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LRR Energy LP (NYSE:LRE)

Q1 2014 Earnings Conference Call

May 2, 2014 11:30 a.m. ET

Executives

Jaime Casas – VP, CFO and Secretary

Eric Mullins – Chairman and Co-CEO

Charles Adcock – Co-CEO

Tim Miller – VP and COO

Chris Butta – VP and Chief Engineer

Analysts

Kevin Smith – Raymond James & Associates

Ethan Bellamy – Robert W. Baird

Praneeth Satish – Wells Fargo Securities, LLC

Mike Schmitz – Ladenburg Thalmann

Abhishek Sinha – Wunderlich Securities

Operator

Good morning. My name is Holly and I’ll be your conference operator today. At this time, I’d like to walk on that brief line to LRR Energy Quarter One 2014 Earnings Conference 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).

I would now like to turn today’s conference over to Jaime Casas. Please go ahead, sir.

Jaime Casas

Thanks, operator and good morning everyone. Welcome to LRR Energy’s first quarter 2014 earnings conference call. Also presenting this morning are our Co-Chief Executive Officers, Eric Mullins and Charlie Adcock; and our Chief Operating Officer, Tim Miller. Chris Butta, our Chief Engineer is also with us and available for questions.

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 risks and uncertainties and may not prove to be accurate. These risks and uncertainties are included in the Risk Factors section of our 2013 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 ratio 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 Mullins

Thanks, Jaime and good morning everyone. We appreciate you joining us for our first quarter conference call. In a few minutes, Charlie, Tim and Jaime will discuss our results in detail. But in summary, we are pleased with our first quarter operating and financial results.

For the first quarter, production averaged 6,367 barrel of oil equivalents per day, adjusted EBITDA was $21 million flat, distributable cash flow was $13.4 million and our total unit distribution coverage was 1.02 times. First quarter financial results benefited from materially lower LOE and workover expenses compared to the fourth quarter of 2013.

During the first quarter we faced a couple of operational and infrastructure-related issues that impacted production. Despite the impact of these events, we were able to increase our adjusted EBITDA, distributable cash flow and distribution coverage ration compared to the fourth quarter of 2013.

On the acquisition front, we continue to see active deal flow in our currently evaluating transactions of various sizes, commodity mix and geographic footprints. While we can’t predict the timing of our next transaction, we are encouraged by the current backlog of potential transactions. We remain committed to a disciplined approach of acquiring assets that we believe are well suited for the MLP structure and that provide long-term distributable cash flow per unit accretion.

Turning to more recent developments, our Board of Directors confirmed the financial test required for conversion of one-third of our outstanding subordinated units into common units and that has been satisfied. Accordingly, 2.24 million subordinated units that Lime Rock Resources Fund 1 owns will convert on a one-for-one basis into common units on May 16, 2014. The conversion of the subordinate units will not impact the amount of cash distributions paid by LRE or 0.1 ownership percentage of LRE which was approximately 32% as of March 31, 2014.

As we had stated in the past, we believe the most efficient way to monetize the LRE common units held by Lime Rock Resources is to sell them over time alongside LRE in a marketed equity offering in conjunction within LRE acquisition.

Lastly, our Board of Directors declared an increase in our [indiscernible] distribution for the quarter bringing our current distribution to $0.49 and $1.25 per unit or $0.97 per unit on an annualized basis. The distribution will be paid on May 15, 2014 and represents the seventh consecutive quarter with a distribution increase.

With that, I will turn the call over to Charlie.

Charles Adcock

Thanks, Eric. I’d like to start by reviewing our operating results for the first quarter. Yesterday, we reported total net production of 573,000 Boe for the first quarter. Our production was 47% natural gas, 38% oil and 15% natural gas liquids for the first quarter. Primarily as a result of our continued liquids-focused development activity during the past year, we increased our first quarter liquids production mix to 53% from 44% during the first quarter of 2013.

Lease operating and workover expenses for the first quarter were $5.8 million or $10.18 per Boe, compared with $7.3 million or $12.21 per Boe in the fourth quarter of 2013. LOE for the quarter included approximately $200,000 of workover expenses. The 17% decrease on a dollar for Boe basis was primarily due to lower workover activity and field employee cost in the first quarter, higher equipment rental and severe weather-related cost in the fourth quarter and prior period accounting adjustments during the fourth and first quarters. For full year 2014, our LOE for Boe guidance remains at $10.50 to $11. Production and ad valorem taxes for the fourth quarter were $2.4 million or $4.19 per Boe and represented 7.6% of gross revenue. This is compared to the production and ad valorem taxes of $2.1 million or $3.56 per Boe in the fourth quarter of 2013.

I will now hand the call over to Tim Miller, who will provide more color on our operations for the period.

Tim Miller

Thanks, Charlie. For the first quarter, our average daily production was 6,367 Boe per day. LRE’s first quarter production was negatively impacted by flaring at our Red Lake field of approximately 75 Boe per day and by winter storms and other delays of approximately 100 Boe per day. At the Red Lake field, LRE is currently flaring approximately 15 Boe per day due to third party flat compressor limits. As a result of late first quarter development activity, improved weather conditions and less flare volumes, ad val’s average net production through to 25th was approximately 6,700 Boe per day.

For the first quarter, our total cash capital expenditures totaled $6.8 million. The majority of the capital was invested in our Red Lake field where we successfully drilled seven well, completed nine wells and recompleted seven wells during the first quarter. By virtue of continued drilling performance improvement, our Red Lake drilling program is approximately 24 days ahead of schedule through the end of April. As a result, we drilled and completed one more well than we ahead budgeted during the first quarter. Our first quarter new drills and recompletions exhibited initial production at or slightly above our expectations.

Our development plan for the second quarter is to drill eight wells which include four Red Lake wells, three non-operated Putnam wells and one non-operated Crow Canyon well and recomplete four wells at Red Lake. As a reminder, our 2014 capital budget is $34 million.

I will now turn the call back to Jaime, who will walk you through our financial results.

Jaime Casas

Thanks, Tim. For the quarter, adjusted EBITDA was $21 million, distributable cash flow was $13.4 million and distribution coverage ratio was 1.02 times. This quarter marks our fourth consecutive quarter with at least a 1.0 times distribution coverage ratio. Excluding our subordinated units, our common unit distribution coverage ratio was 1.36 times for the quarter. In addition to lower operating expenses, our first quarter results benefited from higher realized prices. Our realized oil price for the quarter was $91.67, which was a 1% increase over the fourth quarter of 2013. Our realized natural gas price for the quarter was $5.52, which was a 5% increase over the fourth quarter of 2013.

Next, I would like to provide an update on our current commodity hedge position, which reflects additional 2014 and 2015 oil and NGL swaps we entered into subsequent to the first quarter. Assuming the midpoint of our 2014 production guidance is held flat through 2017, our total production is 84% hedged for the remainder of 2014, 73% in 2015, 55% in 2016 and 44% in 2017. Weighted average prices during the period are $91.48 per barrel of oil and $5.02 per MMBtu of natural gas. More specific details of our hedge position are disclosed in our earnings press release.

Regarding our guidance for full year 2014, we still expect production to average between 6,400 and 6,600 Boe per day, LOE to average between $10.50 and $11 per Boe and our capital program to remain at $34 million. As previously mentioned, we entered into At-the-Market equity offering program in February. During the first quarter, we raised net proceeds of $4.2 million from the sale of approximately 260,000 newly issued common units. We believe the ATM program will allow us to incrementally add to our public equity flow and strengthen our balance sheet in an efficient manner over time. I would like to close with our balance sheet. As of today, we have $200 million of outstanding borrowings under our revolving credit facility and $50 million of outstanding borrowings under our term loan facility.

Our current liquidity position is approximately $58 million consisting of $50 million of availability under our revolving credit facility and approximately $8 million of available cash on hand.

Operator, that concludes our formal remarks and you can open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions). And your first question will come from the line of Kevin Smith with Raymond James.

Kevin Smith – Raymond James & Associates

Hi. Good morning, gentlemen.

Tim Miller

Good morning.

Kevin Smith – Raymond James & Associates

Congrats on the nice quarter. First question I had is how much flaring did you have during this quarter?

Tim Miller

This is Tim Miller. The flaring during the quarter was about 75 Boe per day, but it was really restricted to two primary events that frontier field services had. They had a problem with their sulfur treating unit at their plant and then they had one compression issue. We’re not seeing the continuous flaring like we had prior to them installing additional compressors late in the fourth quarter.

Kevin Smith – Raymond James & Associates

With the flaring of it, was that primarily January or February or was it equally kind of spread out through the quarter?

Tim Miller

There were two events, one was in February and one was in early March.

Kevin Smith – Raymond James & Associates

Okay. And then really is my second question, really the last one I had, would you mind providing more color on the prior period adjustment now though with that need a moving as far as this quarter’s expenses?

Jaime Casas

Yeah. Kevin, I’m Jaime. As relates to the prior period accounting adjustment, the majority of that was related to the fact that we under recruit for operating expenses during the third quarter, which we threw that up during the fourth quarter of last year. So, in a fact the fourth quarter was overstated or higher than otherwise it would have been because of that threw up. And then as in Q1 we didn’t have a threwup increase LOE, so you had option [ph] in LOE as compared to the fourth quarter result of that.

Kevin Smith – Raymond James & Associates

The Q1 wasn’t understated it. It should be your kind of normalized run rate. There shouldn’t be any sort of prior period noise in this quarter as such when you compared to fourth quarter. Is that fair?

Jaime Casas

That’s right.

Kevin Smith – Raymond James & Associates

Okay. Alright. Well, that’s all I had. Thanks.

Jaime Casas

There was also workover expenditures were about $400,000 less than the fourth quarter. So, we obviously get the benefit of that. And those are impossible to predict with any kind of accuracy. Basically, when the well goes down we have to go out to field and spend money to get it back online. So, we did have lower workover expenses during the quarter of $400,000.

Kevin Smith – Raymond James & Associates

Okay. Thanks. Appreciate the color.

Operator

And your next question is going to come from the line of Ethan Bellamy with Baird.

Ethan Bellamy – Robert W. Baird

Good morning, guys. Congrats on the solid quarter. Soon I think about the CapEx budget relative to what you’ve got third of the year behind us. As you go and look forward, does the CapEx as stated get us to 1.1 times coverage in the potential for distribution growth going forward or are we going to stick bit closer to 1 times and more kind of stable distribution and low single-digit growth? What’s your outlook there?

Jaime Casas

Yeah. Ethan, it’s Jaime. First of all, obviously we have public guidance. We don’t specifically guide on distribution coverage ratio. Having said that, our strategy is that on a quarterly basis we want to deliver and provide distribution growth, but given where we trade and given where our coverage ratio is, our primary focus is we want to build our distribution coverage over time to 1.2 times. And so as a result of our development program but also through acquisitions we should see that our focus in terms of any excess cash we have or any accretive deals that we do, the majority of that accretion is going to go towards distribution coverage until we get to a higher level and then once we’re comfortable with that we’ll focus more on distribution growth.

Ethan Bellamy – Robert W. Baird

Okay. You tell me, what I want is answer this. So, under the current commodity prices where can we expect that inflection point where you had that 1.2 times and things get maybe little bit more compelling in terms of growth opportunities on the distribution?

Jaime Casas

Yeah. And that’s obviously a very difficult question I answer because it’s a function of the timing of acquisitions, the size of the acquisitions and an accretion of the acquisitions as well as our ongoing operating activities. So, it’s impossible to give any color on that.

Tim Miller

Ethan, I’m Tim Miller. I will add to that. We are encouraged though we have been very busy, I would say over the course of the first quarter. Looking at potential acquisitions, we haven’t won any obviously, but we are looking at what we consider good transactions of property that would be good fits for us that potentially would be accretive. And given our size and the number of opportunities out there, we’re still very encouraged given what we’re seeing in terms of potentially finding the right acquisition for us over the course of the next year or so.

Ethan Bellamy – Robert W. Baird

Yeah. It’s cost equity and impediment there or is it other factors that are keeping you from winning auctions”

Tim Miller

No. I wouldn’t say that. I would say really it’s just been more that it’s a very competitive market and the price that we’re going to pay with we just haven’t won.

Ethan Bellamy – Robert W. Baird

Got it. And last question from me is with respect to acquisitions. What should we expect for the rest of the year on the dropdown front and what’s available there or is it going to be a third party year?

Tim Miller

Well. I would say obviously just in terms of a sheer volume of properties, we do have quite a few properties that are in a combination of Fund 2 and Fund 3. Today, I think, on an approved basis it makes up right at 54 million barrels of oil equivalents and I would say on a production basis we have about 9,700 barrel of oil equivalents per day that exist on those two funds. So, they’re in various stages of development. And we continually look at those to figure out when the right time would be for us to sell those properties and which properties would actually fit the LRR Energy structure. So, that’s an ongoing process that we monitor very closely and watch very closely. So, that’s…

Ethan Bellamy – Robert W. Baird

In fact in… It’s okay. Sorry, go ahead.

Tim Miller

Exactly when is just the raw data in terms of the factual size of that inventory. And you might have noticed just from previous quarters those numbers do continue to go up because we have added properties on the fund side recently. So, that continues to expand and create opportunities for us potentially as we go forward.

Ethan Bellamy – Robert W. Baird

In terms of financing those dropdowns, it looks like the parent has been a net seller of equity since the IPO and we probably expect that to continue. Correct? Does that oblate [ph] the control for the parent to take equity in a dropdown transaction? And at the parent level or the fund level, do you view the swap of assets for equity securities as somewhat of a deal risking? I’m just trying to understand if taking equity would be a financing tool you would use?

Tim Miller

I think it is a tool we have. It’s not something that I think we have. That’s an auction tool that if we chose to do that. The shares that we own right now is about 8.7 million units and those sit in Fund 1 only. The properties on the other hand are all in Fund 2 and Fund 3.So, you have separate funds obviously. And you’re right, we have had one sale. That was in conjunction with the primary offering that LRE had initiated in order to finance some earlier acquisitions and we think that’s a very efficient way to do it, we still believe that. We just piggy bag on that offering. And I think it’s about $50 million worth of secondary units that were held at Fund 1. And because it’s a marketed offering progress, we just think that’s a good way to monetise some of those holdings without disturbing the underlying unit price. And with the remaining units that we have, we obviously consider all options, but that to us is a very efficient way to over-time monetise those units. We aren’t in a big hurry to do that and our plan is to do it methodically so it won’t disturb the underlying price.

Ethan Bellamy – Robert W. Baird

Yeah. And remind me when that fund sunsets?

Tim Miller

Potentially, we have until the year 2017.

Ethan Bellamy – Robert W. Baird

Okay. Alright. Thanks much, guys. Appreciate it.

Tim Miller

Thank you.

Operator

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

Praneeth Satish – Wells Fargo Securities, LLC

Hi guys. Good morning. Have you look at all extending your midland [indiscernible] basis swaps looks like the differential wind up quite a bit here, just curious about your thoughts on that.

Jaime Casas

Yeah. Hi Praneeth. This is Jaime. We do regularly monitor that and we would like to add on more differential well hedges. We have about 65% of kind of current PDP as heads the rest of this year about $1. And so we definitely would look to and will probably add on more hedges, but obviously the differential is very wide at least over the next couple of months, late this year it gives close to $2. And so I think you should expect us to add on more oil differential hedges once the price is more attractive.

Praneeth Satish – Wells Fargo Securities, LLC

Okay. And then I’m just trying to figure out how much of the 6,700 barrels per day of production, April is kind of flushed production I guess, how much of a reduction could we see as we move through the quarter and rest of the year?

Charles Adcock

This is Charlie. You know a lot of ours were still sticking with our original production guns for the year and a lot of that has to do with your – you’re not talking about huge volumes here. That uplift from the 6,350 to 6,700 barrels is not that big a gap really. A lot of it’s a balancing act and what we try to do and we have that better over time is we try to do a fairly good mix of drill wells at Red Lake along with recompletions that hopefully balanced out the production and keep it relatively stable, but there are going to be very intense [ph] as we go through the year. And we have seen that going back to last year, but we’re still sticking with the original production guidance that we outlined for the year.

Praneeth Satish – Wells Fargo Securities, LLC

Okay, great. That’s all from me. Thank you.

Tim Miller

Thank you.

Operator

And your next question is going to come from the line of Mike Schmitz with Ladenburg.

Mike Schmitz – Ladenburg Thalmann

Yeah. Thanks. Great quarter. I have two questions. One, can you update us about your current inventory in the pertinent of [ph] Red Lake? And two, any additional color on this year’s Mid-Continent program?

Chris Butta

Yeah. This is Chris Butta. As far as the inventory at Red Lake, we still have well over 100 opportunities both from the growing and recompletion perspective in the Red Lake area and we are always looking at opportunities to add to that inventory on a go-forward basis, but at the moment we have a steady inventory going forward in the Red Lake area.

Tim Miller

Mike, this is Tim Miller. As far as the Mid-Continent activity goes, the operator there is a little bit behind schedule on their drilling, but they just reiterated to us here this week that they are still planning to move forward to plan as we had budgeted it. Also, I think the winter weather calm a little bit up there in terms of their drilling and completion work and they have a problem with the frac on one well and had to go back and refrac it. So, it’s a little bit behind schedule and that’s somewhat reflected in our… instead we would have a very minor impact on our first quarter production.

Mike Schmitz – Ladenburg Thalmann

Okay. And then second on acquisition, I know Eric you mentioned very competitive. What have you seen currently apart of meaning competitive other than somewhat you have seen from last year?

Eric Mullins

I’m sorry. Just to – you said what are the things…

Mike Schmitz – Ladenburg Thalmann

What do you think [indiscernible] last year one more opportunities and you change in the type of order that you’re seeing?

Eric Mullins

Not really. I’d say it’s kind of all over the map. We’re seeing both oil related transactions as well as gas related transactions, probably a little bit more of the later in comparing to previous years. I think geographically it’s also pretty well dispersed. We’re seeing deals all over in the Rockies, continuously deals in the Permian, little bit of South Texas, also the Mid-Continent. So, it’s been varied. Third quarter and fourth quarter last year were very, very robust in terms of just the sheer number of deals that we had to look at that we thought were interesting. It’s so down a little bit, I would say, in the first quarter but it’s been steady and hasn’t come to a stop at all and it’s been accelerating as of late going into the second quarter. So, all of that is very encouraging just in terms of what we have to look at as potential options.

Mike Schmitz – Ladenburg Thalmann

You said you’re still targeting at least $50 million to $100 million acquisitions per year?

Eric Mullins

Yeah. What we said is we would expect to do at least a $100 million per year. We would have been on a pace that’s a little bit slower than that, which we realized. But I think as we go forward in a year to two years and we look back and we would still very comfortable, we can hit a number like a $100 million per year. I think so far we have completed between $120 million and $130 million worth of acquisitions and has been two years in one quarter just to give you the stats.

Mike Schmitz – Ladenburg Thalmann

Great. Thanks a lot.

Eric Mullins

Truly.

Operator

(Operator Instructions). And your next questions comes from the line of Abi Sinha with Wunderlich Securities.

Abhishek Sinha – Wunderlich Securities

Yeah. Hi. Good morning. Quick one. Regarding the LOE, just want to get some signs like is it having you guys read the run rate or individually see some rules for more increase in efficiency or is it going to be more of one core activity function of that going forward?

Jaime Casas

Yeah. Abi, it’s Jaime. I think what I would say is that if you look at the fourth quarter, our total LOE including workover was $7.3 million and this quarter was $5.8 million. I’m having kind of run rate would be somewhere in between there. I think the fourth quarter was definitely a high quarter due to some things that just went normal for the period. And likewise given the fact that we had this prior period accounting judgment in the first quarter as well as lower workover expenses, the first quarter was probably lower than we would expect if you average out the next kind of one to two years.

Abhishek Sinha – Wunderlich Securities

Okay. And then regarding your acquisition and regarding your coverage ratio of 1.2 targeted, how much of acquisition has been in to that in a specific scenario [indiscernible] if I don’t see any acquisition happening? What do you think your coverage ratio could come down to?

Jaime Casas

Yeah. I think the 1.2 that we stated, that’s what we want our coverage to grow to. Before you’ll see us focused more on a higher distribution growth and in terms of when we get there and how long it takes, that’s frankly going to be – the main thing that’s going to drive that is the amount of acquisitions we do, when we do and how accretive they are, and those are very hard to accurately predict. Given our capital program I wouldn’t expect a material increase in our distribution coverage organically. I think most of our coverage is going to come to acquisitions.

Abhishek Sinha – Wunderlich Securities

That’s all. Alright. Thank you very much.

Jaime Casas

Thank you.

Operator

(Operator Instructions). And at this time we have no further questions. I’d like to turn the conference back over to management for closing remarks.

Eric Mullins

Thank you and we certainly appreciate everybody participating on the call this morning. Please don’t hesitate to give us a call us if you have any follow-up questions. Thank you.

Operator

Once again we’d like to thank everyone for their participation in today’s conference call. You may now disconnect.

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