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Vanguard Natural Resources, LLC (NASDAQ:VNR)

Q3 2010 Earnings Call Transcript

November 2, 2010 11:00 am ET

Executives

Lisa Godfrey – IR

Scott Smith – President and CEO

Richard Robert – EVP and CFO

Analysts

Richard Roy – Citi

Chad Potter – RBC Capital Markets

Michael Blum – Wells Fargo

Richard Dearnley – Longport Partners

Operator

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Vanguard Natural Resources third 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 Tuesday, November 2, 2010. I'd now like to turn the conference over to Lisa Godfrey with Investor Relations. Please go ahead.

Lisa Godfrey

Good morning, everyone and welcome to the Vanguard Natural Resources, LLC third 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 December 2, 2010 and may be accessed by calling 303-590-3030 and using the passcode 4379639. A website 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, November 2, 2010 and therefore, you are 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'd like to turn the call over to Scott Smith, President and Chief Executive Officer of Vanguard Natural Resources.

Scott Smith

Thank you, Lisa and welcome everyone and thanks for joining us this morning to review our results for the third quarter. With me on the call this morning are Richard Robert, our Executive Vice President and Chief Financial Officer and Britt Pence, our Senior Vice President of Operations.

I'll start off with the summary of our production and operations during the quarter then we'll discuss our development drilling activity. And I'll windup my portion of the call with some observations about the state of the A&D markets and our recent equity offering. Richard will then take over the call for a financial review followed by Q&A.

This quarter, we continue to set new highs in terms of production and adjusted EBITDA from our asset base. Another significant achievement is that for the first time our production mix is now weighted to greater than 50% of oil and natural gas liquids. This increase is – in relative oil production is supported by the contribution from our oil focused acquisitions and development activities over the last 12 months.

The levels of oil production we have seen are in line with the projections made when we closed these purchases. Over the next few months, we plan on focusing our development activities on additional oil projects primarily in the Appalachian region.

Now, on to production. During the third quarter our average daily production rose 49% to 30.5 million cubic feet equivalent per day, up from the 20.4 million cubic feet equivalent per day produced in the third quarter of 2009 and rose 11% over second quarter 2010 volumes.

Looking at the production on an individual product basis, our year-over-year natural gas production rose 11% to 1.9 Bcf, oil production rose 135% to just over 200,000 barrels and NGL production increased 50% to 2.2 million gallons. On a sequential basis, oil production was 30% higher than produced volumes in the second quarter of 2010. Natural gas and NGL production both remained stable at approximate increases of 2% and 4%, respectively, above last quarter's volumes.

The significant increase, we saw in overall oil production this quarter, is primarily attributable to the Mississippi oil acquisition that closed in May and to a lesser extent from a new well we drilled in the Permian Basin that we'll discuss in detail later. During the third quarter, inclusive of our hedges we realized a net price of $9.56 per Mcf of natural gas, $75.46 per barrel of crude oil and $0.99 per gallon of NGLs. These realized prices are comparable to the $10.09 per Mcf, $75.87 per barrel and $0.96 a gallon we realized last quarter and are reflective of the benefits of our overall hedging strategy.

Just an overview on our LOE, I'm very pleased to report that our average LOE [ph] during the quarter with the $1.73 per Mcfe, which is down 7% for the $1.86 per Mcfe, we saw in the second quarter of 2010. This reduction is attributable to several factors, the largest of which is the addition of the low cost production associated with the Mississippi transaction.

With respect to our capital spending, during the quarter, we spent approximately $5.6 million on development drilling, capital workovers and recompletions, which compares to the $6.1 million we spent in the second quarter of 2010. The expenditures were as expected and indicative of the activity level during the quarter.

The most significant capital expenditure this quarter was the drilling and completion of the Benjamin #8H well, a 100% working interest operated horizontal oil well in the Third Bone Spring play in Ward County, Texas. This development well was drilled on an HBP lease that was part of our Ward County acquisition that we completed last December.

This well was completed in late August at seven stages of frac and averaged approximately 400 barrels a day for the first 30 days of production. This well was producing about – between 100 and 200 barrels a day prior to the frac. So we're quite pleased with the results. There are five additional PUD locations in this project that we intent to do – drill and develop over the next two to three years.

We anticipate during the fourth quarter this year, we will complete five vertical oil wells in Appalachia at a total – net cost to us about $1.5 million. This will put our total capital spending for the year at approximately $14.7 million, which is at the lower end of our revised guidance number that Richard released.

Now, few comments on our equity offering in A&D market. In October, we were pleased to complete our largest public equity offering to-date of just under 4.8 million of our common units. These units were offered to the public at a price of $25.40 a unit, which is 10% higher than the $23 price of the units sold in our May 2010 offering and 41% higher than the $18 unit price that we sold units for in December of 2009.

We're very proud of our track record, successfully access in the equity market and putting the money to work through accretive acquisitions, which supported the increases in our distribution. This activity has led to a higher unit price, which has contributed to a lower cost of capital and less solution at each subsequent equity offering.

In light of the very active A&D market, we changed our strategy somewhat this time and are likely to generate additional liquidity to fund a future acquisition before announcing an acquisition. Post the outcome of the borrowing base review, Richard will discuss later. We expect to have approximately $171 million of liquidity to draw on for future acquisitions.

A&D market continues to be well-supplied with domestic assets for sale. However, as one would expect much of this activity is focused on the unconventional but liquids-rich plays such as the Eagle Ford, Marcellus and Wolfberry trends. We continue to actively screen, evaluate and make proposals for acquisitions with long-life low-declining assets to fit our business model.

The market for these type of assets remains very competitive with ample liquidity and ability to close quickly. We believe we're in a great position to take advantage of opportunities, which may become available. That wraps up my remarks and I'll now turn over the call to Richard for the financial review.

Richard Robert

Thanks, Scott. Good morning. We are pleased with our third quarter results. For the third quarter of 2010, we generated record adjusted EBITDA of $22.2 million, up 42% over the amount earned in 2009 and up 16% over the amount earned in the second quarter of 2010. The increases are primarily attributable to the impact of the accretive acquisitions consummated in December of last year and May of this year.

We reported net income for the quarter of $1.9 million or $0.09 per basic unit compared to a reported net income of $0.7 million or $0.05 per basic unit in the third quarter of 2009; however, both quarters included special items. The recent quarter included $10.7 million of unrealized net losses in our commodity and interest rate derivative contracts, offset by a $55,000 non-cash compensation charge.

The 2009 third quarter results included $12.8 million in unrealized net losses in our commodity and interest rate derivatives and a $0.8 million non-cash compensation charge. Excluding the impact of these specific non-cash items, adjusted net income was $12.7 million in the third quarter of 2010 or $0.57 per basic unit, as compared to adjusted net income of $8.4 million or $0.58 per basic unit in the third quarter of 2009.

Our lease operating expenses increased by approximately $1.5 million in the third quarter of 2010 as compared to the same period in 2009, which again was largely related to a full period of costs incurred on the December 2009 and May 2010 acquisitions. However, as Scott mentioned, our LOE declined to $1.73 on an Mcfe basis, as compared to $1.77 in the third quarter of 2009 and $1.86 last quarter. As anticipated, the decline was largely driven by the low production costs recorded on the Parker Creek, Mississippi acquisition.

Our selling, general and administrative expenses declined 48% to $1.1 million for the third quarter from the $2.1 million reported for the third quarter of 2009. However, if you exclude the non-cash compensation expenses recorded in each period, there was little change in our SG&A. We are proud of the fact that we’ve been able to grow the production of the company by approximately 64% over the last two years and yet there has been very little change in our SG&A expense. Bottom line is that we are very conscientious about how we spend our SG&A dollars. Finally, our production and other taxes in the third quarter of 2010 increased by approximately 80% to $1.8 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.

In the same quarter of 2009, our revenue from the sale of our commodities before consideration of hedging activities was $11.3 million and in 2010, it increased to $22.7 million. We spent the majority of our drilling capital in the second quarter and in this quarter. As a result, our distribution coverage was negatively impacted and yet we realized almost 1.2 times coverage.

With our anticipated spend of $1.5 million in the fourth quarter, our drilling capital expenditures for the year is expected to total $14.7 million, which is on the low end of the revised financial guidance numbers, I released in late June of this year. We continue to expect an annual distribution coverage of between 1.25 and 1.3 times, which includes the dilution from the new equity this quarter and no assumption that a new acquisition will be consummated before year end.

Now, I'd like to shift the discussion to our leverage and liquidity. Our borrowing base is currently set at $240 million. Our banks are in the process of completing our semi-annual borrowing base redetermination. Based on the recommendation of our agent bank, we are anticipating a $15 million reduction to the borrowing base but after paying down the facility with the proceeds of the recent equity offering, we will have more liquidity than ever before.

After the impact of the redetermination, we expect to have $171 million available under the facility, as we continue to actively look for accretive acquisition opportunities. We appreciate our investors' continued support and confidence in our ability to put their capital to work in a timely manner. This concludes my comments and we'd be happy to answer any questions you may have.

Question-and-Answer Session

Operator

Thank you, sir. We will now begin the question-and-answer session. (Operator Instructions) Our first question comes from the line of Richard Roy with Citi. Please go ahead.

Richard Roy – Citi

Good morning.

Richard Robert

Good morning, Richard.

Scott Smith

Good morning, Richard.

Richard Roy – Citi

Scott, in your prepared comments, you mentioned that the A&D with stable production group of assets is very competitive and I think last quarter you mentioned that you made some bids for acquisitions that didn't end up getting. Could you just give us more color on as to who you're seeing at the table for these – I mean is it other MLPs, is it private C corp., could you just give us some more detail on that and also do you have bids outstanding currently?

Scott Smith

Well, one, we don't make any comments on bids we have out current but I will say on – there are property packages that we made assets on. Some of those seller elected to pull the transaction, never sold. There has been other transactions that I don't think any of them were of that I can recall that were bought by other or MLP peers. Most of them have been bought by either start-up private equity backed companies, that's really where I'm – that we're seeing I think most of the competition and that goes from smaller transactions in the sub $50 million up to $100 million of transactions.

That probably really is mostly attributable to the Permian Basin, which – that's where we've seen a lot of activity, I think sellers have been trying to monetize in this oil price environment that we're in. And the competition is just really very, very fierce for these type of assets and we've been disciplined in our valuations and – but haven't been worked very successful on some of these packages.

But it hasn't really been the MLPs. Again, I think some of our peers have gone after projects that have much more percentage of PUD reserves and again that's not the arena that we're looking at.

Richard Roy – Citi

Great. Thank you.

Scott Smith

You're welcome.

Richard Roy – Citi

And just a question for Richard. With the borrowing base determination, it sounds like the borrowing base is going to be redetermined downward. Is it because the banks are using a lower natural gas price deck in the out years? Is that what's driving the downward redetermination?

Richard Robert

Yeah. Certainly, that is a big part of the redetermination decline, is that the banks have lowered their price check on the natural gas side. But all things remaining equal, our production is being produced and so you would expect a decline absent in other acquisition or if – unless we put a lot of money into drill bit and increase our reserves that way, looking for (inaudible). But that is the majority of the decrease. It's the rolling off of hedges, obviously, as well as the decline in the natural gas price.

Richard Roy – Citi

Got it. And can you tell us what they're using at this point?

Richard Robert

I think every bank has a different price check. But my impression is that lot of them – and granted, these are the banks that need to be conservative, they're…

Richard Roy – Citi

Certainly, certainly.

Richard Robert

I think they're typically using a tail, which is, what impacts us the most is the tailpiece and I think they're using 4.50, 4.75, or something like that.

Richard Roy – Citi

Got it. Perfect. Thank you very much.

Scott Smith

Welcome.

Operator

Thank you. Our next question comes from the line of Chad Potter with RBC Capital Markets. Please go ahead.

Chad Potter – RBC Capital Markets

Question on the Bone Springs well, how much did that well cost out of 10?

Scott Smith

We round up spending about $6.3 million on that total, which was about 20% higher than our AFP [ph].

Chad Potter – RBC Capital Markets

Was the higher cost due to frac costs?

Scott Smith

Partially, it was frac costs, part of it was when we drilled the well, we had wanted to use a Packers Plus type frac system and when we got the horizontal section of the hole, we basically were not able to get that type of system deployed.

So we wound up having to use a flush joint liner, which again was more expensive. And then the fracking through that flush joint liner which is more expensive than the Packers Plus. So that was – that's probably the largest increase with having to go and complete the well using that technique.

Chad Potter – RBC Capital Markets

And what was the lateral length on the well?

Richard Robert

4,000 feet.

Chad Potter – RBC Capital Markets

4,000 feet. Okay. And yeah, I guess sticking with the Bone Springs for a second, you guys have five PUDs in inventory, you said over the next two or three years. I mean are you still kind of sticking with probably two wells a year, plan there?

Scott Smith

That's kind of what we're thinking right now. Even at the 6 to – a little over $6 million well, I mean this well came in above expectations on producing rate, still has a great IRR. If oil prices continue to see the strength that we have, we might accelerate that to three wells a year, but I don't think we'd go any more than that.

Chad Potter – RBC Capital Markets

So would you – at this point, would the plan be the, the next well comes in first quarter or second quarter of next year?

Scott Smith

It will probably – management will start planning – it'd probably, I will tell you, a lot of it will depend on rig availability, Chad.

Chad Potter – RBC Capital Markets

Yeah.

Scott Smith

There are certain types of rigs that you really want to use in this type of well. And being a company that only drills one or two of these a year. We're not saying – the first call that they make when they're looking for to place this rig. So we're out there, trying to secure it and hopefully we can get the right type of rig with the right horsepower and get it scheduled sometime in the first quarter, early second quarter.

Chad Potter – RBC Capital Markets

Understood. And I guess finally probably for Richard, just sort of the quarterly question is, with the kind of updated thoughts on maintenance CapEx either or both absolute and on a, maybe relative to the EBITDA base?

Richard Robert

Excuse me.

Chad Potter – RBC Capital Markets

You still haven't shaken that cold from (inaudible), have you?

Richard Robert

Yeah. I’m still getting over it. It's been a few weeks now. Yeah, I mean, from a maintenance perspective as we've indicated, we're looking to spent about $14.7 million this year, we’re spending, which is on the lower end of our guidance.

And yet we're still going to achieve adjusted EBITDA in the upper end of our guidance. So on an ongoing basis – the maintenance CapEx really depends on which wells that we drill frankly, but it's still somewhere in the $15-$16 million range, is what I would expect.

Chad Potter – RBC Capital Markets

Thanks, guys.

Scott Smith

Yeah.

Operator

And our next question comes from the line Michael Blum with Wells Fargo. Please go ahead.

Michael Blum – Wells Fargo

Hi. Good morning, guys.

Scott Smith

Hi, Mike.

Michael Blum – Wells Fargo

While most of my questions were asked, but just a couple. One, just to back to the borrowing base, was there any change in the banks oil deck and or they – has that pretty much stayed where it was?

Scott Smith

Yeah. I think the banks pretty much kept their oil deck flat. I think, a couple of them may have raised it, a couple of dollars but nothing significant.

Michael Blum – Wells Fargo

Okay. And then just, and I apologize if this was in the release, I don't have it in front of me, but have you provided a 2011 budget or shall we just expect it to be around that 15 to 16 million number?

Richard Robert

Yeah. I mean that's – I typically have provided guidance in conjunction with our year-end conference call and so I'd anticipate doing the same again. But, yeah, I'm not anticipating a big difference in our anticipated CapEx.

Michael Blum – Wells Fargo

Okay. And then last question is just now that you're kind of sitting at a 50% oil NGL, 50% gas, going forward do you see yourselves having any preference and is there a difference when you are in the market in terms of the competitive level looking for oil versus gas right now?

Scott Smith

We'll look at any – basically a gas deal or an oil deal, Michael, we know it's really just a matter of economics and the opportunities there. There is again, there has been a lot of properties in the Permian being marketed. And obviously, I mean, we're going to take a long hard look at that and I think we can be competitive. But some people look at valuation obviously differently than we do. So maybe it's how they risk certain categories but again we're looking at gas deals, oil deal, gas – with locked NGL deals. There isn't anything that we won't consider.

Richard Robert

But in terms of our drilling dollars obviously we focus that on our oil prospects and we'll continue to do so.

Scott Smith

And gas and high NGL deals. To the extent, we'll probably drill a few wells in that space as well.

Michael Blum – Wells Fargo

Great. Thank you very much, I appreciate it.

Scott Smith

Thank you.

Operator

Thank you. Our next question comes from the line of Richard Dearnley with Longport Partners. Please go ahead.

Richard Dearnley – Longport Partners

Good morning. Could you talk about both in the short-term but then the longer term model? As I understood, it used to be that you would raise 60% of your acquisition money in the equity markets and then use debt for the rest. And then you over equitized because of the '09 experience and, sort of, got the equity ratio up within the last acquisition or two was still all equity. Is that a change and where do you see this going? I realize the decreased borrowing base probably feeds into that so you might weave that into the answer as well.

Richard Robert

Yeah. I mean, we clearly made a conscious decision to lower our leverage. When back in early '09 liquidity got pretty tight there for a while when banks were reducing their borrowing bases and price decks were coming down hard and that's something that we consciously decided we wanted to avoid going forward. So yes, we did over equitized per se the next couple of acquisitions and yet we still were able to raise our distribution, that's the important point.

I mean we may be over equitizing, but we're also making good deals that allowed us to raise our distribution at the same time. And that's something that we're quite proud of the fact that we have been able to delever somewhat and raise our distributions. So I think we're doing our investors a service by doing stuff. Going forward, I think we'll be looking at each transaction kind of on a standalone basis. There may be situations where we'll have to lever ourselves temporarily with the idea of delevering over a period of time.

Richard Dearnley – Longport Partners

So does – are you seeing that the – in general, the plan is to increase the equity ratio, sounds like well above 60%?

Richard Robert

No, I mean it's more of a debt-to-EBITDA level that we're comfortable with. Our debt-to-EBITDA level is down about to two times level, which is kind of our comfort level. We'd like to see it lower. But that's certainly a number that we feel very comfortable operating in and we feel is the differentiator as I think that's one of the lower ones in our peer group.

Richard Dearnley – Longport Partners

Okay. Thank you.

Operator

Thank you. (Operator Instructions) And I'm showing no further questions in queue. I'd like to turn the call back over to management for closing remarks.

Scott Smith

Okay. Again, everyone thanks again so much for joining us. Again, we're very pleased with this third quarter. Again, we're very active in the market. We have – there is lot of interesting things going on and we look forward to having hopefully a great rest of this year as we head into 2011. So again, if anybody has any questions, please feel free to call Richard and I on our numbers. Thanks. Bye.

Operator

Thank you. Ladies and gentlemen, this does conclude our conference for today. We'd like to thank you for your participation and you may now disconnect.

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