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Penn Virginia Resource Partners LP (NYSE:PVR)

Q2 2012 Earnings Call

July 25, 2012 10:00 am ET

Executives

William H. Shea - Chief Executive Officer of Penn Virginia Resource GP LLC, President of Penn Virginia Resource GP LLC and Director of Penn Virginia Resource GP LLC

Bruce D. Davis - Executive Vice President of Penn Virginia Resource GP LLC, Secretary of Penn Virginia Resource GP LLC and General Counsel of Penn Virginia Resource GP LLC

Robert B. Wallace - Chief Financial Officer of Penn Virginia Resource GP LLC and Executive Vice President of Penn Virginia Resource GP LLC

Keith D. Horton - Co-President of Coal - Penn Virginia Resource GP LLC and Chief Operating Officer of Coal - Penn Virginia Resource GP LLC

Mark Casady

Analysts

Jim Spicer - Wells Fargo & Company

Elvira Scotto - RBC Capital Markets, LLC, Research Division

Operator

Hello, and welcome to the PVR Partners Second Quarter 2012 Earnings Call. [Operator Instructions] This conference is being recorded.

I'd now like to turn the conference over to Bill Shea. Mr. Shea?

William H. Shea

Thank you, very much. I appreciate it. Good morning, everyone. Thank you for joining us on our second quarter earnings call. With me today, I have Rob Wallace, our CFO; Bruce Davis, our EVP and General Counsel; Ron Page, our Senior Vice President of Midstream and Midcontinent; Keith Horton, our Senior VP of Coal; and Mark Casady, our Senior VP of Eastern Business -- Executive Eastern Midstream. Steve Milbourne, our Investor Relations Manager, is here; and I am here. So thank you again for joining us and, Bruce, would you like to give the forward-looking statements?

Bruce D. Davis

Thank you. In the course of our remarks and the subsequent Q&A session, we may be making forward-looking statements. For purposes of facilitating a good discussion, I'll refer you to the forward-looking statements, as referenced in this morning's press release, noting that our business is subject to a variety of risks and uncertainties. For a fuller discussion of these and other risks that could cause our results to change, please refer to PVR's Form 10-K most recently filed with the SEC.

William H. Shea

Thanks, Bruce. It goes without saying the second quarter was difficult for PVR. And in fact, it’s in stark contrast to how we view our future prospects, especially in the midstream business going forward. As a result of the discussions that we've had in the board in the last day and a half related especially to our future expectations, the board approved a $0.01 per unit increase on the distribution to $0.53 per unit or $2.12 a unit annualized. This represents an 8.2% increase versus the second quarter of 2011.

Our strategy to focus on the midstream business, particularly in the Marcellus, has and will continue to generate the returns in cash flow that we expect at PVR. I do, of course, have to comment on the quarter. As you can see from the press release, we're now managing and reporting our business along 3 business segments: Coal, Midstream Midcontinent, Midstream Eastern. This should make it a lot easier, I hope, for everyone to follow the performance of PVR.

In the Coal segment, we have adjusted EBITDA of $26.7 million versus $42.3 million last year. Volume was down 2.3 million tons. And the royalty pricing per ton was about $3.76 per ton versus $4.40 per ton last year. In the current environment, volume is more important and is a more important issue versus pricing. Keith can expand on the Coal segment as you desire during the Q&A segment. But it's clear that we have experienced reduced ships, extended vacations, idling of facilities and operator contract terminations.

In the Midcon Midstream segment, adjusted EBITDA was down $4.7 million from 2011. The decrease is almost entirely NGL price related as volumes were up on average 31 million cubic feet a day from 2011. What we're finding in the Midcon area is that activity levels are still high, producers are not backing off from the drilling plans but current NGL pricing especially the S.A. [ph] and the Conway [ph] is very low.

In the Eastern Midstream segment, adjusted EBITDA was up $12.5 million from 2011 to $17.2 million as a result of a Chief acquisition as well as what we're calling our legacy Lycoming County system. Volumes were 344 million cubic feet a day versus 38 million cubic feet a day last year, a substantial increase in activity. We closed the Chief acquisition on May 17, and we're very pleased with the integration of the operations and with the prospects in front of us as a result of this acquisition and the continued development of our Lycoming County system, the system that we entered the Marcellus with anchored by Range Resources. Today we're looking at 50-plus wells in both Lycoming and Wyoming County that has been drilled, completed and frac-ed waiting on us to hook them up, and we're diligently working on doing just that. As importantly, drilling activity continues to exceed our expectations in the Marcellus. And we're very, very thankful for that of course.

The current gas pricing in the strip are helping for sure, and so we expect to see that drilling activity continue throughout the year. We continue to expand our system in Lycoming County, batched up by our agreements with Southwest Energy, Range and an affiliate of Shell. This project, announced after the Chief acquisition, extends both the gas and the water pipelines beyond Phase 2 and will be online in the fourth quarter of this year, at which time we will bring incremental volumes onto the system.

Our Wyoming County truck line -- trunk line, a cornerstone of the Chief acquisition, is proceeding on time, on budget and we expect to start it up in early the fourth quarter. It will provide gathering and transportation to the Transco pipeline for Chief, Chesapeake and others. And today, going into the Transco pipeline is a much better alternative versus Tennessee. So we expect a lot of volume onto that line when it starts up. Remember, all of our Marcellus activities are fee-based and much of the initial activity is also batched up by take-or-pay agreements.

To date, we have invested about $130 million on internal growth projects during the second quarter including $106 million in the Marcellus. As of June 30, we had $560 million of capacity under our revolver. We have updated our guidance for 2012. We expect full year adjusted EBITDA now in the range of $245 million to $260 million and DCFs in the area of $120 million to $130 million.

For 2013, we expect coal to continue to be depressed and the slow recovery in NGL pricing. We also expect several internal growth projects of the Eastern region to partially offset these issues. 2013 guidance then is revised to adjusted EBITDA of $415 million to $480 million versus $480 million to $540 million.

If you -- if we achieve the midpoint, which we fully expect to that and more, our new guidance provides a distribution coverage certainly within the range of our 1.1x, but that's also impacted by financing and distribution decisions by the board but on a pro forma basis, gets us to that 1.1x. Providing guidance as we have certainly is appropriate for disclosure and for your analytical efforts but make no mistakes, I am very confident in our development plans in the Marcellus and believe we will achieve the results we've guided to. Coal, while a challenge in this environment, is still going to produce $100 million, plus or minus of adjusted EBITDA, and our Midstream Midcontinent results will positively reflect our increased processing capacity and a gradual increase in NGL pricing on a going-forward basis.

At this point, I will take questions. And we have business segment executives here as well as Rob Wallace, our CFO.

Question-and-Answer Session

Operator

[Operator Instructions] And the first question comes from Adam Light [ph] from RBC Capital Markets.

Unknown Analyst

I guess the first question on the revised guidance, especially for next year, how much of the midstream change is related to Midcon NGL versus any changes in expectations for the Marcellus?

Robert B. Wallace

Hello, Adam, this is Rob Wallace. And in looking at the revised guidance for 2013, about 2/3 of the reduction is due to our revised expectations on our coal royalty business. The remainder is, I think, split between the Eastern operations and the Midcontinent operations. I think now that we've taken over the ownership of Chief, we might have revised it down a little bit and then the other portion on Midcontinent is due to pricing. I think volumes, in general, in our midstream business, are not the issue. I think the issue is coming from the pricing side on the Midcontinent side. But I will say that in the Eastern operational area, we have -- now that we've owned Chief, we have run into a couple of permitting issues but nothing that we would view as very material. But it is reflected in the guidance.

Unknown Analyst

Can you give us a sense what the Chief's volume contribution was in the quarter?

Robert B. Wallace

I think it was about 220 million a day on average.

William H. Shea

Volume.

Robert B. Wallace

Volume.

Unknown Analyst

Yes. I got it. Okay. So the well permitting in Northeast Pennsylvania has been on a decline all except Lycoming. Rig count looks like it's coming down later in the year. For your volumetric guidance in Northeast Pennsylvania, you did not change your expectations for drilling activity or anything else for 2013? I'm just trying to get to that.

William H. Shea

In general, no, not to -- I mean, I think around the periphery, the numbers changed a little bit based on changes in plans from producers but not to a material amount.

Unknown Analyst

Okay. And can you give us a sense of how much impact Crossroads has on the numbers?

Robert B. Wallace

Sure. Crossroads is a plant that was in East Texas, an $80-million-a-day plant which was not part of, kind of, our core operations. We didn't see a whole lot of growth there, and it was sold July 3 to DCP for $63 million. On an EBITDA basis, that was somewhere in the area of $4 million to $5 million of EBITDA on our part.

Unknown Analyst

Okay. That's kind of what I thought. And so on the volumes at Antelope Hills, with the expansion, are you filling that up or producers reducing their production? And are you seeing any issues in the barrel mix? Are you're getting heavier barrels and sort of ethane rejection? And are those causing any mechanical problems or efficiency issues?

William H. Shea

Adam, I think the answer to that is that the -- I don't hear Ron Page on the line right now. The answer to that is that the Antelope Hills processing plant is filling up. I think we're doing about 355 million to 360 million a day, processing throughout the system with a capacity of around 400 million. So it is filling up I don't believe we're seeing any decline in drilling activity. And I will have to get back to you as to whether or not the barrels are heavier or have changed from what our expectations are. I don't believe so.

Robert B. Wallace

No, they haven't changed, Bill. And I think that, as far as ethane rejection, we did start to see ethane rejection in the middle of May. And that, of course, is driving a lot of our reestimate on the guidance. If you look at our -- at the average NGL barrel, probably almost 2/3 of it is ethane and propane, which have been the 2 products which have been impacted the most since, let's say, March or April. And so -- but the makeup of the barrel hasn't changed as a result of bringing on that new capacity.

Unknown Analyst

Okay. And I think you were talking about an additional 100 million cubic feet a day next year, is that sort of a status as to be determined, or is that moving ahead or...

William H. Shea

It's moving ahead. We have a spot in line for that plant. We continue to assess the market dynamics to see whether or not we'll need it. Fortunately, there is plenty of activity in the rest of the country and a couple of the other basins, as you know, Eagle Ford and the Permian as an example. So that we believe that if for some reason we were not to take delivery of that plant, we will be able to sell it or trade it out. But we have a spot in line should the volumes continue to develop in the -- in our Panhandle area.

Unknown Analyst

Okay. That's great. On coal revised guidance combination of volumes and prices, is that safe to say or is it skewed?

Robert B. Wallace

From our -- and from our perspective, the issue is mostly production, it's tonnage. And I would say they are probably 2/3 of the adjustment in our -- about 2/3 of our adjustment in our expectations is due to volumes. Its prices are definitely down, but the more material impact to our EBITDA is production. And you can't -- we just couldn't have seen, I guess, the impact of the warm weather and low natural gas prices and the impact they would have on coal demand since the beginning of the year.

Unknown Analyst

And you talked a little bit about contract rejections, can you, A, tell us where that is and, B, who your -- or what the proportion of top operators are and what -- any update on Patriot?

Keith D. Horton

Well, of course, the largest operator is -- it's Keith Horton. The largest operator is Peabody and their volumes have been largely unaffected by the -- since they sell into a niche market in the Southwestern United States. The Patriot bankruptcy, Patriot had operated on this in 3 locations: one, in West Kentucky, Central App and Northern App. Our conversations with Patriot to date, they have indicated that everything they have running, their anticipated plan is to continue to run. So the production really is not falling on account of the bankruptcy, although they have cut back some production in Central Appalachia. Our other major producers all have taken Central App in particular have taken hits in terms of volumes. Alpha [ph] [indiscernible] has, and what is going on is anything that was not sold, of course, at this point has been -- the spot prices that have been well below the producer's ability to sell, so anything that was done under contract going into 2012 has been unable to move. Inventories and utilities are very high although they have started to come down, and they actually started to come down in May, which is usually a building month. So there is some increased burn going on. A lot of the pricing has declined and the spot market has occurred due to the fact that many of the utilities were selling excess inventory. And so they've driven the price down because they had to take under existing contracts more coal than they are currently burning. We think that supply and demand is getting close to balance, and the contracts that have been pushed into 2013 will certainly dampen the ability to bounce back in '13 and some coal scheduled for delivery in '12 is going to be delivered in 2013. And since there's so many moving chess pieces, it's very difficult to give you a hand-on where that's all going to shake out at this point.

Unknown Analyst

And can you give us some color on what you're seeing in recontracting?

Keith D. Horton

We haven't seen any real recontracting at this point in time. It's all been -- there was very light contracting during late 2011. And we have no new -- I have no information -- new information to report on recontracting going into '13.

William H. Shea

But the normal timing on that is the third quarter.

Keith D. Horton

Normal is third and early fourth quarter. So it's a little early yet and a lot of the several variables will have to be factored in today.

Unknown Analyst

Okay, that's great. And then finally, last couple of questions. CapEx, you didn't revise your expected CapEx for this year, do you have any color for next year? Can you update us on that?

Robert B. Wallace

I think regarding 2012 CapEx, cash in accrued CapEx through June was about $200 million. We're looking at probably a $300 million or so spend for the rest of the year. So I think the guidance range that we have outstanding of $480 million to $540 million is probably is still okay. And then for 2013, we haven't provided any. I don't think we've provided any guidance on that. So we're still working through how much that's going to be, but I think we had indicated somewhere around 200-plus, but we're still working on that number. Because as you know, we released the news about a month ago that we had -- we signed another major contract with Shell, Southwestern and Range in Lycoming County. And so that's a growth project that's starting this year and continuing on into next year.

Operator

And the next question comes from Jim Spicer with Wells Fargo.

Jim Spicer - Wells Fargo & Company

A couple of questions for me. I guess, one of the comments that was in Range's press release last night was that they are dropping rigs in Lycoming County. And it just -- it doesn't sound like you're really anticipating much drilling declines in the way of drilling declines out there. So I just wanted to know what if any impact that might have.

Robert B. Wallace

James, as far as Range is concerned, we have a backlog today of -- in excess of 25 wells. So that by the time we get them all connected up and even if they go from currently 3 rigs in Lycoming County down to 1 rig, we will see probably volumetric growth on the Range system alone through '13. So it's just timing is always the issue. It’s just very difficult. And long lead time to get all of these wells online, hence the backlog that we have today so...

Jim Spicer - Wells Fargo & Company

Okay, I understand. And then just a question or clarification, the reduction in guidance on the Midstream side from 200 to 210 down to 145 to 155, it sounded like that's almost entirely due to NGL pricing in the Midcon. Is that -- did I understand that correctly?

William H. Shea

Actually, there -- I think I said there was kind of an equal split there. It is a lot of the NGL pricing but I think in the Eastern operations now that we have acquired the Chief assets and they're under our management, and we've taken into account some change and expectations from producers as we started to talk to them, that's in those numbers as well. But again, I think my point is, it was nothing material that would change our long-term outlook in that area. It was a timing issue.

Jim Spicer - Wells Fargo & Company

Okay. And then in your prepared remarks, you talked about the termination of contracts on the coal side but then it sounds like those were not Patriot contracts. I'm just wondering which company you're seeing contract terminations with and what the trend is there?

William H. Shea

I guess, James, I'll turn it over to Keith. I think my comment was related more as related to utility -- terminating a contract with an operator, which I think we've seen in a couple case, not terminating certainly with us, but a utility terminating a contract with an operator.

Keith D. Horton

Or, or deferred modifications of the delivery schedule. Those are really the kinds of things that are occurring right now, the 2012 deliveries pushed into 2013.

Jim Spicer - Wells Fargo & Company

Okay, so you guys haven't seen any termination of those contracts?

William H. Shea

Not at leases but with less oars [ph] with us.

Keith D. Horton

No, no.

Jim Spicer - Wells Fargo & Company

Okay. And then I guess, just maybe bigger picture here with CapEx remaining the same, EBITDA projections coming down, your overall leverage is going to look a little bit higher than I think some people might have expected. Can you just talk about what your thoughts are on leverage, what you feel comfortable with? And thoughts on financing the growth here.

Robert B. Wallace

This is Rob Wallace, and I would say that on the leverage front, we've got -- we knew and we amended our revolver to give us a cushion through the end of this year on leverage and it's got to return back at the beginning of next year in the first quarter. And I think all the options are on the table to make sure that we bring that down. It's -- you've got to increase your EBITDA, you've got to rationalize your CapEx and capital raising is on the table, I suppose. And we'll make the necessary steps to get within where we are supposed to be on the debt side. I can't go into many details now, James, I'm sure you'd appreciate how...

Operator

[Operator Instructions] We have a question coming from Elvira Scotto from RBC Capital Markets.

Elvira Scotto - RBC Capital Markets, LLC, Research Division

Thanks for breaking out the Midcon and Eastern Midstream segments. Can you just remind us what is the contract mix on -- in the Midcon?

Robert B. Wallace

Well, it's a little bit of a moving target now, but basically the key polls are about 15% to 20% of the total volumes. The POPs are probably about 60-plus-percent with the remainder fee. But I have to kind of caution you a little bit on the POPs that we do have a good amount of 100/100 POPs with a fee-based component but they're classified as POPs. So there's -- when we said in the press release there's been a migration towards a more stable type of cash flow that’s hurt our margins a little bit -- the margins have been impacted by NGL pricing. It's been -- and it's been impacted a little bit by the 100/100 POPs in the fee-based, so -- but that's our breakdown of our contracts. But I think Midstream, in total, as we've laid out in the past few months, with the Chief acquisition and the growth in Eastern operations, we're looking to be at about 80% fee by the end of next year.

Elvira Scotto - RBC Capital Markets, LLC, Research Division

Okay. That helps. So the other question I had is, on the Midstream side, obviously, your Eastern operations, Marcellus and Granite Wash or Panhandle are the areas of focus. You recently sold Crossroads. What are your thoughts on some of the other systems that you have in terms of potentially kind of rationalizing those systems?

William H. Shea

Elvira, this is Bill. I'm not sure that we're focused on rationalizing what we have left because as an example, what we call our Crescent System, is right at within the Mississippian line and Oklahoma, so we actually think we have potential growth opportunities there. And interestingly enough in a system that we call Hamlin also has been experiencing some -- I guess some exploratory or experimental drilling in a new formation out in that area but may or may not pan out. In and of itself, it's a very rich liquids system and so we are very happy with its performance, although it's very small at this point. So I don't sense us rationalizing anything else. In fact, I think we see some opportunities in some of these other areas.

Elvira Scotto - RBC Capital Markets, LLC, Research Division

Okay. That's great. On the Chief acquisition, I think initially you had laid out some synergies or expectations for synergies, any update or change on those expectations?

William H. Shea

Well, as far as synergies go, there -- I don't think there was a lot that we had in...

Mark Casady

Capital synergies.

William H. Shea

It was capital synergies. It wasn't operating synergies. There are capital synergies because there are some overlapping of the systems. But from an operating standpoint, there weren't a lot. And, Mark, you want to extrapolate on those capital?

Mark Casady

No, in -- all the capital synergies are ongoing. For example, producers who drill a well which would require a long and extended extension of the old Chief system will connect into the PVR system and I think in 2003 -- or 2013 next budget year, we're planning on doing that for a number of wells especially in our East Lycoming system. So what we mapped out in the acquisition as far as capital synergies, I think you'll see come to fruition in 2013.

Operator

[Operator Instructions] All right. As there are no more questions at the present time, I'd like to turn the call back over to management for any closing remarks.

William H. Shea

Well, thanks very much. Thank you, everyone, for listening in. And I appreciative you taking the time doing it. Again, a difficult quarter but we see some great opportunities and great results coming forward as a result of our Midstream growth plans and programs. So thanks again very much and call us with any questions and certainly, we'll be talking with you again next quarter. Thank you.

Operator

Thank you. This does conclude today's teleconference. You may now disconnect your phone lines. Thank you for participating, and have a nice day.

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