000%] to 57,000 barrels.

On a sequential basis, oil production was 26% higher than produced volumes in the 2009 fourth quarter. Natural gas production was 4% less than fourth quarter '09 volumes and NGL production was approximately 2% higher than fourth quarter '09 volume.

Including the positive impact of our hedges in the first quarter, we realized the net price of $10.12 per Mcf for natural gas, $77.28 per barrel of crude oil and $1.20 per gallon of natural gas.

With respect to our lease operating cost, in the first quarter our average LOE was $1.74 per Mcfe, which compares to $1.54 per Mcfe in the fourth quarter of 2009. The bulk of this increase was attributable to replacing tubing strings and adding pumping units in some of the Ward County wells, most of these costs were expected as the wells need this equipment once they reach a certain production level.

We continue to focus our efforts on reducing LOE through increasing pumping efficiency and shutting in high LOE wells, which contribute literally no value from a revenue perspective.

As I mentioned previously, we spent a small amount of capital in the first quarter. We have ramped up our activity in the second quarter with the drilling of horizontal Olmos wells with our operating partner Lewis and South Texas and with the drilling of our first PUD location in the Ward County property.

Olmos horizontal well is currently be completed and although early appears to be a nice well with the production rate of approximately 1 million per day during the clean-up stage.

The Ward County well has been drilled through the vertical section and we are now drilling the horizontal leg targeted at approximately 3000 feet. So far this well is a week or so ahead of schedule and we hope to have this completed at the end of the quarter.

We have also begun drilling five wells program to develop oil reserves with our Appalachian drilling partner Vinland and are anticipating some good results from this effort.

Now onto the news we announced this morning. We are very pleased that we have entered in to purchase and sell agreement for the acquisition of our portfolio primarily oil producing assets in Mississippi, Texas and New Mexico for purchase price of $113.1.

Reserves being acquired approximately 4.7 million barrels of oil equipment and we estimate the production right at closing prior to the end of the month will be approximately 850 barrels a day since we are currently in the process of completing a recently drilled well.

The production being acquired is very low associated operating costs and therefore the margin we see on each barrel produced is much higher than we typically see in mature producing results.

There is an inventory of 16 identified PUD locations, that we are in our operating partners in the wells plan to develop over the course for the next three to four years. This drilling should allow us to maintain current production rate over this time period. These PUD locations are all oil related projects and have projected rates of return in excess of 100%, using strip pricing. First of these locations we expect to be drilling next month.

With respect to other acquisition opportunities, I think we are seeing most of the assets in the market that are appropriate for our structure as well as many asset packages, where the undeveloped component is too large percentage of value considering the amount of reinvestment we can make and still make distributions.

There have been numerous announcements of asset sales by select majors and margin dependents. So the market should be well supplied for the next several quarters. We will continue to look at and evaluate opportunities to acquire high quality reserves at attractive metrics that would be accretive to cash flows and produce stable production volumes to support our distributions going forward.

Thanks again for joining us this morning and I will turn the call over to Richard for the financial review.

Richard Robert

As Scott mentioned, we are pleased with our first quarter results. The first quarter of 2010 we generated adjusted EBITDA of approximately $18.5 million, up 46% of the amount earned in 2009, and up 26% over the amount earned in the fourth quarter of 2009. The increase was primarily attributable to the impact of the accretive acquisitions consummated in August and December of last year.

We reported net income for the quarter of $21.7 million or $1.15 per basic unit compared to a reported net loss of $50 million or $3.98 per basic unit in the first quarter of 2009; however, both quarters included special items.

The recent quarter included $10.6 million of non-cash unrealized net gains in our commodity and interest rate derivatives contracts offset by a $270,000 non-cash compensation charge for the unrealized fair value of phantom units granted to management.

2009 first quarter results included a $9.8 million unrealized net gain in our commodity and interest rate derivatives offset by a $63.8 million non-cash impairment charge to our natural gas and oil properties and a $1.3 million non-cash compensation charge for the unrealized fair value of phantom units granted to management.

Excluding the net impact of the specific non-cash items mentioned above, adjusted net income was $11.2 million in the first quarter of 2010 or $0.59 per basic unit, as compared to adjusted net income of $5.4 million or $0.43 per basic unit in the first quarter of 2009.

It was nice not to have large non-cash impairment charge distorting the results this quarter. Hopefully, the impairment charges are behind us, but I continue to be concern that new acquisitions may resolve and are having to take additional impairment charges as a result of the new SEC last 12-month pricing calculation requirement.

As an example, the acquisition we announced this morning was model based on an approximate $90 per barrel four-year strip pricing area. We concurrently hedge and let’s sit down for all years after the hedging expires.

However, coming June 30, we will have to calculate our impairment test using the average of the last 12 months of oil price, which at March 31 was $67. Obviously the PV-10 of the properties using $67 a barrel versus a $90 a barrel is quite a bit lower. We would be require to record impairment if the full cost, full of all the properties wasn’t sufficient to make up the short fall in that one property.

Many of our investors understand the difference between a cash and a non-cash charge and adjust the reported results accordingly, but unfortunately there are so many they don’t take the time to differentiate and these large impairments make a difficult for the average investor to compare reported periods.

Moving on, as Scott mentioned, our lease operating expenses increased by approximately $900,000 in the first three months of 2010 as compared to the same period in 2009, which again was largely related to the full period of cost incurred on the Ward County acquisition and some high upfront costs associated with replacing tubing strings and pumping units.

Our selling, general and administrative expenses were $1.4 million for the quarter, which represented $1.8 million decline from the amount reported in the first quarter of 2009. This decline is entirely related to the difference in the amount of non-cash compensation expense recorded in each of these quarters.

I've spent a fair amount of time on our conference call last year, talking about the fair value of the phantom units granted to management and the resulting expense recorded on our books as our unit price improved throughout the year.

Unfortunately for management, our new three-year employment agreements do not have similar provisions and the fair value of the phantom units granted pursuant to our new employment agreements, generated a charge of $27,000 for the quarter compared to $1.3 million for the first quarter of last year.

In addition, in 2009 management finished investing in the majority of the units that were granted upon their initial employment, therefore the amount charge for non-cash unit compensation declined from $887,000 in the first quarter in 2009 to $254,000 in 2010.

Finally, our production and other taxes in the first three months of 2010 increased by approximately 146% to $1.6 million due to the significantly higher revenues recorded in the 2010 quarter as a result of more of our revenue stream coming from oil, which has increased in price.

For the first three months of 2009, our revenue from the sale of our commodities before consideration of hedging activities is approximately $9.2 million in 2010 that increased to $20 million. Also property taxes are recorded on this line in the income statement. The property tax accruals now include the two acquisitions in 2009, which also contributed to the increase.

Not a lot of capital was spent this quarter. Scott mentioned that we spent $1.6 million on a variety of small projects, which contributed to the high distribution coverage, 1.53 times. However as I said in the past, there will be volatility in distributable cash flow on a quarter-to-quarter basis.

As indicated in our press release, we expect capital expenditures of approximately $6.3 million for consideration of any additional spending on a new acquisition. This equates to approximately half of our capital budget for the year and we’ll have a significant impact on our reported distribution coverage for the second quarter.

Now, I would like to shift the discussion to our leverage and liquidity. Our borrowing base is currently set at $195 million. We were in the middle of our regularly scheduled semi-annual borrowing base redetermination, but the process was delayed as a result of the impending acquisition. We were anticipating a small decrease to the borrowing base, but with the inclusion of the new acquisition, we expect that the borrowing base will be significantly increased prior to this redetermination and the impact of this acquisition and approximately $67 million available under the facility.

This acquisition should have many positive impacts for being our and its unitholders. Whenever we present in conferences and speak to investors, we emphasize that one of the major benefits of our size is that acquisitions have a meaningful impact on our distributable cash flow. This acquisition is no exception. Unlike some of our larger peers, we were able to increase our distribution after the last acquisition and upon closing this acquisition, we will make a commendation to our Board of Directors increase our distribution again.

That being said, we have also told our investors that we have elected to use some of the [accretion] from new acquisitions throughout our cash flows in 2012 when our natural gas hedges expire. This way we are not forced to hedge natural gas at current prices, essentially we’ll create an option for ourselves on natural gas pricing. I don’t prove we will be able to maintain our distribution, but if they do go up by 2012, it will be in a very good position to capitalize on increased cash flow to be able to distribute that to our investors.

Finally, now that we have remedied any cash shortfalls related to natural gas hedges falling off, we should have more leeway in increasing distributions in the future, free cash flow from future acquisitions.

In terms of our growth prospects, Scott already summarized our feelings, that the acquisition market should be well supplied for the next several quarters. We are confident that given access to capital at reasonable cost, we will be able to successfully grow this company via acquisition.

We appreciate our investor's continued support and look forward to a great year. This concludes my comments, we will be happy to answer any questions you may have.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Eli Kantor with Jefferies.

Eli Kantor - Jefferies

What’s the maintenance capital program associated with the recent acquisition? How does it impact your $13million 2010 program?

Richard Robert

We are anticipating a pretty low reinvestment requirement on this acquisition. That's one of the great things about this acquisition, the low rate investment requirement to maintain production and we expect that number to be somewhere between 10% and 15% of EBITDA. We do expect to spend that money this year as well, so it will be added to the forecast, but keep in mind that, till we close the acquisition, we don't want to talk too much about our forecast, but needless to you will be updated as soon as we do close.

Eli Kantor - Jefferies

Just in regard to the drilling inventory I think I missed the PUD location number that you guys threw out, but how many wells are coming on production there? How many wells are unbooked or prospects are unbooked there and then again just what’s the PUD location number?

Scott Smith

We have 16 identified PUDs. The total well count on a gross basis is 73 total well.

Eli Kantor - Jefferies

How many drilling locations are have you guys identified that are currently unbooked?

Scott Smith

Those are unbooked?

Eli Kantor - Jefferies

Yes.

Scott Smith

I’m just giving you the numbers we have booked. We didn’t get into probable or possible.

Eli Kantor - Jefferies

Okay, and then just lastly can you give any color in terms of the types of formations that you guys are targeting the completion methodology, cost per well in this new area?

Scott Smith

The bulk of the activity is all in Mississippi and the PV locations it’s a combination of Hosston, which is the Cotton Valley type of equivalent as well as there is the Rodessa, Sligo and there is some other upholds that look prospective but we didn’t have on it. These are conventional wells. There is no big crack. They are just great producers that come on at very nice rate and produce a long value.

Operator

Our next question comes from the line of Joel Havard with Hilliard Lyons.

Joel Havard - Hilliard Lyons

Good work. You may have said this not in cachet, but is you said the bulk of this is Mississippi. Do you have any regional, operational infrastructure there already?

Scott Smith

No, we don’t.

Joel Havard - Hilliard Lyons

You are not. Okay is that baked in to your cash flow comments earlier do we need to look for something different in G&A or what that?

Scott Smith

No, I don’t think so. All of these assets are operated by a local operator, who has an interest in the properties. The largest value property, we will have the right if we ever chose to do so to takeover operations, but again this guy is doing an excellent job makes operating cost and again that's one of the real drivers of this acquisition. Like I said, the very, very low operating costs that this guy has been able to do and maintain over the years we don’t see any reason to change.

Joel Havard - Hilliard Lyons

Are the Texas and New Mexico properties that come with this and this is all one transaction I presume?

Scott Smith

That's correct.

Joel Havard - Hilliard Lyons

The Texas and New Mexico properties, are they more or less or generally contiguous to your West Texas operations now?

Scott Smith

No, they’re really they’re spread all over the place. The Texas and New Mexico percentage of this deal is less than 10% and it just hodge-podge assets all over the place. As we get into it, there maybe some opportunities to acquire some more interest in some of these, but they were not the driver of the transaction.

Joel Havard - Hilliard Lyons

I guess is too preliminary, but any thoughts on the funding structure?

Scott Smith

We are looking on alternative and obviously we want to continue to keep fairly conserved capital structure, but we are actively looking at our options at this time.

Joel Havard - Hilliard Lyons

I think you touched on it and I missed that for sure. The CapEx forecast for 2010 with and without the acquisition and what would be the part?

Richard Robert

Our 2010 forecast before this acquisition was $12.5 million to $13.5 million. The incremental CapEx related to this acquisition is probably going to be somewhere in the $2 million to $2.5 million range.

Operator

Our next question comes from the line of Ethan Bellamy with Wunderlich Securities.

Ethan Bellamy - Wunderlich Securities

What’s your total cost estimate on the bones springs horizontal well?

Britt Pence

On the bone spring $5 million all in.

Ethan Bellamy - Wunderlich Securities

Do you guys have a target IRR you could disclose there?

Britt Pence

Yes, well, when we ran our numbers it is roughly about 30%.

Ethan Bellamy - Wunderlich Securities

Okay. With respect to the acquisition, are there opportunities for Bolton around there and would you expect with the operator to have a similar relationship to what you with have Lewis right now?

Scott Smith

In this case the operator has a much smaller percentage and this guy was evolved in the drilling these properties initially and with them a long time and you again has a much smaller interest. With respect to Bolton’s, we’ll see what happens. There are other interest owners in these properties obviously if they are interested in discussing possible unit. Selling all our portion if they’re interest we’ll definitely talk to them and there are fields nearby that again looking at the production rates and the profiles look like there would be very attractive possibilities for us and once we get close and start looking further in to the area. I think hopefully we expand our interest.

Ethan Bellamy - Wunderlich Securities

Okay last question. What’s the natural decline rate on all your assets now, pro forma for the acquisition?

Scott Smith

We are looking at about 16% decline on PDP, but obviously with the capital investment, if that is close to zero, we can.

Operator

(Operators Instructions) We do have one more question from the line of Richard Dearnley with Longport Partners.

Richard Dearnley- Longport Partners

The comment about, how this acquisition essentially fills the decline in hedge prices, or the lack of hedges in 2012? Would you amplify on that please?

Richard Robert

Sure. As you can see from our financial results, a portion of our cash flow that we are generating now comes from the natural gas hedges that we have in place, and currently we have been cognizant of the fact that when those hedges were lot we will have less cash flow. So we have elected and we have told the street that we are going to fill that decline with the accretion from new acquisitions. That's what this acquisition has done for us. It basically filled that gap.

Richard Dearnley- Longport Partners

So, in your mind it totally fills the gap created by the fact that there are no hedges in 12?

Scott Smith

It allows us to have comfortable distribution coverage in 12. It’s our forecast.

Operator

(Operator Instructions). We do have a follow-up from the line of Ethan Bellamy with Wunderlich Securities.

Ethan Bellamy - Wunderlich Securities

Real quick guys, what are you seeing on service cost?

Scott Smith

Britt I’ll let you to take care of that, if you don’t mind.

Britt Pence

Well, on the service cost, I’ll say this on drilling; feel like we are in a good position to keep the cost down. We haven’t see it relatively flat on the rig rates, which is nice, when you are drilling oil and oil prices are high and I think that because we are in a environment, where the gas prices are low and so that helps to keep things going to balanced out on the rig rates. There are some of the service cost, which seem to be going up, the fracing some of that seems to be creeping up on costs, but other services that seem like pretty flat on LOE and other cost.

Operator

Thank you and management I’m showing no further questions in queue at this time.

Scott Smith

Okay. Again thanks everyone for joining us today. We are again very excited about our new acquisition. Pleased with our results this quarter, looking forward to getting this transaction closed here by end of the month. Again, we continue to look at opportunities in the market, we continue to get bigger on behalf of the unitholders. Again, thanks, and we will talk to you again next quarter. Thanks.

Operator

Ladies and gentlemen, this concludes the Vanguard Natural Resources, LLC first quarter 2010 earnings conference call. You may now disconnect. Thank you for using ACT Conferencing.

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