Legacy Reserves LP 2Q 2008 Earnings Call Transcript

Sep.19.08 | About: Legacy Reserves (LGCY)

Legacy Reserves LP (NASDAQ:LGCY)

2Q 2008 Earnings Call Transcript

August 7, 2008 4:00 pm ET

Executives

Steve Pruett – President, CFO and Secretary

Cary Brown – Chairman and CEO

Analysts

Pavel Molchanov – Raymond James

Michael Hall – Stifel Nicolaus

John Kang – RBC Capital Markets

Michael Blum – Wachovia

Yves Siegel – Aroya Capital

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Legacy Reserves summary second quarter 2008 results conference call. Your speakers for today are Cary Brown, Chairman and Chief Executive Officer and Steve Pruett, President and Chief Financial Officer. At this time all participants are in a listen-only mode. Following the call, there will be a question-and-answer session. As a remainder, this call is being recorded today August 7, 2008.

I will now turn the conference over to Mr. Pruett; please go a head, sir.

Steve Pruett

Thank you and welcome to Legacy Reserves second quarter earnings call, and thank you for joining us. Before we begin, we would like to remind you that during the course of this call Legacy management will make certain statements concerning the future performance of Legacy and other statements that will be forward-looking as defined by securities laws.

These statements reflect our current views with regard to future events and are subject to various risks, uncertainties and assumptions. Actual results may materially differ from those discussed in these forward-looking statements and you should refer to the additional information contained in Legacy Reserves LP’s Form 10-K for the year ended December 31, 2007 and subsequent reports including our 10-Q as filed with Securities and Exchange Commission. Legacy Reserves is an independent oil and natural gas limited partnership headquartered in Midland, Texas and we are focused on the acquisition and development of long-lived oil and natural gas properties, primarily located in the Permian Basin and Mid-Continent regions.

I will now turn the conference over to Cary Brown, Legacy’s Chairman and Chief Executive Officer.

Cary Brown

Thanks Steve, and thanks guys for joining us. We had another strong quarter with acquisitions, production growth and oil and gas prices have been a very good quarter of ’08. Over the past year, our revenues have tripled, increasing our operating income six fold to $34.8 million in the second quarter from $5.2 million in the second quarter of 2007. These results enabled us to increase our distributions about $0.03 compared to the prior quarter. Our fifth consecutive quarterly increase with increase distributions 27%, since our IPO, early last year.

Our year-to-date distribution covered is 1.52 times based on this increased distribution in the second quarter, which will be payable on August 14. Comparing the second quarter of ’08 to the first quarter of ’08, our production increased 8% to 7,363 barrel oil equivalent per day. Our revenues increased 36% to $66.6 million. Adjusted EBITDA increased 16% to $31.5 million. Development capital expenditures increased from $3 million to $6.1 million and distributable cash flow increased 13% to $25.3 million.

Comparing the six months ended June 30, to the six months of ’08 versus the six months ended June 30, ’07. Production increased 73% to 7,088 barrel per day. Adjusted EBITDA more than doubled increasing to $58.7 million, up over the $25.8 million in the first six months ’07 and distributable cash flow increased to $47.7 million. The improvement in our financial performance has been driven by the outstanding execution of our operations group and also due to the acquisitions.

Our operating team has outperformed our production expectations adding un-hedged oil and gas to production, which is benefited from recorded high oil prices in the second quarter. Approximately 32% of oil and natural gas is un-hedged in the second quarter. Results from our development program continued to exceed our expectations so far this year. In light our strong cash flow and based on the results of the first two quarters, we had another good problem, which is what to do with an excess cash after raising with the Board, we decided to increase our capital spending to $28.6 million. This is based on the projects we are seeing; we think this is the best use for our shareholders.

You might see our quarterly coverage, you’re very likely to see tightened in the third and fourth quarter as we spend this excess cash flow on good capital projects, but we think this will set us up for continued distribution increases in the future and more us into 2009 in good shape both on the production side. We’ve also been busy on the acquisition front, in the second quarter we made five acquisitions totaling a $107.2 million, those where the Permian Basin in the Panhandle around properties and we currently own.

These acquisitions have added about 1074 barrels oil equivalent per barrel production. 70% of that is oil or natural gas liquids, these assets added about 6.1 million barrels of proved reserves 83% of that being proved developed producing. These assets are similar nature to our existing properties and fit well with already established footprint and operations.

Since the end of the quarter, we’ve acquired an additional 14.6 million of properties, which we expect to contribute into this year 129 barrels of oil equivalent per day production and about 808,000 barrels of proved reserves, a 100% of those were PDP barrels.

Year-to-date we have closed 156 million in acquisitions adding 9.1 million barrels, 87% PDP, 1500 barrels a day production, about 72% of that was oil and natural gas liquids. Before I conclude my remarks I just want to add, how proud I’m of the job our employees are doing. They continue to outperform my expectations and continue to execute on that game plan that Legacy had day one when the win public.

If I look at our the health of our company with prices where they are today we’ve had a recent pull backup from 140 to 120, but we are still benefiting greatly as $70 hedge roll off and we get to replace those with higher price hedges that increase our cash flow and set itself well for distribution increases in the future. I think we are in a great shape and feel very good about Legacy’s prospects or acquisition pipeline.

We continue to see deals that we like, we are not buying every deal, but we continue to see good deals and good deal float. So, with that I will turn it over to Steve to go from some specific numbers from the quarter.

Steven Pruett

Thanks Cary. Let me just – as apart from the past on and summarize on a higher level, but we are pleased to report unaudited preliminary financial information that we extracted from our 10-Q which we will file tomorrow. I will be making comparisons of the second quarter 2008 sequentially to the first quarter of 2008, and I encourage all of you to review the information as contained in our earnings release and for more detailed disclosure, we encourage you to access our Form 10-Q which will be available tomorrow on our website, that’s LegacyLP.com.

I will start with the headline of higher oil and gas prices, our price realization in the second quarter were $122.32 per barrel and gas was $10.82 per Mcf that is a record for Legacy and probably for the industry as well in the second quarter. That was before the impact of our hedging program. Our swap settlements for the quarter $15.1 million, that’s up from the first quarter when prices were lower at $6.8 million.

The eye catching element of our earnings are relate to the unrealized hedge loss of $201.3 million, I will talk more about that in a minute that causes to report net loss of $175.8 million. If you exclude the unrealized loss on our swap portfolio we would have reported $25.5 million of net income.

I want to talk a bit about volatility in oil, natural gas and natural gas liquids prices and illustrate that by our mark-to-market. Our press release contained through summary of our oil and natural gas in NGL derivative positions. 68% of our produced oil NGL natural gas volumes in the second quarter were covered by swaps all of which are with our bank groups that were not subject to margin calls. For the remainder of this year all of our commodity derivatives are in the form of swaps. However, beginning in January 2009 through December 2012 we hedged approximately 200 barrels WTI oil with costless collars with the floor of $120 and $156.30 call.

We have swapped some place for 2012 in excess of 45% of our expected future net production of oil NGL nature gas. I would also add we hedged approximately 400 barrels a day of oil in a swap format of $140 of barrel for 2009, 2010 and 2011. We’ve entered into natural gas liquid swaps and natural gas basis swaps improve our hedge effectiveness.

We hedge our gas onto Waha and ANR-Oklahoma industries because those more close to reflect the basis on which we are selling most of our gas in West Texas and the Texas Panhandle and in Oklahoma.

Illustrate the impact of volatility in oil and natural gas, natural gas liquids prices which have effectively doubled since this time last year at least in the case of oil. I am going to quote fair market values of various points in times since the start of this year. These fair market values are also commonly known as mark-to-market. At year-end December 31, 2007 Legacy Reserves had an $82.3 million liability to our counterparties on our oil and natural gas and natural gas liquid swaps. That was based on a year-end oil price at almost $96 of barrels approximately 750 per MMBtu for gas.

On March 31, 2008 oil prices has increased and the closing prices for that day were $101, $101.58, $2.10 of gas and that resulted an increase to our mark-to-market or fair value of $34 million with our liability of a $116.3 million. June 30, we had another remarkable increase to $140 of barrel, $13.35 per MMBtu for Henry Hub natural gas. All of these gas prices on accordingly Henry Hub.

Our mark-to-market as published in our earnings release was $317.6 million, which resulted in the $201.3 million charges of earnings or increase in our liability quarter-over-quarter and as many of you aware oil prices and natural gas prices have declined significantly since June 30, July 31.

The closing price of oil was $124.08, gas $9.12, our mark-to-market or fair value liability decreased $102.8 million resulting of July 31 balance of fair value liability of $240.8 million. So, in the period of 31 days our mark-to-market liability declined almost a $103 million, that’s a pretty remarkable decrease and of course that volatility will continue to effect our earnings quarter-over-quarter and if oil and natural gas prices stay at these lower levels and lower than June 30, moving into the quarter then we will see an unrealized gain to our earnings, but again it’s a volatile measure and does not effect our immediate cash available to distribute.

The other items I’d like to highlight, relate to costs. Our production costs increased in the quarter by $4.80 per Boe to $20.17 from $15.37 in the prior quarter we are experiencing increased production costs that are related to high oil and natural gas prices primarily electricity, contract services, labor, chemicals even tubular goods, some which we use to replace existing tubulars. This amount increase or ad valorem taxes, which also move with oil and gas prices since it based on oil and gas property valuations.

I would also add our severance tax, which is paid to the state as the percentage of revenue went from approximately $4 of barrel in the first quarter to $6.10 a barrel, again that’s cost just the percentage of revenue, percentage of oil and gas prices in effect. Our G&A expense however, decline on a cash basis from $4.64 in the first quarter to $3.57 per Boe and second quarter as we have more barrels to spread out fixed cost over. That figures excludes $1.3 million non-cash compensation expense related to our long-term incentive plan.

I would add also our capital development dollars were $3 million in the first quarter, $4.4 million in the second quarter and as Cary noted our board has approved our recommended budget increase. We will be spending on the order of $10 million a quarter in Q3 and Q4 taking advantage of identified opportunities that are very compelling, so there is a growth for additional cash flow later this year and into next year.

We currently have $103 million of un-drawn borrowing capacity under our credit facility. Our borrowing base is under review and we expect that it will be increase effective October 1st, as the result of the additional reserves added to our acquisition program through the operations program converting upside reserves or non-PDP reserves, to group developed producing which have a higher advance rate and finally our bank group is increasing – we believe they are increasing their oil and gas pricing assumptions and given our long-lived reserves for the unhedged portion of our reserve base that has a material impact and helping us increased our borrowing base, which is the lower cost form of capital that funds our acquisition business plan.

We will pay a $0.52 per unit distribution attributable to the second quarter on August 14 unless of record August 1, 2008. This is the 6.1% increase over a first quarter distribution and approximately 27% over our second quarter 2007 distribution. We are very happy carrying out with our distribution growth, which is probably almost important report card.

Details regarding our $31.5 million of second quarter adjusted EBITDA and $25.3 million of Distributable cash flow are both non-GAAP financial measures. We encourage you look at the last page of our second quarter’s earnings press release to evaluate how we calculate those measures. We encourage you to review our earnings in full and we appreciate your attention and at this time, we’d like to turn this over to questions.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) and we’ll take our first question from Pavel Molchanov from Raymond James.

Pavel Molchanov – Raymond James

Hi, good afternoon guys.

Cary Brown

Hello, Pavel Molchanov how are you?

Pavel Molchanov – Raymond James

Question about M&A, as oil prices have moderated, have you seen any evolution in the multiples that buyers or sellers rather are starting to perhaps ask for their properties in Permian and elsewhere or do you think its just too soon to tell it right now?

Cary Brown

Pavel, what you see the multiples probably are going to change much. The multiples have more to do with the shape of the forward curve than they do at what price you are buying, but the absolute dollars you’re paying for barrels in the ground are continue to go up as oil prices go up and they’ll go down as oil prices go down. So, what’s your paying for flowing barrel and crude barrel in the ground has gone up, as prices gone up, but because generally you’re buying a discounted cash flow stream those multiples seem to stay pretty constant in the good times and the bad times, you might see access to capital seems to have more effect on multiples than does the price.

Steve Pruett

Pavel, speaking with the cash flow multiples there. The barrel multiples will move up and down, but we’ve seen cash flow multiples as we stated in our early days of our IPO, those have been the five to six times range for us at least based on the kind of valuable pay for oil and gas assets, but we have seen reserved multiples creep up and we would expect that our prices continue to climb. We’ll see the reserved multiples in the reserves are those multiples pay per barrel where their production, will move tandem with oil and natural gas prices. It’s a bit early, we haven’t seen the full I guess results given this declines about a couple of weeks old.

Cary Brown

We here a lot to talk about the election and how that new tax receiving has got guys thinking about selling this year, but it’s more to talk that I’ve seen it actually impact the deal yet. Late this year, you might see some gas that, want to go ahead to monetize when they know what taxes are going to be instead of next year, when they don’t want taxes are going to be.

Steve Pruett

Pavel, to answer your question in other words the decline in oil and gas prices and what we can hedge has definitely effective what we will pay for reserves and we build in a certain amount of our hedging into our cash flow, just kind of cash flow analysis and we certainly can’t pay as much for a package of properties today as we could in mid-July, when prices were about a $140 of barrel.

Pavel Molchanov – Raymond James

Absolutely, versus six months ago, in absolute terms dollars a barrel, weight on average, have you seen valuation still?

Steve Pruett

In terms of what we were willing to pay, I think in ’07 we averaged somewhere around $13 of barrel equivalent for our first three reserves and as our press release indicate, I think we were closer to $17 of Boe, 9,153/156 are doing math in real time closer to $17 a barrels, so we did see a creep from ‘07 to the first half of ‘08 and those are the only to relevant data points I can you tell you. I suspect that $17 is a sparing of prices ranging from a $100 to $140 a barrel so –

Cary Brown

My guess is 17 or below, but we’re based on because we’ve bought some things in the first quarter and had a real nice run up and even though it feels like prices are coming down. I think our ground acquisition was an $80 million acquisition and our hedge on that one it was right at a $100. So, we are very tickled with all the acquisitions we’ve made for the six months of this year because the un-hedge production is coming in well above what we were expecting on the tail prices or the un-hedged prices they are. So it’s been a kind of good thing and we will see where prices go.

I continue to believe we can buy in ups and downs and all cycles its just making sure we spent that capital as effectively as we can that’s going to drive the success of legacy.

Pavel Molchanov – Raymond James

Great and last question on your hedging, are you trying to shift away perhaps from a historical emphasis on swaps towards either puts or costless collars?

Cary Brown

Certainly a lot of discussion around that, we did do one costless collar, the 120 by 156 on a small portion, but then the last hedge we did it was actually a swap, the $140 swap we did which was basically replacing some barrels that we were rolling off from prior periods that we had entered in the hedges. The advantage to the swaps is, you get impact on your borrowing base, if you look at the long-term price that banks are running on their borrowing basis somewhere in the $50 to $70 range, somewhere in there that significantly out of the money and if you buy a costless collar you’re going to get the value on your borrowing base of the bottom end of that collar.

So, we look at it, it wouldn’t be surprise if we do some collars, but we still believe that the swaps, if your business plan is to grow distributions consistently to unitholders. We think that the swap give you best chance in the most certainty to do that consistently quarter in and quarter out and we believe that’s our business plan.

Pavel Molchanov – Raymond James

It sounds great, thanks very much.

Cary Brown

Thank you, Pavel.

Operator

We will take our next question from Michael Hall with Stifel Nicolaus.

Cary Brown

Well, Michael Hall from Stifel Nicolaus, how are you?

Michael Hall – Stifel Nicolaus

Good, thanks. How are you?

Cary Brown

Great.

Michael Hall – Stifel Nicolaus

Real quick on the bump in CapEx plans, is there any sort of signal to showing or seeing maybe more organic growth opportunities relative to what you are seeing on acquisitions or better economics at this point, or is it more just being opportunistic with the portfolio?

Cary Brown

We try not to get ahead of our sales on the cash we spent. Look at want we made in the first two quarters and the excess cash flow. Our option are pay down bank debt, pay out more distributions and we’ve chosen this to go with the steadier growth and distributions then try to give it all in onetime. So, the third option is, put it back in the ground and with the projects we see we think that’s the best option, definitely feel like the increasing capital spending is going to be grow CapEx not maintenance CapEx, but we have troubled defining what’s maintenance and what’s growth, it’s always been a struggle.

So we are just saying we have excess cash flow, where the best place to is spent it and we really like the opportunities we are seeing and I think we are going to see some real good benefit over the next six month.

Steve Pruett

Michael, to add to Cary’s comment, this increase is inline with our historical spending levels. Last year we spent, 2007 we reinvested about 23.7% of our EBITDA to development projects and this is just trying to keep pace with our ever increasing EBITDA both influence by acquisitions by out performance on our development portfolio and higher prices than we originally forecast for the year. So, we are just trying to keep pace with our cash flow and we do calculate and see better rates of return on development than we do in acquisitions at least at the outset of making an acquisition.

Fortunately our development team adds more value to the acquisitions and we initially estimate and that’s really what makes Legacy work is development projects on those acquisitions. That’s really a reflection of the opportunity set that we got on our existing properties and properties we have acquired.

Michael Hall – Stifel Nicolaus

I guess too much cash is a classy problem to have. Can you talk a little bit more about the development opportunities you are going after here?

Steve Pruett

One, that’s first on my mind, is that they just approved about $4 million of ASPs that Paul Horne’s team submitted. There is approximately $1 million that related to adding additional pay and some recently drills Spraberry, Wolfcamp wells, where we completed the Wolfcamp and now we’ve got additional Spraberry intervals to add, those are very high, 100% plus type rates of returns expected.

We have three additional wells drill in Pullman-Moscow area, its an area that’s where arena and range have been very actively completed, three wells there each of were 100 barrels of day on initial potential in April of this year and we’ve got three more, Paul correct me if I’m wrong, three wells three more that each of about $750 to $800,000 of per well, 100% working interest that will spud in the third quarter.

We are very pleased, we’ve got footage contracts on those and we have ongoing re-fracture stimulation program at South Justis Unit, that particular activity was on our reserve report and this is out third round of those and its been very successful to us. We do have additional Spraberry, Wolfcamp wells drill in the second half of the year, so we are very excited about that program as well, given where oil and gas prices are and where we are able to drill and complete those, they offer excellent rates of return.

Not to sound boring, but its more of the same tackling that we do combination of re-completions, well walkovers and gas rigs drilling projects, both infilling and additional Spraberry, Wolfcamp drilling, which is for the most part until drilling to 80 acres.

Michael Hall – Stifel Nicolaus

Okay, Cary I can’t get into a point you’ve maybe alluding to regarding 2009 any risk of may be sort of drying up the opportunities for acquisitions, assist there is a lot of selling at the end of this year, a head of potential tax changes. Is that at all on our radar as a risk or do you think your pretty well set?

Cary Brown

I think that the acquisition market has been out here doing this since 1981. We’ve got a business plan that’s with a couple of $100 million year of acquisitions, we can continue to grow distributions at the level we think is sustainable and there has a many years since 1981, that I didn’t think we had a really good shot of being able to make a couple of $100 million of acquisitions in the bases we’ve liked.

It’s always been a 3 to 4, 5 days out of market. So, we don’t have to win everyone and I’d say its very, very unlikely, we are going to go a quarter where we don’t make an acquisition and you guys are going to go “hay what happened you didn’t make a acquisition this quarter”. I find it highly unlikely that we would go a year without making acquisitions like we’d continue to make and so, if anything I would see the other, go in the other way which is if we get a little pull back in prices and we start to see guys needing to sale and they want monetize it and it’s a $400 million transactions its on right metrics, we are going to trying to figure out how to get it done.

So, I worry more about having a big transaction thank I can’t finance that I do not getting the transactions have been able to continue to execute the game plan, acquisition is a hard game and there will be a quarter or two after some day that we don’t make an acquisition. So far it hadn’t happen, but it will happen, its not happened this next quarter because we’re already made one, but I feel very good about the pipeline, the way we’re going about it, the disciplined approach we have the acquisitions and just the network of people we still get about a phone call a day from somebody want to talk about it. Unfortunately, most of time we will say no, but every now that we say yes and that’s good.

Michael Hall – Stifel Nicolaus

Okay good to hear and then finally and then I’ll pass. Has it raised some kind of bump in cost, clearly some fuel inflation and other oil fuel inflation working its way through the cost lines. How much of that would you say is less sticky I guess on the way down in the sense that we’re seeing some correction in commodity prices. I mean any ability to quantify how – we may see cost come back in the next couple quarters?

Cary Brown

I think you are going to see cost come in based on when you’re doing lots of acquisitions. The month after you take over an acquisition you are doing some, well reactivation, you clean it up, you’re getting it as least up to standard. So, there is a fairly significant amount of our costs that that’s kind of work. We’ve seen about a 20% increase across the board in power, people cost, pipe costs those kinds of things and those will not come down as fast as they go up.

So, they are not completely elastic and if we see a little bit of bump in costs, next quarter I wouldn’t be surprised because the industry is running at a level that is full out. So, guys were able to praise their services and what they get, if we have a sustained drop in prices, you are going to see LOE drop, but you haven’t seen the pick of the LOE, I don’t believe.

Michael Hall – Stifel Nicolaus

Okay. That’s helpful.

Steve Pruett

I think this cost like, as you know the gasoline pump, equipment pump prices are down. Certainly, diesel was a very important input, so it’s electricity to our business. So those will be very response, as Cary describes some of the hard assets certainly steel, which is moreover a factor on our drill wells and on repair work has seeming headed, we are hopping it could stabilize at some point and labor will stick too.

Cary Brown

But, if you go back to our cost that maybe $1 to $2 of barrel in fixing leases as we are buying them and if the weren’t making any acquisitions it would probably rollback so.

Steve Pruett

That’s a great point, some of that non-recurring reactivating wells and getting the much hard standards because we are rolling up a the lot of moment pops.

Michael Hall – Stifel Nicolaus

So, it’s not a work over of that?

Cary Brown

Yes, work over reactivations.

Michael Hall – Stifel Nicolaus

Okay.

Cary Brown

You’ll also find that seller doesn’t pay as much attention to his operations while he is preparing to sell and the dip leases and loan holders a lot of wells that are offline and fortunately Paul got a very responsive operating team and they get them back on online and that create surge in work-over expense.

Michael Hall – Stifel Nicolaus

Okay, great. Well, congrats.

Cary Brown

Thank you, Michael.

Michael Hall – Stifel Nicolaus

Take care.

Operator

We’ll take our next question from John Kang with RBC Capital Markets.

John Kang – RBC Capital Markets

Hey, good afternoon everybody.

Steve Pruett

Good afternoon.

John Kang – RBC Capital Markets

I think most of my questions are actually answered. I’m trying to think it is any there that I can ask, but I do have a couple and I know you don’t like to give guidance, but in terms of the stepped up CapEx, I would imagine that would ultimately increase your production output in the third and fourth quarter. Any targeted growth sequentially that you maybe able to enlighten us with or?

Cary Brown

Without giving you guidance, just to give you general thought Paul Horne our VP of operations will response to you John.

John Kang – RBC Capital Markets

Okay, great. Thanks.

Paul Horne

I don’t think you’ll see any increase in production rates in Q3. We are talking about increase in spending in Q3 and Q4, so you will only start seeing that in Q4 and with 25% of the remaining money is to be spent in the second half of Q4. You won’t see that fully realized either, so really what we’re talking about is a good 2008 exit rate and setting as up for first half of ‘09.

Cary Brown

John, one thing that will help us set a discussion with (inaudible) corporate finance associates that we acquired assets throughout second quarter and we of course had a couple of $14.6 million come in July and beginning of August. So, we didn’t get the full second quarter benefit from those acquisitions even including the Crown Oil Partners acquisition, which closed effectively I sort of hopping its May 1. So, when we have a full-quarter those contribution that will gives us a bump to compliment that what Paul’s describing which could start to help, a development capital could start to help us in Q4 and then into 2009.

John Kang – RBC Capital Markets

Great and then I guess you all kind of target a low single-digit type of growth rate…?

Cary Brown

I don’t think it’s a low growth rate actually last year it was about 8.2%, so.

John Kang – RBC Capital Markets

Right those, yes so defiantly higher than that low single-digit, and then I guess just not to talk too much on the cost side, but I guess you’re expecting relatively flat, LOE type of expenses for the rest of the year then judging from the comments?

Paul Horne

I’ll tell you the same thing I told Cary and Steve, tell me what prices are going to be and I’ll tell you what LOE is going to be. If prices stay whether right now I would expected them to be relatively flat, if prices jump back where they were 30-days ago and continued raise, no I think you’ll significant increases in LOE. There is generally just based on experience, there is about a three month lag, expenses catching up to increasing price and there is about a six month lag of expenses catching up with the decreasing price and that’s just what I’ve seen in the cyclical market over the last 23-years.

John Kang – RBC Capital Markets

That’s very good color. I guess in terms of cost, if you had to put a percentage around some of the various components, what would be the big – will the electricity and fuel be the biggest percent?

Cary Brown

Electricity runs about 22% of our total LOE that’s excluding G&A and your taxes, but LOE is the largest single item at about 22%.

John Kang – RBC Capital Markets

Well and I guess the coal prices kind of increasing electricity could increase this well, but all right great, that’s the follow-up questions I had. Thanks for your answers.

Cary Brown

Thanks for joining us and thanks for the question.

Operator

Michael Blum with Wachovia has our next question.

Michael Blum – Wachovia

Good afternoon everyone.

Cary Brown

Good afternoon, Michael.

Michael Blum – Wachovia

I’ll try to come up with some more questions, my gosh. First question I guess is, just to go back to the Michael Hall’s question about rate, about the increased CapEx spend for drilling. Can you just talk about kind of I guess the thought process behind reinvesting in the business versus perhaps building coverage and then having some the excess cash flow to fund in fluid equity, so to speak?

Steve Pruett

That’s an interesting question, with our equity trading where it is, we are pretty jealous of it and certainly the idea of issuing equity in this trading ranges is unpalatable to, so we do protect our borrowing base, but as we said earlier Michael the more PDP reserves we have and if they are certainly converted to high rates return that adds value to our borrowing base and provides coverage out hear it’s a subsequent period.

So, what we find in modeling, our development portfolio and even more conservative assumptions on rates of return and what we’ve been able to deliver. We see improvement in coverage out in time. So there is, we think a rational for reinvesting in the organic projects to improving coverage in the long-term health of the company both in replacing and growing production at relatively modest level replacing reserve. So, for better or worse we’ve decided something in the mid 20% reinvestment ranges is kind of a sweet spot for us. It’s a level where our development team can manage the capital well and generate very attractive rates of returns.

We like creating high single-digit even some case double-digit rates organic growth without creating a cliff for ourselves by drilling too many wells. We try to become Chesapeake, even some of our, one of our MLP brother is very active. More than one of them are active drillers, we create shorter (inaudible) and cliffs and a greater production replacement challenge. So, we like this 20% to 30% range and counting in on this 23% to 25% reinvestment range seems to be an area, where we can improve our coverage overtime versus just paying down debt.

Michael Blum – Wachovia

Okay.

Steve Pruett

I think it’s in terms if you were asking our philosophy on, what do we payout versus what do we put back into ground. I think it’s, we’d all agree that we don’t think 1.5 times coverage is the right coverage long-term, but we also feel like given out sustained quarter-over-quarter increases in distribution is in the best interest that we’d like for, you guys going to look back in Legacy and say for the last X number of quarters have along where in business that you were seeing increases in distribution.

So, we try to model all that into model and say, okay with that yeah, let’s go ahead and spend some more CapEx here and it’s all a balance, but very definitely don’t want to send the market the signal that we think 1.5 times is the right number long-term. So, you should be able to hopefully read between that or somewhere. There is more distribution increases to come, but the CapEx seem like the best place to go right now.

Michael Blum – Wachovia

Thanks that’s helpful. So, maybe another way to think about this, from a debt-to-EBITDA metric perspective, I mean how higher are you comfortable taking that level?

Cary Brown

Most of the borrowing base given what the bank price debts are creates a lot of discipline there, but in general we find three times debt-to-EBITDA and a area of great discomfort I mean, we get closer to 2.5 times it’s a signal that we need to either issue equity or hopefully our acquisitions and our development projects have added value and the next borrowing base increased pulls that down and the EBITDA performance pulls that ratio down, so that’s we stay in comfortable confines and if the market are friendly, we are close to that 2.5 times level, we’ll issue equity.

We did at last year with our $75 million product placement it wasn’t an optimal price that the units were issued at, but it did give us dry powders through the winter to keep executing our acquisition program. So, we are going to be conservative with our debt leave availability, so that we can be opportunistic and keep enabling in common growth acquisition program and not run out dry powder that we need comes with the next good roll up to the movement pop or even a somewhat larger [Audio Gap].

Michael Blum – Wachovia

Do you carry to though it an adventure, where you think the borrowing base could go to in October?

Cary Brown

Well, I better not since we are in the middle of it, we will have the actual result of it speak for itself which will be out in the next 45-days or so.

Michael Blum – Wachovia

Okay.

Steve Pruett

I think it’s going to give us lease based on the pace of acquisitions we’ve been pursuing that we’ll have an appreciable increase and for give us dry powder to keep executing as we have in the first half of the year.

Michael Blum – Wachovia

Okay. Last question is just, the G&A line is a little high. Just curious was there anything going on there and is that a sort of a good run rate or ...?

Steve Pruett

I’m glad to answer that question, you said the G&A line that makes me think Michael, you are asking about $3.7 million of G&A and that included $1.33 million of non-cash comp expense with the nice sharp in the arm of a unit price that ran up in previous quarter.

Cary Brown

We’ve thought our units are going to get the back where they needed to be and then a pull back.

Steve Pruett

Because, we had such a good run at the end of the quarter in June in trading up, I think above 24 even, not I think I know if just don’t remember what the month end price was, we had a lot of non-cash comp expense commuted into our unit depreciation rights and then on units and of course that’s been reversed. Hopefully we won’t close the quarter when we are trading out, but if we did, we see a reversal of that non-cash comp expense.

So, if you back up the $1.3 million were, even where substantially lower on a dollar per Boe basis a level that we’re pretty comfortable with $3.57 per Boe, I believe of cash G&A just 357 that’s kind of like where we’d liked it to be in terms of bottling our future. So, definitely take a look at the disclosure, if you look at the back page of our earnings release, there is a disclosure on the EBITDA reconciliation of the non-cash comp expense on options, unit depreciations that in Sand Unit.

Michael Blum – Wachovia

Okay, thank you very much.

Cary Brown

Well, thank you Michael.

Operator

We have a follow-up question from Michael Hall with Stifel Nicolaus.

Michael Hall – Stifel Nicolaus

I was going to ask you to take a step with the borrowing base, but since I got just this is a high-level for particularly versus, smaller companies. Is there any time when you were starring at a $145 oil and a pretty big move in the mark-to-market, is there any time there where you ever get worried about margin calls. Is that ever an issue or is that given us counterparties that doesn’t have any sort of problem?

Steve Pruett

I’m glad to answer that Michael, lot of our investors asked that question and others worry about it. We don’t worry about margin calls, but we do consciously bring in bank groups or banks rather that have good hedging departments. We do think its wise to spread our hedging activity around our bank group just to mitigate, counterparty risk which arguably are at least historically, the banks that we do business will have better credit rating than Legacy has, but really the banking environment has changed.

Cary Brown

We thought, we had some good credit on the other side, or maybe not supposed to….

Steven Pruett

But I will tell you that given our large, I mentioned $317 million of mark-to-market liability we owe to the bank. Certainly, some of the banks have to think twice about doing additional hedging business with Legacy, if they have large exposures and we have a coupled with the banks that have been with us longtime.

We have larger concentrations and frankly they know it, we talked about, we steer business away from them in toward members, newer members of our bank group and we’re going to add two or three more banks this next round for that purpose and frankly Michael, as you can imagine the banks aren’t as thrilled about having large amounts of money advances they used to be. So, having more banks, strong banks with smaller hold positions and banks that have good derivative shops is wise and we’ll continue to spread the business around, but we’ve had no hints or whispers of margin calls, but we have run into a situations where our exposure to given bankers is such that it prompt us to hedge with other banks where we don’t have as large and exposure to spread that business around and to spread that exposure around.

Cary Brown

To clarifies Steve; we don’t have margin calls at this point.

Steven Pruett

No, we do not and the reason is and Michael, you know this or anything one else that might be curious, the banks have mortgages on our reserves and to the extent that oils and natural gas prices rise our liability on these older hedges rises with that, but the value of the collateral on the ground if the banks have to look to rises as well. So the banks are effectively hedged and secured by virtue of more valuable reserve values in the ground or more valuable collateral in the ground if that makes sense so.

Cary Brown

And, we don’t worry at all about margin. The long answer is no we don’t worry about margin costs.

Michael Hall – Stifel Nicolaus

Good color, I appreciate it. All right, take care. Thanks.

Steven Pruett

Well, thanks for the question.

Operator

(Operator instructions) We will take our next question from Yves Siegel of Aroya Capital.

Yves Siegel – Aroya Capital

Thanks. Good afternoon.

Steven Pruett

Good afternoon, Yve, good to hear from you.

Yves Siegel – Aroya Capital

Thank you sir. Two quick questions, one is because there’s an obvious disconnect between stock prices and underlying fundamentals. It digs the question of the how overheated is the space on the prospective of where you guys stand as it relates to employees and is the management team exactly the way you want it at this point in time?

Cary Brown

The question is about our team. I’ll give you my answer; I feel like I guess the most experienced team in our basin doing what we do, I wouldn’t change a guy on it. In fact, on the other way I’m trying make sure that I keep them happy because, I think we’ve get a phenomenal team put together and they’re doing an executing the way I think they ought to execute now. They may have questions about me, because [Audio Gap] stocks trading below our net asset value, so I may not be doing a good job of educating the market out there of where we should we trading, but no our team, I think we can handle as much properties as we can buy, this team can manage and as much properties as Steve and I can finance they can integrate. We’re going to continue to grow strategically and meaningfully, you’re not going to see us grow all over the world, but we’re going to continue to grow with this team.

Steven Pruett

Yves, is your question around with a low unit price to our employees below options and unit appreciations.

Yves Siegel – Aroya Capital

No, no it really is just more of the fact that it’s a growth story and as a growth story you would think you’d get some credit in the stock price and as a growth story one of the things I was get concerned about is being able to have the people in place to be able to properly manage that growth?

Steven Pruett

That’s a great question. I’ve continued to be encouraged by the quality of talent we’ve been able to acquire; we’re up to about 55 employees in the office now. We’ve converted from a couple of years ago a contract field organization, one that’s largely company employees with company foreman, company’s production technicians, which deserves a lot of credit for that Bill, most built up to his administrative organization because of our growth and visibility and the kind of people that I’ve been fortune to associate myself with here, the Brown and McGraw and Paul and Bill.

We’ve been able to attract, those who have come in have helped us attract more from places and these are people that often worked for either a very small company or in some cases larger companies without a town headquarters that are kind of remote and removed and we’re centralized here and have developed a pretty strong and supportive culture.

We just interviewed the land menu and some how found them self in Florida who wants to come back as is very encouraged. I don’t know that he’s accepted yet, but we are finding employees from all over the country based on our unique network of relationships and that continues to enable us to grow and manage our growth.

Yves Siegel – Aroya Capital

And I appreciate that, the color and the final question is as you look at acquisitions are you seeing that the same competition for acquisitions, are you still seeing as many guys in the data room as you did maybe six months ago?

Steven Pruett

I’ll answer it. Absolutely, there is a competition in the data rooms; what we’re not seen as much is we’re going to buy this asset for $1.30 and then MLP for $2 tomorrow. So it seems to have settled out; there is not as many MLPs out there that are they think. Everything fits in MLP, which is leading us there is a natural selection those of us who are out and are public are getting more calls.

I expect other guys are too, hey I want to team up within MLP, I think this in MLP assets. We are talking more and so from a MLP competition, the competition has decreased, but there is never been a time and nor where there ever be time where people are chasing good oil and gas assets and that. So its competitive maybe not quite as juiced up as it was 12-months ago for the step we’re looking at.

Yves Siegel – Aroya Capital

Great, thank you.

Steve Pruett

Kyle and his team has been digging out have been negotiated deals out in places like Borger Texas or Penrose Sand, places you’ve never heard off with less than 1,000 or few 1,000 people, but there is big challenges just convincing these entrepreneurs that Penrose Sand where the right party to sell to, it was a bit different going to bit situation in a data room where a very skilled broker has over, maybe over evaluated the upside and trying to discount that and plan the rule that game and dealing with winters curse.

So, we haven’t had to do with that much since that was proprietary deal flow that’s Kyle and his colleagues and which Cary’s network developed and we’ve taking good advantage of.

Yves Siegel – Aroya Capital

Okay, that’s great, I appreciate it.

Cary Brown

Thank you Yves.

Steve Pruett

Thank you Yves.

Operator

It appears there are no further questions at this time, Mr. Pruett; I’d like to turn the conference back over to you for any additional or closing remark.

Steven Pruett

Well, I would just like to echo Cary’s sentiment that, we appreciate what all of our employees and management and Board of Directors have done this quarter to set us up with an excellent quarter. We are very excited about the prospects in the second half of the year and I appreciate all of you joining us today and following Legacy, following our path and hope to recover from the August doldrums very soon, but that’s something that we don’t control, but we all have smiles in our face here, we are giving ourselves a raise with our $0.03 distribution increase, favorable in a weeks time. So in spite of the lower equity price the distribution increases. It’s got a smiling and there is more of that to come as Cary noted. So, thanks again.

Operator

That concludes today’s conference call. We appreciate your participation. You may now hang up.

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