UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C.  20549




FORM
10-Q




x QUARTERLY REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE




SECURITIES
EXCHANGE ACT OF 1934




For
the quarterly period ended September 30, 2008




OR




o TRANSITION REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE




SECURITIES
EXCHANGE ACT OF 1934




For
the transition period
from                       
to




Commission
file number 1-33249









Legacy
Reserves LP


(Exact
name of registrant as specified in its charter)




Delaware
            
            16-1751069(State
      or other jurisdiction of
              incorporation
      or organization)
            
            (I.R.S.
      Employer
              Identification
      No.)303
      W. Wall, Suite 1400
              Midland,
      Texas
            
            79701(Address
      of principal executive offices)
            
            (Zip
      code)






(432)
689-5200


(Registrant’s
telephone number, including area code)




Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.




x Yes  o  No




Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.




Large
      accelerated filer o
            
            Accelerated
      filer o





Non-accelerated
      filer x(Do
      not check if a smaller reporting company)
            
            Smaller
      reporting company o












Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). o Yes  x No




31,074,339 units
representing limited partner interests in the registrant were outstanding as of
November 6, 2008.















TABLE
OF CONTENTS




PageGlossary
      of Terms
              
              3Part
      I - Financial InformationItem
      1.
              
              Financial
      Statements.Condensed
      Consolidated Balance Sheets as of September 30, 2008 and December 31, 2007
      (Unaudited)
              
              6Condensed
      Consolidated Statements of Operations for the three and nine months ended
      September 30, 2008 and 2007 (Unaudited)
              
              8Condensed
      Consolidated Statement of Unitholders' Equity for the nine months ended
      September 30, 2008 (Unaudited)
              
              9Condensed
      Consolidated Statements of Cash Flows for the nine months ended September
      30, 2008 and 2007 (Unaudited)
              
              10Notes
      to Condensed Consolidated Financial Statements (Unaudited)
              
              11Item
      2.
              
              Management's
      Discussion and Analysis of Financial Condition and Results of
      Operations.
              
              22Item
      3.
              
              Quantitative
      and Qualitative Disclosures About Market Risk.
              
              33Item
      4T.
              
              Controls
      and Procedures.
              
              
              34Part
      II - Other InformationItem
      1.
              
              Legal
      Proceedings.
              
              
              35Item
      1A.
              
              Risk
      Factors.
              
              
              35Item
      2.
              
              Unregistered
      Sales of Equity Securities and Use of Proceeds.
              
              36Item
      3.
              
              Defaults
      Upon Senior Securities.
              
              36Item
      4.
              
              Submission
      of Matters to a Vote of Security Holders.
              
              36Item
      5.
              
              Other
      Information.
              
              
              36Item
      6.
              
              Exhibits.
              
              
              37Signature
              
              38




Page
2




GLOSSARY
OF TERMS




Bbl.  One stock
tank barrel or 42 U.S. gallons liquid volume.




Bcf.  Billion cubic
feet.




Boe.  One barrel of
oil equivalent, determined using a ratio of six Mcf of natural gas to one Bbl of
crude oil, condensate or natural gas liquids.




Boe/d.  Barrels of
oil equivalent per day.




Btu.  British
thermal unit, which is the heat required to raise the temperature of a one-pound
mass of water from 58.5 to 59.5 degrees Fahrenheit.




Developed
acreage.  The number of acres that are allocated or assignable
to productive wells or wells capable of production.




Development
project.A drilling or other project which may target proven
reserves, but which generally has a lower risk than that associated with
exploration projects.





Development
well.  A well drilled within the proved area of an oil or
natural gas reservoir to the depth of a stratigraphic horizon known to be
productive.




Dry hole or
well.  A well found to be incapable of producing hydrocarbons
in sufficient quantities such that proceeds from the sale of such production
would exceed production expenses and taxes.




Field.  An area
consisting of a single reservoir or multiple reservoirs all grouped on or
related to the same individual geological structural feature and/or
stratigraphic condition.




Gross acres or gross
wells.  The total acres or wells, as the case may be, in which
a working interest is owned.




MBbls.  One
thousand barrels of crude oil or other liquid hydrocarbons.




MBoe.  One thousand
barrels of crude oil equivalent, using a ratio of six Mcf of natural gas to one
Bbl of crude oil, condensate or natural gas liquids.




Mcf.  One thousand
cubic feet.




MMBbls.  One
million barrels of crude oil or other liquid hydrocarbons.




MMBoe.  One million
barrels of crude oil equivalent, using a ratio of six Mcf of natural gas to one
Bbl of crude oil, condensate or natural gas liquids.




MMBtu.  One million
British thermal units.




MMcf.  One million
cubic feet.




MMGal.One million
gallons of natural gas liquids or other liquid hydrocarbons.





Net acres or net
wells.  The sum of the fractional working interests owned in
gross acres or gross wells, as the case may be.




NGLs or natural gas
liquids.  The combination of ethane, propane, butane and
natural gasolines that when removed from natural gas become liquid under various
levels of higher pressure and lower temperature.




NYMEX.  New York
Mercantile Exchange.




Page
3




Oil.  Crude oil,
condensate and natural gas liquids.




Productive well.  A
well that is found to be capable of producing hydrocarbons in sufficient
quantities such that proceeds from the sale of such production exceeds
production expenses and taxes.




Proved developed
reserves.  Reserves that can be expected to be recovered
through existing wells with existing equipment and operating methods. Additional
oil and natural gas expected to be obtained through the application of fluid
injection or other improved recovery techniques for supplementing the natural
forces and mechanisms of primary recovery are included in “proved developed
reserves” only after testing by a pilot project or after the operation of an
installed program has confirmed through production response that increased
recovery will be achieved.




Proved developed non-producing or
PDNP’s.  Proved oil and natural gas reserves that are developed
behind pipe, shut-in or can be recovered through improved recovery only after
the necessary equipment has been installed, or when the costs to do so are
relatively minor. Shut-in reserves are expected to be recovered from
(1) completion intervals which are open at the time of the estimate but
which have not started producing, (2) wells that were shut-in for market
conditions or pipeline connections, or (3) wells not capable of production
for mechanical reasons. Behind-pipe reserves are expected to be recovered from
zones in existing wells that will require additional completion work or future
recompletion prior to the start of production.




Proved
reserves.  Proved oil and natural gas reserves are the
estimated quantities of natural gas, crude oil and natural gas liquids that
geological and engineering data demonstrates with reasonable certainty to be
recoverable in future years from known reservoirs under existing economic and
operating conditions, i.e., prices and costs as of the date the estimate is
made. Prices include consideration of changes in existing prices provided only
by contractual arrangements, but not on escalations based on future
conditions.




Proved undeveloped drilling
location.  A site on which a development well can be drilled
consistent with spacing rules for purposes of recovering proved undeveloped
reserves.




Proved undeveloped reserves or
PUDs.  Proved oil and natural gas reserves that are expected to
be recovered from new wells on undrilled acreage or from existing wells where a
relatively major expenditure is required for recompletion. Reserves on undrilled
acreage shall be limited to those drilling units offsetting productive units
that are reasonably certain of production when drilled. Proved reserves for
other undrilled units can be claimed only where it can be demonstrated with
certainty that there is continuity of production from the existing productive
formation. Under no circumstances should estimates for proved undeveloped
reserves be attributable to any acreage for which an application of fluid
injection or other improved recovery technique is contemplated, unless such
techniques have been proved effective by actual tests in the area and in the
same reservoir.




Recompletion.  The
completion for production of an existing wellbore in another formation from that
which the well has been previously completed.




Reserve acquisition
cost.  The total consideration paid for an oil and natural gas
property or set of properties, which includes the cash purchase price and any
value ascribed to units issued to a seller adjusted for any post-closing
items.




R/P ratio (reserve
life).  The reserves as of the end of a period divided by the
production volumes for the same period.




Reserve
replacement.  The replacement of oil and natural gas produced
with reserve additions from acquisitions, reserve additions and reserve
revisions.




Reserve replacement
cost.  An amount per Boe equal to the sum of costs incurred
relating to oil and natural gas property acquisition, exploitation, development
and exploration activities (as reflected in our year-end financial statements
for the relevant year) divided by the sum of all additions and revisions to
estimated proved reserves, including reserve purchases. The calculation of
reserve additions for each year is based upon the reserve report of our
independent engineers. Management uses reserve replacement cost to compare our
company to others in terms of our historical ability to increase our reserve
base in an economic manner. However, past performance does not necessarily
reflect future reserve replacement cost performance. For example, increases in
oil and natural gas prices in recent years have increased the economic life of
reserves adding additional reserves with no required capital expenditures. On
the other hand, increases in oil and natural gas prices have increased the
cost of reserve purchases and reserves added through development. The reserve
replacement cost may not be indicative of the economic value added of the
reserves due to differing product values (e.g. oil vs. natural gas), lease
operating expenses per barrel and differing timing of production.





Reservoir.  A
porous and permeable underground formation containing a natural accumulation of
producible oil and/or natural gas that is confined by impermeable rock or water
barriers and is individual and separate from other reserves.




Page
4




Standardized
measure.  The present value of estimated future net revenues to
be generated from the production of proved reserves, determined in accordance
with assumptions required by the Financial Accounting Standards Board and the
Securities and Exchange Commission (using prices and costs in effect as of the
period end date) without giving effect to non-property related expenses such as
general and administrative expenses, debt service and future income tax expenses
or to depreciation, depletion and amortization and discounted using an annual
discount rate of 10%. Because we are a limited partnership that allocates our
taxable income to our unitholders, no provisions for federal or state income
taxes have been provided for in the calculation of standardized measure.
Standardized measure does not give effect to derivative
transactions.




Undeveloped
acreage.  Lease acreage on which wells have not been drilled or
completed to a point that would permit the production of commercial quantities
of oil and natural gas regardless of whether such acreage contains proved
reserves.




Working
interest.  The operating interest that gives the owner the
right to drill, produce and conduct operating activities on the property and a
share of production.




Workover.  Operations
on a producing well to restore or increase production.




Page
5




Part
I – FINANCIAL INFORMATION




Item
1.  Financial Statements.





LEGACY
      RESERVES LPCONDENSED
      CONSOLIDATED BALANCE SHEETS(UNAUDITED)ASSETSSeptember
      30,
            
            
            December
      31,2008
            
            
            2007(Dollars
      in thousands)Current
      assets:Cash
      and cash equivalents
            
            $
            7,668
            
            
            $
            9,604Accounts
      receivable, net:Oil
      and natural gas
            
            
            24,107
            
            
            
            19,025Joint
      interest owners
            
            
            5,269
            
            
            
            4,253Affiliated
      entities and other (Note 4)
            
            
            382
            
            
            
            26Fair
      value of derivatives (Notes 6 and 7)
            
            
            1,986
            
            
            
            310Prepaid
      expenses and other current assets
            
            
            4,791
            
            
            
            340Total
      current assets
            
            
            44,203
            
            
            
            33,558Oil
      and natural gas properties, at cost:Proved
      oil and natural gas properties, at cost, using thesuccessful
      efforts method of accounting:
            
            
            709,831
            
            
            
            512,396Unproved
      properties
            
            
            78
            
            
            
            78Accumulated
      depletion, depreciation and amortization
            
            
            (103,049
            )
            
            
            (72,294
            )606,860
            
            
            
            440,180Other
      property and equipment, net of accumulated depreciaton andamortization
      of $605 and $251, respectively
            
            
            1,993
            
            
            
            775Deposits
      on pending acquisitions
            
            
            3,087
            
            
            
            -Operating
      rights, net of amortization of $1,286 and $865,
    respectively
            
            
            5,731
            
            
            
            6,151Fair
      value of derivatives (Notes 6 and 7)
            
            
            2,129
            
            
            
            -Other
      assets, net of amortization of $777 and $391, respectively
            
            
            956
            
            
            
            822Investment
      in equity method investee (Note 3)
            
            
            89
            
            
            
            92Total
      assets
            
            $
            665,048
            
            
            $
            481,578See
      accompanying notes to condensed consolidated financial
      statements.


Page
6





LEGACY
      RESERVES LPCONDENSED
      CONSOLIDATED BALANCE SHEETS(UNAUDITED)LIABILITIES
      AND UNITHOLDERS' EQUITYSeptember
      30,
            
            
            December
      31,2008
            
            
            2007(Dollars
      in thousands)Current
      liabilities:Accounts
      payable
            
            $
            3,515
            
            
            $
            2,320Accrued
      oil and natural gas liabilities
            
            
            22,675
            
            
            
            10,102Fair
      value of derivatives (Notes 6 and 7)
            
            
            28,416
            
            
            
            26,761Asset
      retirement obligation (Note 8)
            
            
            2,405
            
            
            
            845Other
      (Note 10)
            
            
            5,477
            
            
            
            3,429Total
      current liabilities
            
            
            62,488
            
            
            
            43,457Long-term
      debt (Note 2)
            
            
            231,000
            
            
            
            110,000Asset
      retirement obligation (Note 8)
            
            
            29,476
            
            
            
            15,075Fair
      value of derivatives (Notes 6 and 7)
            
            
            72,264
            
            
            
            57,316Other
      long-term liabilites
            
            
            251
            
            
            
            -Total
      liabilities
            
            
            395,479
            
            
            
            225,848Commitments
      and contingencies (Note 5)Unitholders'
      equity:Limited
      partners' equity - 31,049,299 and 29,670,887 units issuedand
      outstanding at September 30, 2008 and December 31, 2007,
      respectively
            
            
            269,511
            
            
            
            255,663General
      partner's equity (approximately 0.1%)
            
            
            58
            
            
            
            67Total
      unitholders' equity
            
            
            269,569
            
            
            
            255,730Total
      liabilities and unitholders' equity
            
            $
            665,048
            
            
            $
            481,578See
      accompanying notes to condensed consolidated financial
      statements.




Page
7





LEGACY
      RESERVES LPCONDENSED
      CONSOLIDATED STATEMENTS OF OPERATIONS(UNAUDITED)Three
      Months Ended
              
              
              Nine
      Months EndedSeptember
      30,
              
              
              September
      30,2008
              
              
              2007
              
              
              2008
              
              
              2007(In
      thousands, except per unit data)Revenues:Oil
      sales
              
              $
              47,912
              
              
              $
              22,442
              
              
              $
              132,400
              
              
              $
              51,396Natural
      gas liquids sales
              
              
              5,031
              
              
              
              1,714
              
              
              
              13,314
              
              
              
              2,891Natural
      gas sales
              
              
              12,668
              
              
              
              5,241
              
              
              
              35,293
              
              
              
              13,776Total
      revenues
              
              
              65,611
              
              
              
              29,397
              
              
              
              181,007
              
              
              
              68,063Expenses:Oil
      and natural gas production
              
              
              15,784
              
              
              
              7,580
              
              
              
              38,827
              
              
              
              18,408Production
      and other taxes
              
              
              4,096
              
              
              
              1,886
              
              
              
              10,654
              
              
              
              4,361General
      and administrative
              
              
              2,158
              
              
              
              1,443
              
              
              
              8,872
              
              
              
              6,039Depletion,
      depreciation, amortization and accretion
              
              
              13,082
              
              
              
              6,959
              
              
              
              33,223
              
              
              
              19,065Impairment
      of long-lived assets
              
              
              339
              
              
              
              950
              
              
              
              447
              
              
              
              1,230Loss
      on disposal of assets
              
              
              317
              
              
              
              156
              
              
              
              391
              
              
              
              387Total
      expenses
              
              
              35,776
              
              
              
              18,974
              
              
              
              92,414
              
              
              
              49,490Operating
      income
              
              
              29,835
              
              
              
              10,423
              
              
              
              88,593
              
              
              
              18,573Other
      income (expense):Interest
      income
              
              
              11
              
              
              
              54
              
              
              
              82
              
              
              
              205Interest
      expense (Notes 2, 6 and 7)
              
              
              (4,198
              )
              
              
              (1,905
              )
              
              
              (7,164
              )
              
              
              (3,423
              )Equity
      in income of partnerships
              
              
              47
              
              
              
              30
              
              
              
              135
              
              
              
              41Realized
      gain (loss) on oil, NGL and natural gas swaps (Notes 6 and
    7)
              
              
              (19,750
              )
              
              
              408
              
              
              
              (41,659
              )
              
              
              4,236Unrealized
      gain (loss) on oil, NGL and natural gas swaps (Notes 6 and
    7)
              
              
              222,138
              
              
              
              (6,844
              )
              
              
              (13,214
              )
              
              
              (24,388
              )Other
              
              
              (9
              )
              
              
              -
              
              
              
              (28
              )
              
              
              1Income
      (loss) before income taxes
              
              
              228,074
              
              
              
              2,166
              
              
              
              26,745
              
              
              
              (4,755
              )Income
      taxes
              
              
              (122
              )
              
              
              -
              
              
              
              (628
              )
              
              
              -Income
      (loss) from continuing operations
              
              
              227,952
              
              
              
              2,166
              
              
              
              26,117
              
              
              
              (4,755
              )Gain
      on sale of discontinued operation (Note 3)
              
              
              -
              
              
              
              -
              
              
              
              4,954
              
              
              
              -Net
      income (loss)
              
              $
              227,952
              
              
              $
              2,166
              
              
              $
              31,071
              
              
              $
              (4,755
              )Income
      (loss) from continuing operations per unit - basic and diluted (Note
      9)
              
              $
              7.34
              
              
              $
              0.08
              
              
              $
              0.86
              
              
              $
              (0.19
              )Gain
      on discontinued operation per unit - basic and diluted
              
              $
              -
              
              
              $
              -
              
              
              $
              0.16
              
              
              $
              -Net
      income (loss) per unit - basic and diluted (Note 9)
              
              $
              7.34
              
              
              $
              0.08
              
              
              $
              1.02
              
              
              $
              (0.19
              )Weighted
      average number of units used in computing net income per unit -basic
              
              
              31,041
              
              
              
              26,022
              
              
              
              30,443
              
              
              
              25,493diluted
              
              
              31,076
              
              
              
              26,073
              
              
              
              30,492
              
              
              
              25,493See
      accompanying notes to condensed consolidated financial
      statements.




Page
8




LEGACY
      RESERVES LPCONDENSED
      CONSOLIDATED STATEMENT OF UNITHOLDERS' EQUITYFOR
      THE NINE MONTHS ENDED SEPTEMBER 30, 2008(UNAUDITED)TotalNumber
      of
              
              
              Limited
              
              
              General
              
              
              Unitholders'Limited
      Partner Units
              
              
              Partner
              
              
              Partner
              
              
              Equity(In
      thousands)Balance,
      December 31, 2007
              
              
              29,671
              
              
              $
              255,663
              
              
              $
              67
              
              
              $
              255,730Costs
      associated with private placement equity offering in prior
      period
              
              
              -
              
              
              
              (6
              )
              
              
              -
              
              
              
              (6
              )Units
      issued to  Legacy Board of Directors for
services
              
              
              13
              
              
              
              263
              
              
              
              -
              
              
              
              263Compensation
      expense on restricted unit awards issued to employees
              
              
              -
              
              
              
              256
              
              
              
              -
              
              
              
              256Vesting
      of restricted units
              
              
              20
              
              
              
              -
              
              
              
              -
              
              
              
              -Units
      issued in COP III acquisition
              
              
              1,345
              
              
              
              27,000
              
              
              
              -
              
              
              
              27,000Distributions
      to unitholders, $1.46 per unit
              
              
              -
              
              
              
              (44,718
              )
              
              
              (27
              )
              
              
              (44,745
              )Net
      income
              
              
              -
              
              
              
              31,053
              
              
              
              18
              
              
              
              31,071Balance,
      September 30, 2008
              
              
              31,049
              
              
              $
              269,511
              
              
              $
              58
              
              
              $
              269,569See
      accompanying notes to condensed consolidated financial
      statements.







Page
9





LEGACY
      RESERVES LPCONDENSED
      CONSOLIDATED STATEMENTS OF CASH FLOWS(UNAUDITED)Nine
      Months Ended September 30,2008
              
              
              2007(Dollars
      in thousands)Cash
      flows from operating activities:Net
      income (loss)
              
              $
              31,071
              
              
              $
              (4,755
              )Adjustments
      to reconcile net income (loss) to net cash provided by operating
      activities:Depletion,
      depreciation, amortization and accretion
              
              
              33,223
              
              
              
              19,065Amortization
      of debt issuance costs
              
              
              386
              
              
              
              140Impairment
      of long-lived assets
              
              
              447
              
              
              
              1,230Loss
      on derivatives
              
              
              54,456
              
              
              
              20,426Equity
      in income of partnership
              
              
              (134
              )
              
              
              (41
              )Amortization
      of unit-based compensation
              
              
              1,295
              
              
              
              (69
              )(Gain)
      loss on disposal of assets
              
              
              (4,563
              )
              
              
              387Changes
      in assets and liabilities:Increase
      in accounts receivable, oil and natural gas
              
              
              (5,082
              )
              
              
              (4,997
              )(Increase)
      decrease in accounts receivable, joint interest owners
              
              
              (1,016
              )
              
              
              695(Increase)
      decrease in accounts receivable, other
              
              
              (356
              )
              
              
              11Increase
      in other current assets
              
              
              (4,451
              )
              
              
              (559
              )Increase
      (decrease) in accounts payable
              
              
              1,195
              
              
              
              (2,250
              )Increase
      in accrued oil and natural gas liabilities
              
              
              12,573
              
              
              
              2,685Increase
      in other liabilities
              
              
              844
              
              
              
              1,331Total
      adjustments
              
              
              88,817
              
              
              
              38,054Net
      cash provided by operating activities
              
              
              119,888
              
              
              
              33,299Cash
      flows from investing activities:Investment
      in oil and natural gas properties
              
              
              (151,372
              )
              
              
              (98,267
              )Increase
      in deposit on pending acquisition
              
              
              (3,087
              )
              
              
              (4,638
              )Investment
      in other equipment
              
              
              (1,573
              )
              
              
              (502
              )Net
      cash settlements on oil and natural gas swaps
              
              
              (41,659
              )
              
              
              4,236Investment
      in equity method investee
              
              
              137
              
              
              
              (46
              )Net
      cash used in investing activities
              
              
              (197,554
              )
              
              
              (99,217
              )Cash
      flows from financing activities:Proceeds
      from long-term debt
              
              
              188,000
              
              
              
              111,000Payments
      of long-term debt
              
              
              (67,000
              )
              
              
              (133,800
              )Payments
      of debt issuance costs
              
              
              (519
              )
              
              
              (336
              )Proceeds
      (costs) from issuance of units, net
              
              
              (6
              )
              
              
              121,555Distributions
      to unitholders
              
              
              (44,745
              )
              
              
              (29,204
              )Net
      cash provided by financing activities
              
              
              75,730
              
              
              
              69,215Net
      increase (decrease) in cash and cash equivalents
              
              
              (1,936
              )
              
              
              3,297Cash
      and cash equivalents, beginning of period
              
              
              9,604
              
              
              
              1,062Cash
      and cash equivalents, end of period
              
              $
              7,668
              
              
              $
              4,359Non-Cash
      Investing and Financing Activities:Asset
      retirement obligations associated with property
    acquisitions
              
              $
              15,694
              
              
              $
              1,023Units
      issued in exchange for oil and natural gas properties
              
              $
              27,000
              
              
              $
              18,022Non-cash
      excahnge of oil and gas properties:Properties
      received in exchange
              
              $
              7,746
              
              
              $
              -Properties
      delivered in exchange
              
              $
              (3,122
              )
              
              $
              -See
      accompanying notes to condensed consolidated financial
      statements.




Page
10




LEGACY
RESERVES LP


NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)




(1)  Summary
of Significant Accounting Policies





(a)  Organization,
Basis of Presentation and Description of Business





Legacy
Reserves LP and its affiliated entities are referred to as Legacy, LRLP or the
Partnership in these financial statements.




Certain
information and footnote disclosures normally included in the financial
statements prepared in accordance with generally accepted accounting principles
in the United States (“GAAP”) have been condensed or omitted in this Form 10-Q
pursuant to the rules and regulations of the Securities and Exchange Commission.
These condensed consolidated financial statements should be read in connection
with the consolidated financial statements and notes thereto included in the
Partnership’s Annual Report on Form 10-K  and 10-K/A for the year
ended December 31, 2007.





LRLP, a
Delaware limited partnership, was formed by its general partner, Legacy Reserves
GP, LLC (“LRGPLLC”), on October 26, 2005 to own and operate oil and natural
gas properties. LRGPLLC is a Delaware limited liability company formed on
October 26, 2005, and owns less than a 0.1% general partner interest in
LRLP.





Significant
information regarding rights of the limited partners includes the
following:





• Right
to receive, within 45 days after the end of each quarter, distributions of
available cash, if distributions are declared.




• No
limited partner shall have any management power over LRLP’s business and
affairs; the general partner shall conduct, direct and manage LRLP’s
activities.




• The
general partner may be removed if such removal is approved by the unitholders
holding at least 66 2/3 percent of the outstanding units, including
units held by LRLP’s general partner and its affiliates provided that a unit
majority has elected a successor general partner.




• Right
to receive information reasonably required for tax reporting purposes within
90 days after the close of the calendar year.




In the
event of a liquidation, all property and cash in excess of that required to
discharge all liabilities will be distributed to the unitholders and LRLP’s
general partner in proportion to their capital account balances, as adjusted to
reflect any gain or loss upon the sale or other disposition of Legacy’s assets
in liquidation.




Legacy
owns and operates oil and natural gas producing properties located primarily in
the Permian Basin of West Texas and Southeast New Mexico and the
Mid-continent region. Legacy has acquired oil and natural gas producing
properties and undrilled leaseholds.





The
accompanying condensed consolidated financial statements have been prepared on
the accrual basis of accounting whereby revenues are recognized when earned, and
expenses are recognized when incurred. These condensed consolidated financial
statements as of September 30, 2008 and for the three and nine months ended
September 30, 2008 and 2007 are unaudited. In the opinion of management,
such financial statements include the adjustments and accruals which are
necessary for a fair presentation of the results for the interim periods. These
interim results are not necessarily indicative of results for a full year.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with GAAP have been condensed or omitted in
these financial statements for and as of the three and nine months ended
September 30, 2008 and 2007.





(b)  Recently
Issued Accounting Pronouncements





In
September 2006, the FASB issued Statement of Financial Accounting Standards No.
157, Fair Value
Measurements. Statement No. 157 defines fair value as used in numerous
accounting pronouncements, establishes a framework for measuring fair value in
GAAP and expands disclosure related to the use of fair value measures in
financial statements. Legacy adopted the statement effective January 1, 2008 and
the adoption did not have a significant effect on our consolidated results of
operations, financial position or cash flows. See Note 6 for other disclosures
required by Statement No. 157.




Page
11




In
December 2007, the FASB issued Statement of Financial Accounting Standards No.
141 (revised 2007), Business
Combinations (“SFAS 141(R)”), which replaces FASB Statement No. 141. SFAS
141(R) establishes principles and requirements for how an acquirer recognizes
and measures in its financial statements the identifiable assets acquired, the
liabilities assumed, any non-controlling interest in the acquiree and the
goodwill acquired. The Statement also establishes disclosure requirements that
will enable users to evaluate the nature and financial effects of the business
combination. SFAS 141(R) is effective for acquisitions that occur in an entity’s
fiscal year that begins after December 15, 2008, which will be the Partnership’s
fiscal year 2009. The impact, if any, will depend on the nature and size of
business combinations Legacy consummates after the effective date.





In
December 2007, the FASB issued Statement of Financial Accounting Standards No.
160, Non-controlling Interest
in Consolidated Financial Statements – an amendment of ARB No. 51 (“SFAS
160”). SFAS 160 requires that accounting and reporting for minority interests
will be re-characterized as non-controlling interests and classified as a
component of equity. SFAS 160 also establishes reporting requirements that
provide sufficient disclosures that clearly identify and distinguish between the
interests of the parent and the interests of the non-controlling owners. SFAS
160 applies to all entities that prepare consolidated financial statements,
except not-for-profit organizations, but will affect only those entities that
have an outstanding non-controlling interest in one or more subsidiaries or that
deconsolidate a subsidiary. This statement is effective as of the beginning of
an entity’s first fiscal year beginning after December 15, 2008, which will be
the Partnership’s fiscal year 2009. Based upon the September 30, 2008 balance
sheet, the statement would have no impact.





In March,
2008, the FASB issued Statement of Financial Accounting Standards No. 161, Disclosures about Derivative
Instruments and Hedging Activities (“SFAS 161”). SFAS 161 amends and
expands the disclosure requirements of FASB Statement No. 133, Accounting for Derivative
Instruments and Hedging Activities. SFAS 161 requires disclosures related
to objectives and strategies for using derivatives; the fair-value amounts of,
and gains and losses on, derivative instruments; and credit-risk-related
contingent features in derivative agreements. This statement is effective as of
the beginning of an entity’s fiscal year beginning after December 15, 2008,
which will be the Partnership’s fiscal year 2009. The effect on Legacy’s
disclosures for derivative instruments as a result of the adoption of SFAS 161
in 2009 will depend on the Legacy’s derivative instruments and hedging
activities at that time.




(2)  Credit
Facility




As an
integral part of the formation of Legacy, Legacy entered into a credit agreement
with a senior credit facility (the “Legacy Facility”). Legacy has oil and
natural gas properties pledged as collateral for borrowings under the Legacy
Facility. The initial terms of the Legacy Facility permitted borrowings in the
lesser amount of (i) the borrowing base, or (ii) $300 million,
increased to $500 million pursuant to the Third Amendment effective October 24,
2007. The borrowing base under the Legacy Facility, $320 million as of September
30, 2008, was initially set at $130 million. Pursuant to the Fourth
Amendment to the credit agreement, the borrowing base was initially increased to
$272 million as of April 24, 2008 and further increased to $320 million
coincident with the closing of the COP III Acquisition, which closed on April
30, 2008. The borrowing base is re-determined every six months and will be
adjusted based upon changes in the fair market value of Legacy’s oil and natural
gas assets. Under the Legacy Facility, as amended, interest on debt outstanding
is charged based on Legacy’s selection of a LIBOR rate plus 1.25% to 1.875%, or
the alternate base rate (“ABR”) which equals the higher of the prime rate or the
Federal funds effective rate plus 0.50%, plus an applicable margin between 0%
and 0.25%.




As of
September 30, 2008, Legacy had outstanding borrowings of $231 million
at a weighted-average interest rate of 4.6%. Legacy had approximately
$88.7 million of availability remaining under the Legacy Facility as of
September 30, 2008. For the three-month and nine-month periods ended
September 30, 2008, Legacy paid $2.5 million and $6.2 million of interest
expense on the Legacy Facility, respectively. The Legacy Facility contains
certain loan covenants requiring minimum financial ratio coverages, including
the current ratio and EBITDA to interest expense. At September 30, 2008, Legacy
was in compliance with all aspects of the Legacy Facility.





Long-term
debt consists of the following at September 30, 2008 and December 31,
2007:





September
      30,
            
            
            December
      31,2008
            
            
            2007(Dollars
      in thousands)Legacy
      Facility- due March 2010
            
            $
            231,000
            
            
            $
            110,000




Page
12




(3)  Acquisitions




Binger
Acquisition




On April
16, 2007, Legacy purchased certain oil and natural gas properties and other
interests in the East Binger (Marchand) Unit in Caddo County, Oklahoma from
Nielson & Associates, Inc. for a net purchase price of $44.2 million
(“Binger Acquisition”). The purchase price was paid with the issuance of 611,247
units valued at $15.8 million and $28.4 million paid in cash. The effective date
of this purchase was February 1, 2007. The $44.2 million purchase price was
allocated with $14.7 million recorded as lease and well equipment, $29.4 million
of leasehold costs and $0.1 million as investment in equity method investee
related to the 50% interest acquired in Binger Operations, LLC. Asset retirement
obligations of $184,636 were recorded in connection with this acquisition. The
operating results from these Binger Acquisition properties have been included
from their acquisition on April 16, 2007.





Ameristate
Acquisition




On May 1,
2007, Legacy purchased certain oil and natural gas properties located in the
Permian Basin from Ameristate Exploration, LLC for a net purchase price of
$5.2 million (“Ameristate Acquisition”). The effective date of this purchase was
January 1, 2007. The $5.2 million purchase price was allocated with $0.5 million
recorded as lease and well equipment and $4.7 million of leasehold costs. Asset
retirement obligations of $51,414 were recorded in connection with this
acquisition. The operating results from these Ameristate Acquisition properties
have been included from their acquisition on May 1, 2007.





TSF
Acquisition




On May
25, 2007, Legacy purchased certain oil and natural gas properties located in the
Permian Basin from Terry S. Fields for a net purchase price of $14.7
million (“TSF Acquisition”). The effective date of this purchase was March 1,
2007. The $14.7 million purchase price was allocated with $1.8 million recorded
as lease and well equipment and $12.9 million of leasehold costs. Asset
retirement obligations of $99,094 were recorded in connection with this
acquisition. The operating results from these TSF Acquisition properties have
been included from their acquisition on May 25, 2007.





Raven
Shenandoah Acquisition




On May
31, 2007, Legacy purchased certain oil and natural gas properties located in the
Permian Basin from Raven Resources, LLC and Shenandoah Petroleum
Corporation for a net purchase price of $13.0 million (“Raven Shenandoah
Acquisition”). The effective date of this purchase was May 1, 2007. The $13.0
million purchase price was allocated with $6.0 million recorded as lease and
well equipment and $7.0 million of leasehold costs. Asset retirement obligations
of $378,835 were recorded in connection with this acquisition. The operating
results from these Raven Shenandoah Acquisition properties have been included
from their acquisition on May 31, 2007.





Raven
OBO Acquisition





On August
3, 2007, Legacy purchased certain oil and natural gas properties located
primarily in the Permian Basin from Raven Resources, LLC and private
parties for a net purchase price of $20.0 million (“Raven OBO Acquisition”). The
effective date of this purchase was July 1, 2007. The $20.0 million purchase
price was allocated with $1.6 million recorded as lease and well equipment and
$18.4 million of leasehold costs. Asset retirement obligations of $224,329 were
recorded in connection with this acquisition. The operating results from these
Raven OBO Acquisition properties have been included from their acquisition on
August 3, 2007.





TOC
Acquisition





On
October 1, 2007, Legacy purchased certain oil and natural gas properties located
in the Texas Panhandle from The Operating Company, et al, for a net purchase
price of $60.6 million (“TOC Acquisition”). The effective date of this purchase
was September 1, 2007. The $60.6 million purchase price was allocated with $23.7
million recorded as lease and well equipment and $36.9 million of leasehold
costs. Asset retirement obligations of $1.6 million were recorded in connection
with this acquisition. The operating results from these TOC Acquisition
properties have been included from their acquisition on October 1,
2007.





Summit
Acquisition





Also on
October 1, 2007, Legacy purchased certain oil and natural gas properties located
in the Permian Basin from Summit Petroleum Management Corporation for a net
purchase price of $13.4 million (“Summit Acquisition”). The effective date of
this purchase was September 1, 2007. The $13.4 million purchase price was
allocated with $2.1 million recorded as lease and well equipment and $11.3
million as leasehold cost. Asset retirement obligations of $128,705 were
recorded in connection with this acquisition. The operating results from these
Summit Acquisition properties have been included from their acquisition on
October 1, 2007.




Page
13




COP
III Acquisition





On April
30, 2008, Legacy purchased certain oil and natural gas properties located
primarily in the Permian Basin and to a lesser degree in Oklahoma and
Kansas from a third party for a net purchase price of $78.5 million. The
purchase price was paid with the issuance of 1,345,291 newly issued units valued
at $27.0 million and $51.5 million paid in cash (“COP III Acquisition”). The
effective date of this purchase was January 1, 2008. The $78.5 million purchase
price was allocated with $19.5 million recorded as lease and well equipment and
$59.0 million as leasehold cost. Asset retirement obligations of $4.0 million
were recorded in connection with this acquisition. The operating results from
these COP III Acquisition properties have been included from their acquisition
on April 30, 2008.





Reeves
Unit Exchange





On May 2,
2008, Legacy entered into a non-monetary exchange with Devon Energy in which
Legacy exchanged its 12.9% non-operated working interest in the Reeves Unit for
a 60% interest in two operated properties. Prior to the exchange, Legacy’s basis
in the Reeves Unit was $4.4 million offset by $1.3 million of accumulated
depletion. In addition, Legacy had asset retirement obligations of $0.3 million
related to the Reeves Unit. Due to the commercial substance of the transaction,
the excess fair value of $4.9 million above the carrying value of the Reeves
Unit was recorded as a gain on sale of discontinued operation in the nine-month
period ended September 30, 2008. Due to immateriality, Legacy has not reflected
the operating results of the Reeves Unit separately as a discontinued operation
for any of the periods presented.





Pro
Forma Operating Results




The
following table reflects the unaudited pro forma results of operations as though
the Binger, Ameristate, TSF, Raven Shenandoah, Raven OBO, TOC, Summit and COP
III Acquisitions had each occurred on January 1 of the respective year. The
pro forma amounts are not necessarily indicative of the results that may be
reported in the future:





Three
      Months Ended
              
              
              Nine
      Months EndedSeptember
      30,
              
              
              September
      30,2008
              
              
              2007
              
              
              2008
              
              
              2007(In
      thousands, except per unit data)Revenues
              
              $
              65,611
              
              
              $
              38,783
              
              
              $
              188,252
              
              
              $
              102,377Net
      income (loss)
              
              $
              227,952
              
              
              $
              3,937
              
              
              $
              33,001
              
              
              $
              (294
              )Income
      (loss) per unit - basic and diluted:
              
              $
              7.34
              
              
              $
              0.14
              
              
              $
              1.06
              
              
              $
              (0.01
              )Units
      used in computing income (loss) per unit:basic
              
              
              31,041
              
              
              
              27,367
              
              
              
              31,032
              
              
              
              27,073diluted
              
              
              31,076
              
              
              
              27,418
              
              
              
              31,081
              
              
              
              27,073




(4)  Related
Party Transactions




Cary D.
Brown, Legacy’s Chairman and Chief Executive Officer, and Kyle A. McGraw,
Legacy’s Executive Vice President – Business Development and Land, own
partnership interests which, in turn, own a combined non-controlling 4.16%
interest as limited partners in the partnership which owns the building that
Legacy occupies. Monthly rent is $14,808, without respect to property taxes and
insurance. The lease expires in August 2011.




Legacy
uses Lynch, Chappell and Alsup for legal services. Alan Brown, brother of Cary
D. Brown, is a less than ten percent shareholder in this firm. Legacy paid legal
fees to Lynch, Chappell and Alsup of $88,253 and $87,274 for the nine months
ended September 30, 2008 and 2007, respectively.




Page
14




(5)  Commitments
and Contingencies




From time
to time Legacy is a party to various legal proceedings arising in the ordinary
course of business. While the outcome of lawsuits cannot be predicted with
certainty, Legacy is not currently a party to any proceeding that it believes,
if determined in a manner adverse to Legacy, could have a potential material
adverse effect on its financial condition, results of operations or cash flows.
Legacy believes the likelihood of such a future event to be remote.




Additionally,
Legacy is subject to numerous laws and regulations governing the discharge of
materials into the environment or otherwise relating to environmental
protection. To the extent laws are enacted or other governmental action is taken
that restricts drilling or imposes environmental protection requirements that
result in increased costs to the oil and natural gas industry in general, the
business and prospects of Legacy could be adversely affected.




Legacy
has employment agreements with its officers that specify that if the officer is
terminated by Legacy for other than cause or following a change in control, the
officer shall receive severance pay ranging from 24 to 36 months salary
plus bonus and COBRA benefits.




On
September 24, 2008, Legacy entered into a participation agreement with Black Oak
Resources, LLC committing up to $20 million over three years to jointly invest
in and develop oil and natural gas properties. Unless Black Oak Resources, LLC
were to increase the $110 million of equity commitments initially committed or
enter into a borrowing relationship, Legacy’s obligations are expected to be in
the range of $8 million over the next three years.




(6)  Fair
Value Measurements





Legacy
adopted SFAS No. 157, Fair
Value Measurements, effective January 1, 2008 for financial assets and
liabilities measured at fair value on a recurring basis. SFAS No. 157
applies to all financial assets and financial liabilities that are being
measured and reported on a fair value basis. In February 2008, the FASB issued
FSP No. 157-2, which delayed the effective date of SFAS No. 157 by one year for
non-financial assets and liabilities. As defined in SFAS No. 157, fair value is
the price that would be received upon the sale of an asset or paid to transfer a
liability in an orderly transaction between market participants at the
measurement date. SFAS No. 157 requires disclosure that establishes a
framework for measuring fair value and expands disclosure about fair value
measurements. The statement requires fair value measurements be classified and
disclosed in one of the following categories:





Level
      1:
            Unadjusted
      quoted prices in active markets that are accessible at the measurement
      date for identical, unrestricted assets or liabilities. Legacy considers
      active markets as those in which transactions for the assets or
      liabilities occur in sufficient frequency and volume to provide pricing
      information on an ongoing basis.Level
      2:
            Quoted
      prices in markets that are not active, or inputs which are observable,
      either directly or indirectly, for substantially the full term of the
      asset or liability. This category includes those derivative instruments
      that Legacy values using observable market data. Substantially all of
      these inputs are observable in the marketplace throughout the term of the
      derivative instrument, can be derived from observable data, or supported
      by observable levels at which transactions are executed in the
      marketplace. Instruments in this category include non-exchange traded
      derivatives such as over-the-counter commodity price swaps and interest
      rate swaps.Level
      3:
            Measured
      based on prices or valuation models that require inputs that are both
      significant to the fair value measurement and less observable from
      objective sources (i.e. supported by little or no market
      activity). Legacy's valuation models are primarily industry standard
      models that consider various inputs including: (a) quoted forward prices
      for commodities, (b) time value, and (c) current market and contractual
      prices for the underlying instruments, as well as other relevant economic
      measures. Level 3 instruments primarily include derivative instruments,
      such as basis swaps and NGL derivative swaps. Although Legacy utilizes
      third party broker quotes to assess the reasonableness of its prices
      and valuation techniques, Legacy does not have sufficient corroborating
      evidence to support classifying these assets and liabilities as Level
      2.





As
required by SFAS No. 157, financial assets and liabilities are classified based
on the lowest level of input that is significant to the fair value measurement.
Our assessment of the significance of a particular input to the fair value
measurement requires judgment, and may affect the valuation of the fair value of
assets and liabilities and their placement within the fair value hierarchy
levels. The following table summarizes the valuation of our investments and
financial instruments by SFAS No. 157 pricing levels as of September 30,
2008:





Fair
      Value Measurements at September 30, 2008 UsingQuoted
      Prices in
              
              
              Significant
      Other
              
              
              SignificantActive
      Markets for
              
              
              Observable
              
              
              Unobservable
              
              
              Total
      CarryingIdentical
      Assets
              
              
              Inputs
              
              
              Inputs
              
              
              Value
      as ofDescription
              
              (Level
      1)
              
              
              (Level
      2)
              
              
              (Level
      3)
              
              
              September
      30, 2008(Dollars
      in thousands)Oil,
      NGL and natural gas derivative swaps
              
              $
              -
              
              
              $
              (102,707
              )
              
              $
              1,436
              
              
              $
              (101,271
              )Oil
      collars
              
              
              -
              
              
              
              -
              
              
              
              5,785
              
              
              
              5,785Interest
      rate swaps
              
              
              -
              
              
              
              (1,079
              )
              
              
              -
              
              
              
              (1,079
              )Total
              
              $
              -
              
              
              $
              (103,786
              )
              
              $
              7,221
              
              
              $
              (96,565
              )
  Page
15


The
following table sets forth a reconciliation of changes in the fair value of
financial assets and liabilities classified as level 3 in the fair value
hierarchy:





Significant
      Unobservable Inputs(Level
      3)Three
      Months Ended
              
              
              Nine
      Months EndedSeptember
      30, 2008
              
              
              September
      30, 2008(Dollars
      in thousands)Beginning
      balance
              
              $
              (23,131
              )
              
              $
              (4,502
              )Total
      gains or (losses)
              
              
              28,793
              
              
              
              7,841Settlements
              
              
              1,559
              
              
              
              3,882Transfers
      in and/or out of level 3
              
              
              -
              
              
              
              -Balance
      as of September 30, 2008
              
              $
              7,221
              
              
              $
              7,221Change
      in unrealized gains (losses) included in earnings relating to derivatives
      still held as of September 30, 2008
              
              $
              30,352
              
              
              $
              11,723


(7)  Derivative
Financial Instruments




Due to
the volatility of oil and natural gas prices, Legacy periodically enters into
price-risk management transactions (e.g., swaps or collars) for a portion of its
oil and natural gas production to achieve a more predictable cash flow, as well
as to reduce exposure to price fluctuations. While the use of these arrangements
limits Legacy’s ability to benefit from increases in the price of oil and
natural gas, it also reduces Legacy’s potential exposure to adverse price
movements. Legacy’s arrangements, to the extent it enters into any, apply to
only a portion of its production, provide only partial price protection against
declines in oil and natural gas prices and limit Legacy’s potential gains from
future increases in prices. None of these instruments are used for trading or
speculative purposes.




All of
these price risk management transactions are considered derivative instruments
and accounted for in accordance with Statement of Financial Accounting Standards
(“SFAS”) No. 133 — Accounting for Derivative
Instruments and Hedging Activities. These derivative instruments are
intended to reduce Legacy’s price risk and may be considered hedges for economic
purposes but Legacy has chosen not to designate them as cash flow hedges for
accounting purposes. Therefore, all derivative instruments are recorded on the
balance sheet at fair value with changes in fair value being recorded in
earnings for the period ended September 30, 2008.




By using
derivative instruments to mitigate exposures to changes in commodity prices,
Legacy is exposed to credit risk and market risk. Credit risk is the failure of
the counterparty to perform under the terms of the derivative contract. When the
fair value of a derivative contract is positive, the counterparty owes Legacy,
which creates repayment risk. Legacy minimizes the credit or repayment risk in
derivative instruments by entering into transactions with high-quality
counterparties that are parties to our Credit Agreement.




For the
three and nine months ended September 30, 2008 and 2007, Legacy recognized
realized and unrealized gains and losses related to its oil, NGL and natural gas
derivatives. The impact on net loss from derivative activities was as
follows:





Three
      Months Ended
            
            
            Nine
      Months EndedSeptember
      30,
            
            
            September
      30,2008
            
            
            2007
            
            
            2008
            
            
            2007(Dollars
      in thousands)Crude
      oil derivative contract settlements
            
            $
            (17,463
            )
            
            $
            (846
            )
            
            $
            (36,636
            )
            
            $
            1,199Natural
      gas liquid derivative contract settlements
            
            
            (1,359
            )
            
            
            (118
            )
            
            
            (3,092
            )
            
            
            (159
            )Natural
      gas derivative contract settlements
            
            
            (928
            )
            
            
            1,372
            
            
            
            (1,931
            )
            
            
            3,196Total
      derivative contract settlements
            
            
            (19,750
            )
            
            
            408
            
            
            
            (41,659
            )
            
            
            4,236Unrealized
      change in fair value - oil contracts
            
            
            185,730
            
            
            
            (7,677
            )
            
            
            (18,848
            )
            
            
            (20,861
            )Unrealized
      change in fair value - natural gas liquid contracts
            
            
            4,143
            
            
            
            (650
            )
            
            
            1,560
            
            
            
            (941
            )Unrealized
      change in fair value - natural gas contracts
            
            
            32,265
            
            
            
            1,483
            
            
            
            4,074
            
            
            
            (2,586
            )Total
      unrealized change in fair value
            
            
            222,138
            
            
            
            (6,844
            )
            
            
            (13,214
            )
            
            
            (24,388
            )Total
      effect of derivative contracts
            
            $
            202,388
            
            
            $
            (6,436
            )
            
            $
            (54,873
            )
            
            $
            (20,152
            )




Page
16




As of
September 30, 2008, Legacy had the following NYMEX West Texas Intermediate crude
oil swaps paying floating prices and receiving fixed prices for a portion of its
future oil production as indicated below:





Average
              
              PriceCalendar
      Year
              
              Volumes
      (Bbls)
              
              Price
      per Bbl
              
              Range
      per BblOctober
      - December 2008
              
              326,781
              
              $                 74.62
              
              $62.25
      - $108.502009
              
              1,488,969
              
              $                 82.82
              
              $61.05
      - $140.002010
              
              1,397,973
              
              $                 82.37
              
              $60.15
      - $140.002011
              
              1,155,712
              
              $                 88.07
              
              $67.33
      - $140.002012
              
              873,812
              
              $                 81.41
              
              $67.72
      - $109.20




On June
24, 2008, Legacy entered into a NYMEX West Texas Intermediate crude oil
derivative collar contract that combines a put option or “floor” with a call
option or “ceiling”. The following table summarizes the contract as of September
30, 2008:





Average
              
              AverageCalendar
      Year
              
              Volumes
      (Bbls)
              
              Floor
              
              Ceiling2009
              
              75,400
              
              $               120.00
              
              $                 156.302010
              
              71,800
              
              $               120.00
              
              $                 156.302011
              
              68,300
              
              $               120.00
              
              $                 156.302012
              
              65,100
              
              $               120.00
              
              $                 156.30


As of
September 30, 2008, Legacy had the following NYMEX Henry Hub, ANR-OK and
Waha natural gas swaps paying floating natural gas prices and receiving fixed
prices for a portion of its future natural gas production as indicated
below:





Average
              
              PriceCalendar
      Year
              
              Volumes
      (MMBtu)
              
              Price
      per MMBtu
              
              Range
      per MMBtuOctober
      - December 2008
              
              837,071
              
              $                   8.13
              
              $6.85
      - $9.102009
              
              3,167,142
              
              $                   8.06
              
              $6.85
      - $10.182010
              
              2,840,859
              
              $                   7.87
              
              $6.85
      - $9.732011
              
              2,127,316
              
              $                   8.01
              
              $6.85
      - $8.702012
              
              1,579,736
              
              $                   8.02
              
              $6.85
      - $8.70




As of
September 30, 2008, Legacy had the following natural gas basis swaps in which it
receives floating NYMEX prices less a fixed basis differential and pays prices
on the floating Waha index, a natural gas hub in West Texas. The prices that
Legacy receives for its natural gas sales in the Permian Basin follow Waha
more closely than NYMEX:





BasisCalendar
      Year
              
              Volumes
      (MMBtu)
              
              Range
      per McfOctober
      - December 2008
              
              355,500
              
              ($0.84)2009
              
              1,320,000
              
              ($0.68)2010
              
              1,200,000
              
              ($0.57)




As of
September 30, 2008, Legacy had the following Mont Belvieu, Non-Tet OPIS natural
gas liquids swaps paying floating natural gas liquids prices and receiving fixed
prices for a portion of its future natural gas liquids production as indicated
below:





Average
              
              PriceCalendar
      Year
              
              Volumes
      (Gal)
              
              Price
      per Gal
              
              Range
      per GalOctober
      - December 2008
              
              1,582,035
              
              $                   1.27
              
              $0.66
      - $1.622009
              
              2,265,480
              
              $                   1.15
              
              $1.15


On August 29, 2007, Legacy entered into
LIBOR interest rate swaps beginning in October of 2007 and extending through
November 2011. The swap transaction has Legacy paying its counterparty fixed
rates ranging from 4.8075% to 4.82%, per annum, and receiving floating rates on
a total notional amount of $54 million. The swaps are settled on a quarterly
basis, beginning in January of 2008 and ending in November of 2011.





On March
14, 2008, Legacy entered into a LIBOR interest rate swap beginning in April of
2008 and extending through April of 2011. The swap transaction has Legacy paying
its counterparty a fixed rate of 2.68% per annum, and receiving floating rates
on a notional amount of $60 million. The swap is settled on a quarterly basis,
beginning in July of 2008 and ending in April of 2011.





Legacy
accounts for these interest rate swaps pursuant to SFAS No. 133 – Accounting for Derivative
Instruments and Hedging Activities, as amended. This statement
establishes accounting and reporting standards requiring that derivative
instruments be recorded at fair market value and included in the balance sheet
as assets or liabilities.




Page
17




As the
term of Legacy’s interest rate swaps extends through November of 2011, a period
that extends beyond the term of the Legacy Facility, which expires on March 15,
2010, Legacy did not specifically designate these derivatives as cash flow
hedges, even though they reduce its exposure to changes in interest rates.
Therefore, the mark-to-market of these instruments is recorded in current
earnings. The table below summarizes the interest rate swap position as of
September 30, 2008.





EstimatedFair
      Market ValueFixed
              
              Effective
              Maturity
              
              at
      September 30,Notional
      Amount
              
              
              Rate
              
              Date
              Date
              
              2008(Dollars
      in thousands)$
              29,000
              
              
              
              4.8200
              %
              10/16/2007
              10/16/2011
              
              $
              (1,182
              )$
              13,000
              
              
              
              4.8100
              %
              11/16/2007
              11/16/2011
              
              
              (516
              )$
              12,000
              
              
              
              4.8075
              %
              11/28/2007
              11/28/2011
              
              
              (476
              )$
              60,000
              
              
              
              2.6800
              %
              4/1/2008
              4/1/2011
              
              
              1,095Total
      Fair Market Value
              
              $
              (1,079
              )


(8)  Asset Retirement
Obligation




SFAS No. 143
requires that an asset retirement obligation (“ARO”) associated with the
retirement of a tangible long-lived asset be recognized as a liability in the
period in which it is incurred and becomes determinable. Under this method, when
liabilities for dismantlement and abandonment costs, excluding salvage values,
are initially recorded, the carrying amount of the related oil and natural gas
properties is increased. The fair value of the ARO asset and liability is
measured using expected future cash outflows discounted at Legacy’s
credit-adjusted risk-free interest rate. Accretion of the liability is
recognized each period using the interest method of allocation, and the
capitalized cost is depleted over the useful life of the related
asset.




The
following table reflects the changes in the ARO during the year ended
December 31, 2007 and nine months ended September 30, 2008.





September
      30,
              
              
              December
      31,2008
              
              
              2007(Dollars
      in thousands)Asset
      retirement obligation - beginning of period
              
              $
              15,920
              
              
              $
              6,493Liabilities
      incurred with properties acquired
              
              
              15,694
              
              
              
              3,033Liabilities
      incurred with properties drilled
              
              
              -
              
              
              
              114Liabilities
      settled during the period
              
              
              (314
              )
              
              
              (372
              )Liabilities
      associated with properties sold
              
              
              (304
              )
              
              
              -Current
      period accretion
              
              
              885
              
              
              
              470Current
      period revisions to oil and natural gas properties
              
              
              -
              
              
              
              6,182Asset
      retirement obligation - end of period
              
              $
              31,881
              
              
              $
              15,920




(9)  Earnings
(Loss) Per Unit





The
following table sets forth the computation of basic and diluted net earnings
(loss) per unit:





Three
      Months Ended
              
              
              Nine
      Months EndedSeptember
      30,
              
              
              September
      30,2008
              
              
              2007
              
              
              2008
              
              
              2007(In
      thousands, except per unit data)Income
      (loss) available to unitholders
              
              $
              227,952
              
              
              $
              2,166
              
              
              $
              31,071
              
              
              $
              (4,755
              )Weighted
      average number of units outstanding
              
              
              31,041
              
              
              
              26,022
              
              
              
              30,443
              
              
              
              25,493Effect
      of dilutive securities:Unit
      options
              
              
              21
              
              
              
              31
              
              
              
              30
              
              
              
              -Restricted
      units
              
              
              14
              
              
              
              20
              
              
              
              19
              
              
              
              -Weighted
      average units and potential units outstanding
              
              
              31,076
              
              
              
              26,073
              
              
              
              30,492
              
              
              
              25,493Basic
      and diluted earnings (loss) per unit
              
              $
              7.34
              
              
              $
              0.08
              
              
              $
              1.02
              
              
              $
              (0.19
              )
  Page
18


(10)  Unit-Based
Compensation




Long-Term
Incentive Plan




Concurrent
with the Legacy Formation on March 15, 2006, a Long-Term Incentive Plan for
Legacy was created and Legacy adopted SFAS No. 123(R)-Share-Based Payment. Legacy
adopted the Legacy Reserves LP Long-Term Incentive Plan (“LTIP”) for its
employees, consultants and directors, its affiliates and its general partner.
The awards under the LTIP may include unit grants, restricted units, phantom
units, unit options and unit appreciation rights. The LTIP permits the grant of
awards covering an aggregate of 2,000,000 units. As of September 30,
2008, grants of awards net of forfeitures covering 728,916 units had been
made, comprised of 612,050 unit options and unit appreciation rights awards,
65,116 restricted unit awards and 51,750 phantom unit awards. The LTIP is
administered by the compensation committee of the board of directors of Legacy’s
general partner (the “Compensation Committee”).





SFAS No. 123(R)
requires companies to measure the cost of employee services in exchange for an
award of equity instruments based on a grant-date fair value of the award (with
limited exceptions), and that cost must generally be recognized over the vesting
period of the award. Prior to April of 2007, Legacy utilized the equity method
of accounting as described in SFAS No. 123(R) to recognize the cost associated
with unit options. However, SFAS No. 123(R) stipulates that “if an entity that
nominally has the choice of settling awards by issuing stock predominately
settles in cash, or if the entity usually settles in cash whenever an employee
asks for cash settlement, the entity is settling a substantive liability rather
than repurchasing an equity instrument.”





The
initial vesting of options occurred on March 15, 2007, with initial option
exercises occurring in April 2007. At the time of the initial exercise, Legacy
settled these exercises in cash and determined it was likely to do so for future
option exercises. Consequently, in April 2007, Legacy began accounting for unit
option grants by utilizing the liability method as described in SFAS No. 123(R).
The liability method requires companies to measure the cost of the employee
services in exchange for a cash award based on the fair value of the underlying
security at the end of the period. Compensation cost is recognized based on the
change in the liability between periods.




Unit
Options and Unit Appreciation Rights





During
the year ended December 31, 2007, Legacy issued 113,000 unit option awards
to employees which vest ratably over a three-year period. All options granted in
2007 expire five years from the grant date and are exercisable when they vest.
During the nine-month period ended September 30, 2008, Legacy issued 96,000
unit appreciation rights (“UARs”) to employees which vest ratably over a
three-year period and 108,450 UAR’s to employees which cliff-vest at the end of
a three year period. All UARs granted in 2008 expire five years from the grant
date and are exercisable when they vest.




For the
nine-month periods ended September 30, 2008 and 2007, Legacy recorded
$258,127 and $855,345, respectively, of compensation expense due to the change
in liability from December 31, 2007 and 2006 based on its use of the
Black-Scholes model to estimate the September 30, 2008 and 2007 fair value of
these unit options and UARs. As of September 30, 2008, there was a total of
$0.7 million of unrecognized compensation costs related to the un-exercised and
non-vested portion of these unit options and UARs. At September 30, 2008, this
cost was expected to be recognized over a weighted-average period of
approximately 2.1 years. Compensation expense is based upon the fair value
as of September 30, 2008 and is recognized as a percentage of the service period
satisfied. Since Legacy has limited trading history, it has used an estimated
volatility factor of approximately 51% based upon the historical trends of a
representative group of publicly-traded companies in the energy industry and
employed the fair value method to estimate the September 30, 2008 fair value to
be realized as compensation cost based on the percentage of service period
satisfied. In the absence of historical data, Legacy has assumed an estimated
forfeiture rate of 5%. As required by SFAS No. 123(R), Legacy will
adjust the estimated forfeiture rate based upon actual experience. Legacy has
assumed an annual distribution rate of $2.08 per unit.




A summary
of option and UAR activity for the nine-months ended September 30, 2008 is as
follows:





Weighted-Weighted-
              
              AverageAverage
              
              RemainingExercise
              
              ContractualUnits
              
              
              Price
              
              TermOutstanding
      at January 1, 2008
              
              
              399,422
              
              
              $
              19.73Granted
              
              
              204,450
              
              
              $
              20.66Exercised
              
              
              (5,330
              )
              
              $
              17.00Forfeited
              
              
              (14,860
              )
              
              $
              19.44Outstanding
      at September 30, 2008
              
              
              583,682
              
              
              $
              20.09
              
              3.7
      yearsOptions
      and UARs exercisable at September 30, 2008
              
              
              154,136
              
              
              $
              18.61
              
              2.7
      years




Page
19




The
following table summarizes the status of Legacy’s non-vested unit options and
UARs since January 1, 2008:




Non-Vested
      Options and UARsWeighted-Number
      of
              
              
              Average
      FairUnits
              
              
              ValueNon-vested
      at January 1, 2008
              
              
              336,622
              
              
              $
              4.09Granted
              
              
              204,450
              
              
              
              2.18Vested
      - Unexercised
              
              
              (91,336
              )
              
              
              3.84Vested
      - Exercised
              
              
              (5,330
              )
              
              
              6.44Forfeited
              
              
              (14,860
              )
              
              
              3.20Non-vested
      at September 30, 2008
              
              
              429,546
              
              
              $
              2.74




Legacy
has used a weighted-average risk-free interest rate of 3.0% in its Black-Scholes
calculation of fair value, which approximates the U.S. Treasury
interest rates at September 30, 2008 whose term is consistent with the expected
life of the unit options and UARs. Expected life represents the period of time
that options and UARs are expected to be outstanding and is based on Legacy’s
best estimate. The following table represents the weighted-average assumptions
used for the Black-Scholes option-pricing model.





Nine
      Months EndedSeptember
      30,2008Expected
      life (years)
              
              
              5Annual
      interest rate
              
              
              3.0
              %Annual
      distribution rate per unit
              
              $
              2.08Volatility
              
              
              51
              %


Restricted
and Phantom Units





As
described below, Legacy has also issued phantom units under the LTIP. Because
Legacy’s current intent is to settle these awards in cash, Legacy is accounting
for the phantom units by utilizing the liability method.





On June
27, 2007, Legacy granted 3,000 phantom units to an employee which vest ratably
over a five-year period, beginning at the date of grant. On July 16, 2007,
Legacy granted 5,000 phantom units to an employee which vest ratably over a
five-year period, beginning at the date of grant. On December 3, 2007, Legacy
granted 10,000 phantom units to an employee which vest ratably over a three-year
period, beginning at the date of grant. On February 4, 2008, Legacy granted
2,750 phantom units to four employees which vest ratably over a three-year
period, beginning at the date of grant. On May 1, 2008, Legacy granted 3,000
phantom units to an employee which vest ratably over a three-year period,
beginning at the date of grant. In conjunction with these grants, the employees
are entitled to distribution equivalent rights (“DERs”) for unvested units held
at the date of dividend payment. Compensation expense related to the phantom
units and associated DERs was $190,043 and $22,027 for the nine month periods
ended September 30, 2008 and 2007, respectively.





On August
20, 2007, the board of directors of Legacy’s general partner, upon
recommendation from the Compensation Committee, approved phantom unit awards of
up to 175,000 units to five key executives of Legacy based on achievement of
targeted annualized per unit distribution levels over a base amount of $1.64 per
unit.  These awards are to be determined annually based solely on the
annualized level of per unit distributions for the fourth quarter of each
calendar year and subsequently vest over a three-year period. There is a range
of 0% to 100% of the distribution levels at which the performance condition may
be met. For each quarter, management recommends to the board an appropriate
level of per unit distribution based on available cash of Legacy. The level of
distribution is set by the board subsequent to management’s recommendation.
Probable issuances for the purposes of calculating compensation expense
associated therewith are determined based on management’s determination of
probable future distribution levels. Expense associated with probable vesting is
recognized over the period from the date probable vesting is determined to the
end of the three-year vesting period. On February 4, 2008 the Compensation
Committee approved the award of 28,000 phantom units to Legacy’s five executive
officers. In conjunction with these grants, the executive officers are entitled
to DERs for unvested units held at the date of dividend payment. Compensation
expense related to the phantom units and associated DERs was $392,551 for the
nine months ended September 30, 2008.





On
March 15, 2006, Legacy issued an aggregate of 52,616 restricted units to
two employees. The restricted units awarded vest ratably over a three-year
period, beginning on the date of grant. On May 5, 2006, Legacy issued
12,500 restricted units to an employee. The restricted units awarded vest
ratably over a five-year period, beginning on March 31, 2007. Compensation
expense related to restricted units was $255,492 for both the nine months ended
September, 30, 2008 and 2007. As of September 30, 2008, there was a total
of $240,782 of unrecognized compensation expense related to the non-vested
portion of these restricted units. At September 30, 2008, this cost was
expected to be recognized over a weighted-average period of 1.3 years.
Pursuant to the provisions of SFAS 123(R), Legacy’s issued units, as
reflected in the accompanying consolidated balance sheet
at September 30, 2008, do not include 25,040 units related to
unvested restricted unit awards.




Page
20




On
May 1, 2006, Legacy granted and issued 1,750 units to each of its five
non-employee directors as part of their annual compensation for serving on the
board of directors of Legacy’s general partner. The value of each unit was
$17.00 at the time of grant. On November 26, 2007, Legacy granted and issued
1,750 units to each of its four non-employee directors as part of their annual
compensation for serving on Legacy’s board. The value of each unit was $21.32 at
the time of grant. On March 5, 2008, Legacy issued 583 units, granted on January
23, 2008, to its newly elected non-employee director as part of his pro-rata
annual compensation for serving on Legacy’s board. The value of each unit was
$21.20 at the time of grant. On August 29, 2008, Legacy issued 2,500 units,
granted on August 26, 2008, to each of its five non-employee directors as part
of their annual compensation for serving on the board of directors of Legacy’s
general partner. The value of each unit was $20.09 at the time of
issuance.






(10)  Subsequent
Events





On
October 1, 2008, Legacy closed its previously announced acquisition of all the
membership interests of Pantwist, LLC from Cano Petroleum, Inc. for an aggregate
purchase price of approximately $40.8 million, subject to customary post-closing
adjustments, paid in cash. Pantwist owns certain oil and natural gas properties
in Carson, Gray, Hutchison and Moore counties in the Texas
Panhandle.





On
October 6, 2008, Legacy entered into a Fifth Amendment to the Credit Agreement
(the “Fifth Amendment”) to the Legacy Facility. Pursuant to the Fifth Amendment,
the borrowing base has been increased to $383.76 million. Additionally, the
Legacy Facility provides that Legacy may elect that borrowings be comprised
entirely of ABR loans or Eurodollar loans. Under the Fifth Amendment, interest
on the loans is determined as follows: with respect to ABR Loans, the alternate
base rate equals the higher of the prime rate or the Federal funds effective
rate plus 0.50%, plus an applicable margin between 0% and 0.50%; and with
respect to Eurodollar loans, interest is calculated using LIBOR plus an
applicable margin ranging from and including 1.50% and 2.125% depending on the
percentage of the borrowing base that is outstanding at any given
time.





On
October 6, 2008, Legacy entered into LIBOR interest rate swaps beginning on
October 10, 2008, and extending through October 10, 2011 covering $100 million
notional amount of the outstanding borrowings under its Credit Agreement. Under
the swap transactions Legacy pays a weighted average fixed rate of 3.185% per
annum and Legacy’s counterparties pay Legacy a floating rate of interest based
on LIBOR.





On
October 23, 2008, Legacy’s Board of Directors approved a distribution of $0.52
per unit payable on November 14, 2008 to unitholders of record on November 3,
2008.





Page
21




Item
2.  Management’s Discussion and Analysis of Financial Condition and Results
of Operations.





Cautionary
Statement Regarding Forward Looking Information





This
document contains forward-looking statements that are subject to a number of
risks and uncertainties, many of which are beyond our control, which may include
statements about:




•   our
business strategy;





•   the
amount of oil and natural gas we produce;





•   the
price at which we are able to sell our oil and natural gas
production;





•   our
ability to acquire additional oil and natural gas properties at economically
attractive prices;




•   our
drilling locations and our ability to continue our development activities at
economically attractive prices;




•   the
level of our lease operating expenses, general and administrative costs and
finding and development costs, including payments to our general
partner;





•   the
level of capital expenditures;





•   our
future operating results; and





•   our
plans, objectives, expectations and intentions.





All of
these types of statements, other than statements of historical fact included in
this document, are forward-looking statements. In some cases, you can identify
forward-looking statements by terminology such as “may,” “could,” “should,”
“expect,” “plan,” “project,” “intend,” “anticipate,” “believe,” “estimate,”
“predict,” “potential,” “pursue,” “target,” “continue,” the negative of such
terms or other comparable terminology.





The
forward-looking statements contained in this document are largely based on our
expectations, which reflect estimates and assumptions made by our management.
These estimates and assumptions reflect our best judgment based on currently
known market conditions and other factors. Although we believe such estimates
and assumptions to be reasonable, they are inherently uncertain and involve a
number of risks and uncertainties that are beyond our control. In addition,
management’s assumptions about future events may prove to be inaccurate. All
readers are cautioned that the forward-looking statements contained in this
document are not guarantees of future performance, and we cannot assure any
reader that such statements will be realized or the forward-looking events and
circumstances will occur. Actual results may differ materially from those
anticipated or implied in the forward-looking statements due to factors
described in Legacy’s Annual Report on Form 10-K for the year ended December 31,
2007 and this Quarterly Report on Form 10-Q in Item 1A. under “Risk Factors.”
The forward-looking statements in this document speak only as of the date of
this document; we disclaim any obligation to update these statements unless
required by securities law, and we caution you not to rely on them unduly. These
cautionary statements qualify all forward-looking statements attributable to us
or persons acting on our behalf.





Overview




We were
formed in October 2005. Upon completion of our private equity offering and as a
result of the formation of Legacy on March 15, 2006, we acquired oil and
natural gas properties and business operations from our founding investors and
three charitable foundations.




Because
of our rapid growth through acquisitions and development of properties,
historical results of operations and period-to-period comparisons of these
results and certain financial data may not be meaningful or indicative of future
results. The operating results of the Binger properties have been included from
April 16, 2007, the operating results of the Ameristate properties have been
included from May 1, 2007, the operating results of the TSF properties have been
included from May 25, 2007, the operating results of the Raven Shenandoah
properties have been included from May 31, 2007, the operating results of the
Raven OBO properties have been included from August 3, 2007, the operating
results from the TOC and Summit Acquisitions have been included from October 1,
2007 and the operating results from the COP III Acquisition have been included
from April 30, 2008.




Acquisitions
have been financed with a combination of proceeds from bank borrowings,
issuances of units and cash flow from operations. Post-acquisition activities
are focused on evaluating and developing the acquired properties and evaluating
potential add-on acquisitions.




Page
22




Our
revenues, cash flow from operations and future growth depend substantially on
factors beyond our control, such as economic, political and regulatory
developments and competition from other sources of energy. Oil and natural gas
prices historically have been volatile and may fluctuate widely in the future.
Recently, oil and natural gas prices have declined from a high of $145.29 per
Bbl for oil and $13.58 per MMbtu for natural gas in July of 2008 to a recent low
of $62.73 per Bbl for oil and $6.12 per MMbtu for natural gas on October 28,
2008 and October 27, 2008, respectively. Such significant decline in oil and
natural gas prices may have an adverse impact on our cash flow from operations
and our future growth.




Sustained
periods of low prices for oil or natural gas could materially and adversely
affect our financial position, our results of operations, the quantities of oil
and natural gas reserves that we can economically produce, our access to capital
and the amount of our cash distributions.




During
the first three quarters of 2008, higher oil and natural gas prices led to
higher demand for drilling rigs, oilfield tubular goods, operating personnel and
field supplies and services, and caused increases in the costs of those goods
and services. To date, the higher sales prices have more than offset the higher
drilling and operating costs. Given the inherent volatility of oil and natural
gas prices, which are influenced by many factors beyond our control, we plan our
activities and budget based on sales price assumptions which historically have
been lower than the average sales prices received. If drilling and operating
costs remain comparatively high in a low sales price environment, our financial
results may be adversely affected. For the remainder of 2008, we have hedged
approximately 65% of our expected Boe production, exposing us to downside risk
for the remainder of such production. We focus our efforts on increasing oil and
natural gas production and reserves while controlling costs at a level that is
appropriate for long-term operations.




We face
the challenge of natural production declines. As initial reservoir pressures are
depleted, oil and natural gas production from a given well or formation
decreases. We attempt to overcome this natural decline by utilizing multiple
types of recovery techniques such as secondary (waterflood) and tertiary (CO2)
recovery methods to repressure the reservoir and recover additional oil,
drilling to find additional reserves, re-stimulating existing wells and
acquiring more reserves than we produce. Our future growth will depend on our
ability to continue to add reserves in excess of production. We will maintain
our focus on adding reserves through acquisitions and exploitation projects. Our
ability to add reserves through acquisitions and exploitation projects is
dependent upon many factors including our ability to raise capital, obtain
regulatory approvals and contract drilling rigs and personnel.




Our
revenues are highly sensitive to changes in oil and natural gas prices and to
levels of production. As set forth under “Cash Flow from Operations” below, we
have hedged a significant portion of our expected production, which allows us to
mitigate, but not eliminate, oil and natural gas price risk. We continuously
conduct financial sensitivity analyses to assess the effect of changes in
pricing and production. These analyses allow us to determine how changes in oil
and natural gas prices will affect our ability to execute our capital investment
programs and to meet future financial obligations. Further, the financial
analyses allow us to monitor any impact such changes in oil and natural gas
prices may have on the value of our proved reserves and their impact, if any, on
any re-determination of our borrowing base under our credit facility. Finally,
the current level of oil and natural gas prices may result in impairment charges
in the fourth quarter.




Legacy
does not specifically designate derivative instruments as cash flow hedges;
therefore, the mark-to-market adjustment reflecting the unrealized gain or loss
associated with these instruments is recorded in current earnings. As of
September 30, 2008, the fair market value of Legacy’s commodity derivative
positions was a net liability of $95.5 million based on NYMEX near month
prices of $100.64 per Bbl and $7.72 per MMBtu for oil and natural gas,
respectively. As of December 31, 2007, the fair market value of Legacy’s
commodity derivative positions was a net liability of $82.3 million based
on NYMEX near month prices of $95.98 per Bbl and $7.48 per MMBtu for oil and
natural gas, respectively. As of October 31, 2008, the NYMEX near month prices
for oil and natural gas were $67.81 per Bbl and $6.78 per MMBtu, respectively.
As a direct result, the net liability related to the fair market value of
Legacy’s commodity derivative positions decreased by $137.5 million to a net
asset position of $42.0 million.




Production
and Operating Costs Reporting




We strive
to increase our production levels to maximize our revenue and cash available for
distribution. Additionally, we continuously monitor our operations to ensure
that we are incurring operating costs at the optimal level. Accordingly, we
continuously monitor our production and operating costs per well to determine if
any wells or properties should be shut in, re-completed or sold.




Such
costs include, but are not limited to, the cost of electricity to lift produced
fluids, chemicals to treat wells, field personnel to monitor the wells, well
repair expenses to restore production, well work-over expenses intended to
increase production and ad valorem taxes. We incur and separately report
severance taxes paid to the states and counties in which our properties are
located. These taxes are reported as production taxes and are a percentage of
oil and natural gas revenue. Ad valorem taxes are a percentage of property
valuation. Gathering and transportation costs are generally borne by the
purchasers of our oil and natural gas as the price paid for our products
reflects these costs.




Page
23




Operating
Data




The
following table sets forth selected financial and operating data of Legacy for
the periods indicated.





Three
      Months Ended September 30,
              
              
              Nine
      Months Ended September 30,2008
              
              
              2007
              
              
              2008
              
              
              2007(In
      thousands, except per unit data)Revenues:Oil
      sales
              
              $
              47,912
              
              
              $
              22,442
              
              
              $
              132,400
              
              
              $
              51,396Natural
      gas liquid sales
              
              
              5,031
              
              
              
              1,714
              
              
              
              13,314
              
              
              
              2,891Natural
      gas sales
              
              
              12,668
              
              
              
              5,241
              
              
              
              35,293
              
              
              
              13,776Total
      revenue
              
              $
              65,611
              
              
              $
              29,397
              
              
              $
              181,007
              
              
              $
              68,063Expenses:Oil
      and natural gas production
              
              $
              15,784
              
              
              $
              7,580
              
              
              $
              38,827
              
              
              $
              18,408Production
      and other taxes
              
              $
              4,096
              
              
              $
              1,886
              
              
              $
              10,654
              
              
              $
              4,361General
      and administrative
              
              $
              2,158
              
              
              $
              1,443
              
              
              $
              8,872
              
              
              $
              6,039Depletion,
      depreciation, amortization  and accretion
              
              $
              13,082
              
              
              $
              6,959
              
              
              $
              33,223
              
              
              $
              19,065Realized
      swap settlementsRealized
      gain (loss) on oil swaps
              
              $
              (17,463
              )
              
              $
              (846
              )
              
              $
              (36,636
              )
              
              $
              1,199Realized
      loss on natural gas liquid swaps
              
              $
              (1,359
              )
              
              $
              (118
              )
              
              $
              (3,092
              )
              
              $
              (159
              )Realized
      gain (loss) on natural gas swaps
              
              $
              (928
              )
              
              $
              1,372
              
              
              $
              (1,931
              )
              
              $
              3,196Realized
      loss on interest rate swaps
              
              $
              (289
              )
              
              $
              -
              
              
              $
              (412
              )
              
              $
              -Production:Oil
      - barrels
              
              
              416
              
              
              
              312
              
              
              
              1,191
              
              
              
              814Natural
      gas liquids - gallons
              
              
              3,301
              
              
              
              1,345
              
              
              
              8,843
              
              
              
              2,304Natural
      gas - Mcf
              
              
              1,222
              
              
              
              801
              
              
              
              3,518
              
              
              
              2,107Total
      (MBoe)
              
              
              698
              
              
              
              478
              
              
              
              1,988
              
              
              
              1,220Average
      daily production (Boe/d)
              
              
              7,587
              
              
              
              5,196
              
              
              
              7,255
              
              
              
              4,469Average
      sales price per unit:Oil
      price per barrel
              
              $
              115.17
              
              
              $
              71.93
              
              
              $
              111.17
              
              
              $
              63.14Natural
      gas liquid price per gallon
              
              $
              1.52
              
              
              $
              1.27
              
              
              $
              1.51
              
              
              $
              1.25Natural
      gas price per Mcf
              
              $
              10.37
              
              
              $
              6.54
              
              
              $
              10.03
              
              
              $
              6.54Combined
      (per Boe)
              
              $
              94.00
              
              
              $
              61.50
              
              
              $
              91.05
              
              
              $
              55.79Average
      sales price per unit (including realized swap
settlements):Oil
      price per barrel
              
              $
              73.19
              
              
              $
              69.22
              
              
              $
              80.41
              
              
              $
              64.61Natural
      gas liquid price per gallon
              
              $
              1.11
              
              
              $
              1.19
              
              
              $
              1.16
              
              
              $
              1.19Natural
      gas price per Mcf
              
              $
              9.61
              
              
              $
              8.26
              
              
              $
              9.48
              
              
              $
              8.06Combined
      (per Boe)
              
              $
              65.70
              
              
              $
              62.35
              
              
              $
              70.09
              
              
              $
              59.26NYMEX
      oil index prices per barrel:Beginning
      of Period
              
              $
              140.00
              
              
              $
              70.68
              
              
              $
              95.98
              
              
              $
              61.05End
      of Period
              
              $
              100.64
              
              
              $
              81.66
              
              
              $
              100.64
              
              
              $
              81.66NYMEX
      gas index prices per Mcf:Beginning
      of Period
              
              $
              13.35
              
              
              $
              6.77
              
              
              $
              7.48
              
              
              $
              6.30End
      of Period
              
              $
              7.72
              
              
              $
              6.87
              
              
              $
              7.72
              
              
              $
              6.87Average
      unit costs per Boe:Production
      costs, excluding production and other taxes
              
              $
              22.61
              
              
              $
              15.86
              
              
              $
              19.53
              
              
              $
              15.09Production
      and other taxes
              
              $
              5.87
              
              
              $
              3.95
              
              
              $
              5.36
              
              
              $
              3.57General
      and administrative
              
              $
              3.09
              
              
              $
              3.02
              
              
              $
              4.46
              
              
              $
              4.95Depletion,
      depreciation, amortization and accretion
              
              $
              18.74
              
              
              $
              14.56
              
              
              $
              16.71
              
              
              $
              15.63




Page
24




Results
of Operations




Three-Month
Period Ended September 30, 2008 Compared to Three-Month Period Ended
September 30, 2007




Legacy’s
revenues from the sale of oil were $47.9 million and $22.4 million for
the three-month periods ended September 30, 2008 and 2007, respectively.
Legacy’s revenues from the sale of NGLs were $5.0 million and $1.7 million for
the three-month periods ended September 30, 2008 and 2007, respectively.
Legacy’s revenues from the sale of natural gas were $12.7 million and
$5.2 million for the three-month periods ended September 30, 2008 and 2007,
respectively. The $25.5 million increase in oil revenues reflects an
increase in oil production of 104 MBbls (33%) due primarily to Legacy’s
purchase of the oil and natural gas properties acquired in the Binger,
Ameristate, TSF, Raven Shenandoah, Raven OBO, TOC, Summit and COP III
Acquisitions and the increase in average realized price of $43.24 per Bbl.
The $3.3 million increase in proceeds from NGL sales reflects an increase in NGL
production of approximately 1,956 MMGal (145%) due primarily to Legacy’s
purchase of oil and natural gas properties in the Binger, Ameristate, Raven
Shenandoah, Raven OBO, TOC and COP III Acquisitions. The $7.4 million
increase in natural gas revenues reflects an increase in natural gas production
of approximately 421 MMcf (53%) due primarily to Legacy’s purchase of oil
and natural gas properties acquired in the Binger, Ameristate, TSF, Raven
Shenandoah, Raven OBO, TOC, Summit and COP III Acquisitions, and the increase in
average realized price of $3.82 per Mcf.





For the
three-month period ended September 30, 2008, Legacy recorded $202.4 million
of net gains on oil, NGL and natural gas swaps comprised of realized losses of
$19.75 million from net cash settlements of oil, NGL and natural gas swap
contracts and net unrealized gains of $222.1 million. Legacy had large
unrealized net gains from oil swaps because the price of oil decreased during
the three-month period ended September 30, 2008. As a point of reference, the
NYMEX price for light sweet crude oil for the near-month close decreased from
$140.00 per Bbl at June 30, 2008 to $100.64 per Bbl at September 30, 2008, a
price which is greater than the average contract prices of Legacy’s outstanding
oil swap contracts, but less than the price at June 30, 2008, resulting in a
reduction of the liability. Due to the substantial decrease in oil prices during
the quarter, the differential between Legacy’s fixed price oil swaps and NYMEX
decreased, resulting in gains for the quarter. Legacy had unrealized net gains
from NGL swaps because NGL prices decreased during the three-month period ended
September 30, 2008. Legacy had unrealized net gains from natural gas swaps
because the NYMEX natural gas prices declined during the three-month period
ended September 30, 2008. As a point of reference, the NYMEX price for natural
gas for the near-month close decreased from $13.35 per MMBtu at June 30, 2008 to
$7.72 per MMBtu at September 30, 2008, a price which is greater than the average
contract prices of Legacy’s outstanding natural gas swap contracts, but less
than the price at June 30, 2008, resulting in a reduction of the liability. For
the three-month period ended September 30, 2007, Legacy recorded
$6.4 million of net losses on oil, NGL and natural gas swaps comprised of
realized gains of $0.4 million from net cash settlements of oil, NGL and natural
gas swap contracts and a net unrealized loss of $7.7 million on oil swap
contracts, due to the increase in oil prices during the quarter which increased
the differential between the NYMEX oil index price and our fixed price oil
swaps, a net unrealized loss of $0.6 million on NGL swap contracts and a net
unrealized gain of $1.5 million on natural gas swap contracts, due to the
addition of natural gas swaps at fixed prices greater than the NYMEX natural gas
index price, which offset any potential unrealized losses related to the
increase in natural gas prices during the period. Unrealized gains and losses
represent a current period mark-to-market adjustment for commodity derivatives
which will be settled in future periods.




Legacy’s
oil and natural gas production expenses, excluding production and other taxes,
increased to $15.8 million ($22.61 per Boe) for the three-month period
ended September 30, 2008, from $7.6 million ($15.86 per Boe) for the
three-month period ended September 30, 2007. Production expenses increased
primarily because of (i) $4.1 million of production expenses related to the
TOC, Summit and COP III Acquisitions, (ii) $1.3 million related to individually
non-material acquisitions and (iii) $1.0 million related to increases in ad
valorem expenses from higher valuations related to increased oil and natural gas
prices, increased well counts and periods of ownership. In addition, the
increase in production costs per Boe is consistent with industry-wide cost
increases, particularly those directly related to higher commodity prices, such
as the cost of electricity, which powers artificial lift equipment and pumps
involved in the production of oil.




Legacy’s
production and other taxes were $4.1 million and $1.9 million for the
three-month periods ended September 30, 2008 and 2007, respectively. Production
and other taxes increased primarily because of approximately
$0.7 million of taxes related to the TOC, Summit and COP III Acquisitions
and $0.3 million of taxes related to individually non-material acquisitions. The
increase in production and other taxes is primarily due to the increase in
realized prices. As production and other taxes are a function of price and
volume, the increase is consistent with the increase in realized
prices.




Legacy’s
general and administrative expenses were $2.2 million and $1.4 million
for the three-month periods ended September 30, 2008 and 2007, respectively.
General and administrative expenses increased approximately $0.8
million between the three-month periods ended September 30, 2008 and 2007
primarily due to increases in salaries related to an increased headcount due to
growth in our asset base.





Legacy’s
depletion, depreciation, amortization and accretion expense, or DD&A, was
$13.1 million and $7.0 million for the three-month periods ended
September 30, 2008 and 2007, respectively. DD&A increased primarily because
of $2.7 million of DD&A related to the TOC, Summit and COP III
Acquisitions. In addition, the increase in DD&A expense per Boe, from $14.56
to $18.74 for the three-month periods ended September 30, 2007 and 2008,
respectively, reflects the higher cost basis of the producing oil and natural
gas properties acquired in recent acquisitions.




Page
25




Impairment
expense was $339,015 and $950,174 for the three-month periods ended September
30, 2008 and 2007, respectively. In the period ended September 30, 2008, Legacy
recognized impairment expense in twelve separate producing fields, due primarily
to lower commodity prices and rising production costs. The impairment expense
for the period ended September 30, 2007, involved seventeen separate fields due
primarily to costs incurred in the period during which the estimated production
revenues did not exceed the costs.




Legacy
recorded interest income of $11,310 for the three-month period ended September
30, 2008, and $54,284 for the three-month period ended September 30, 2007. The
decrease of $42,974 is a result of lower average cash balances and lower
interest rates for the period ended September 30, 2008.




Legacy
recorded interest expense of $4.2 million and $1.9 million for the three-month
periods ended September 30, 2008 and 2007, respectively, reflecting higher
average borrowings in the period ended September 30, 2008 as well as $1.0
million in non-cash mark-to-market expenses from the increase in the interest
rate swap liability. Legacy repaid the entire $115.8 million outstanding under
its revolving credit facility at the close of its initial public offering on
January 18, 2007.





Legacy recognized $47,286 and $29,690
in income from its equity interest in the Binger Operations, LLC (“BOL”) for the
three-month period ended September 30, 2008 and 2007, respectively. This income
is primarily derived from BOL’s less than 1% interest in the Binger Unit. The
increase of $17,596 is a result of higher average commodity prices in the period
ended September 30, 2008, compared to the three-month period ended September 30,
2007.





Nine-Month
Period Ended September 30, 2008 Compared to Nine-Month Period Ended
September 30, 2007




Legacy’s
revenues from the sale of oil were $132.4 million and $51.4 million
for the nine-month periods ended September 30, 2008 and 2007, respectively.
Legacy’s revenues from the sale of NGLs were $13.3 million and $2.9 million for
the nine-month periods ended September 30, 2008 and 2007, respectively. Legacy’s
revenues from the sale of natural gas were $35.3 million and
$13.8 million for the nine-month periods ended September 30, 2008 and 2007,
respectively. The $81.0 million increase in oil revenues reflects an
increase in oil production of 377 MBbls (46%) due primarily to Legacy’s
purchase of the oil and natural gas properties acquired in the Binger,
Ameristate, TSF, Raven Shenandoah, Raven OBO, TOC, Summit and COP III
Acquisitions and the increase in average realized price of $48.03 per Bbl.
The $10.4 million increase in NGLs is due primarily to Legacy’s purchase of oil
and natural gas properties in the Binger, Ameristate, Raven Shenandoah, Raven
OBO, TOC and COP III Acquisitions. The $21.5 million increase in natural
gas revenues reflects an increase in natural gas production of approximately
1,411 MMcf (67%) due primarily to Legacy’s purchase of oil and natural gas
properties acquired in the Binger, Ameristate, TSF, Raven Shenandoah, Raven OBO,
TOC, Summit and COP III Acquisitions, and the increase in average realized price
of $3.49 per Mcf.





For the
nine-month period ended September 30, 2008, Legacy recorded $54.9 million
of net losses on oil, NGL and natural gas swaps comprised of realized losses of
$41.7 million from net cash settlements of oil, NGL and natural gas swap
contracts and net unrealized losses of $13.2 million. Legacy had unrealized
net losses from oil swaps because the fixed prices of its oil swap contracts
were below the NYMEX index prices at September 30, 2008. As a point of
reference, the NYMEX price for light sweet crude oil for the near-month close
increased from $95.98 per Bbl at December 31, 2007 to $100.64 per Bbl at
September 30, 2008, a price which is greater than the average contract prices of
Legacy’s outstanding oil swap contracts. Due to the increase in oil prices
during the nine-month period ended September 30, 2008, the differential between
Legacy’s fixed price oil swaps and NYMEX increased, resulting in losses for the
nine-months ended September 30, 2008. Legacy had unrealized net gains from NGL
swaps because the fixed prices of its NGL swap contracts were above the NYMEX
index prices at September 30, 2008. Legacy had unrealized net gains from natural
gas swaps because the fixed prices of its natural gas swap contracts were above
the NYMEX index prices at September 30, 2008. In addition, the NYMEX price for
natural gas for the near-month close increased from $7.48 per MMBtu at December
31, 2007 to $7.72 per MMBtu at September 30, 2008, a price which is less than
the average contract prices of Legacy’s outstanding natural gas swap contracts.
For the nine-month period ended September 30, 2007, Legacy recorded
$20.2 million of net losses on oil, NGL and natural gas swaps. This net
loss is comprised of realized gains of $4.2 million from net cash settlements of
oil and natural gas swap contracts and a net unrealized loss of $20.9 million on
oil swap contracts. The unrealized loss on oil swap contracts is due to the
increase in oil prices during the nine-month period ended September 30, 2007,
which increased the differential between the NYMEX oil index price and our fixed
price oil swaps. The remaining balance is due to a net unrealized loss of $0.9
million on NGL swap contracts and a net unrealized loss of $2.6 million on
natural gas swap contracts. The unrealized loss on natural gas swap contracts is
due to the increase in natural gas prices which increased the differential
between the NYMEX natural gas index price and our fixed price natural gas swaps.
Unrealized gains and losses represent a current period mark-to-market adjustment
for commodity derivatives which will be settled in future periods.




Legacy’s
oil and natural gas production expenses, excluding production and other taxes,
increased to $38.8 million ($19.53 per Boe) for the nine-month period
ended September 30, 2008, from $18.4 million ($15.09 per Boe) for the
nine-month period ended September 30, 2007. Production expenses increased
primarily because of (i) $12.4 million of production expenses related
to the Binger, Ameristate, TSF, Raven Shenandoah, Raven OBO, TOC, Summit and COP
III Acquisitions, (ii) $2.2 million related to individually non-material
acquisitions and (iii) $2.0 million related to increases in ad valorem
expenses from increased well counts and periods of ownership. In addition, the
increase in production costs per Boe is consistent with industry-wide cost
increases, particularly those directly related to higher commodity prices, such
as the cost of electricity, which powers artificial lift equipment and pumps
involved in the production of oil.




Page
26




Legacy’s
production and other taxes were $10.7 million and $4.4 million for the
nine-month periods ended September 30, 2008 and 2007, respectively. Production
and other taxes increased primarily because of approximately
$2.9 million of taxes related to the Binger, Ameristate, TSF, Raven
Shenandoah, Raven OBO, TOC, Summit and COP III Acquisitions. The remaining
increase in production and other taxes is primarily due to the increase in
realized prices. As production and other taxes are a function of price and
volume, the increase is consistent with the increase in realized
prices.




Legacy’s
general and administrative expenses were $8.9 million and $6.0 million
for the nine-month periods ended September 30, 2008 and 2007, respectively.
General and administrative expenses increased approximately $2.9
million between periods primarily due to (i) $2.3 million increase in
salaries, (ii) $0.5 million increase in accounting and audit fees and (iii) $0.2
million increase in compensation expense related to our LTIP.





Legacy’s
depletion, depreciation, amortization and accretion expense, or DD&A, was
$33.2 million and $19.1 million for the nine-month periods ended
September 30, 2008 and 2007, respectively. DD&A increased primarily because
of $9.8 million of DD&A related to the Binger, Ameristate, TSF, Raven
Shenandoah, Raven OBO, TOC, Summit and COP III Acquisitions. In addition, the
increase in DD&A expense per Boe, from $15.63 to $16.71 for the nine-month
periods ended September 30, 2007 and 2008, respectively, reflects the higher
cost basis of the producing oil and natural gas properties acquired in recent
acquisitions.




Impairment
expense was $447,200 and $1,229,874 for the nine-month periods ended September
30, 2008 and 2007, respectively. In the period ended September 30, 2008, Legacy
recognized impairment expense in fifteen producing fields, due primarily to
additional costs incurred, lower commodity prices and rising production costs
during the period ended September 30, 2008. The impairment expense for the
period ended September 30, 2007, involved thirty separate fields due primarily
to costs incurred in the period during which the estimated production revenues
did not exceed the costs.




Legacy
recorded interest income of $81,962 for the nine-month period ended September
30, 2008 and $205,443 for the nine-month period ended September 30, 2007. The
decrease of $123,481 is a result of lower average cash balances for the period
ended September 30, 2008.




Interest
expense was $7.2 million and $3.4 million for the nine-month periods ended
September 30, 2008 and 2007, respectively, reflecting higher average borrowings
in the period ended September 30, 2008. Legacy repaid the entire $115.8 million
outstanding under its revolving credit facility at the close of its initial
public offering on January 18, 2007.





Legacy recognized $134,701 and $40,600
in income from its equity interest in BOL for the nine-month periods ended
September 30, 2008 and 2007, respectively. This income is primarily derived from
BOL’s less than 1% interest in the Binger Unit.The increase of $94,101 is a result of
higher average commodity prices in the nine-month period ended September 30,
2008, compared to the nine-month period ended September 30, 2007 as well as a
full nine-month period of ownership in 2008 compared to only a five-month period
of ownership for the nine-month period ended September 30, 2007.





During
the nine-month period ended September 30, 2008, Legacy recorded a gain of $4.9
million related to the disposal of our 12.9% non-operated working interest in
the Reeves Unit in a non-monetary transaction with Devon Energy in exchange for
60% interest in two operated properties. In addition, Legacy paid $630,000 of
cash boot in the transaction. Due to the significant differences in the risk and
timing of the cash flows from the exchanged property sets, Legacy has treated
this exchange as one having commercial substance. As such, we have calculated
the gain on disposal of this discontinued operation based on the fair value of
our interest in the Reeves Unit. Due to immateriality, we have not reflected the
operating results of the Reeves Unit separately as a discontinued operation for
any of the periods presented.








Capital
Resources and Liquidity




Legacy’s
primary sources of capital and liquidity have been bank borrowings, cash flow
from operations, its private offering in March 2006, the IPO in January 2007 and
its private offering in November 2007. To date, Legacy’s primary use of capital
has been for acquisitions, repayment of bank borrowings and development of oil
and natural gas properties.




As we
pursue growth, we continually monitor the capital resources available to us to
meet our future financial obligations and planned capital expenditures. Our
future success in growing reserves and production will be highly dependent on
capital resources available to us and our success in acquiring and developing
additional reserves. We actively review acquisition opportunities on an ongoing
basis. If we were to make significant additional acquisitions for cash, we would
need to borrow additional amounts under our credit facility, if available, or
obtain additional debt or equity financing. Our credit facility imposes certain
restrictions on our ability to obtain additional debt financing. Based upon
current oil and natural gas price expectations for the year ending
December 31, 2008, we anticipate that our cash on hand, cash flow from
operations and available borrowing capacity under our credit facility will
provide us sufficient working capital to meet our planned capital expenditures
of $27.0 million and planned annual cash distributions of
$60.9 million for 2008, which includes the $13.4 million, $15.2
million and $16.1 million of distributions paid in the first, second and third
quarters of 2008, respectively, and $16.2 million of planned distributions
during the fourth quarter of 2008. Please read “— Financing
Activities — Our Revolving Credit Facility.”




Page
27




Cash
Flow from Operations




Legacy’s
net cash provided by operating activities was $119.9 million and
$33.3 million for the nine-month periods ended September 30, 2008 and
2007, respectively, with the 2008 period being favorably impacted by higher
sales volumes and higher commodity prices, offset by the higher working capital
needs of our growing business.




Our cash
flow from operations is subject to many variables, the most significant of which
is the volatility of oil and natural gas prices. Oil and natural gas prices are
determined primarily by prevailing market conditions, which are dependent on
regional and worldwide economic activity, weather and other factors beyond our
control. Our future cash flow from operations will depend on our ability to
maintain and increase production through acquisitions and development projects,
as well as the prices of oil and natural gas.




We enter
into oil, NGL and natural gas derivatives to reduce the impact of oil, NGL and
natural gas price volatility on our operations. Currently, we use swaps and
collars to offset price volatility on NYMEX oil, NGL and natural gas prices,
which do not include the additional net discount that we typically experience in
the Permian Basin. At September 30, 2008, we had in place oil, NGL and
natural gas swaps covering significant portions of our estimated 2008 through
2012 oil, NGL and natural gas production. As of November 7, 2008, we have swap
contracts covering approximately 65% of our remaining expected oil, natural gas
liquid and natural gas production for 2008. As of November 7, 2008, we also have
swap and collar contracts covering approximately 58% of our currently expected
oil and natural gas production for 2009 through 2012 from existing estimated
total proved reserves.




By
reducing the cash flow effects of price volatility from a significant portion of
our oil and natural gas production, we have mitigated, but not eliminated, the
potential effects of changing prices on our cash flow from operations for those
periods. While mitigating negative effects of falling commodity prices, these
derivative contracts also limit the benefits we would receive from increases in
commodity prices. It is our policy to enter into derivative contracts only with
counterparties that are major, creditworthy financial institutions deemed by
management as competent and competitive market makers.




The
following tables summarize, for the periods indicated, our oil and natural gas
swaps currently in place as of November 7, 2008, through December 31, 2012.
We use swaps and collars as our mechanism for offsetting the cash flow effects
of changes in commodity prices whereby we pay the counterparty floating prices
and receive fixed prices from the counterparty, which serves to reduce the
effects on cash flow of the floating prices we are paid by purchasers of our oil
and natural gas. These transactions are settled based upon the NYMEX price of
oil at Cushing, Oklahoma, and NYMEX price of natural gas at Henry Hub and
ANR-OK on the average of the three final trading days of the month and
settlement occurs on the fifth day of the production month.





Average
              
              PriceCalendar
      Year
              
              Volumes
      (Bbls)
              
              Price
      per Bbl
              
              Range
      per BblOctober
      - December 2008
              
              326,781
              
              $                 74.62
              
              $62.25
      - $108.502009
              
              1,488,969
              
              $                 82.82
              
              $61.05
      - $140.002010
              
              1,397,973
              
              $                 82.37
              
              $60.15
      - $140.002011
              
              1,155,712
              
              $                 88.07
              
              $67.33
      - $140.002012
              
              873,812
              
              $                 81.41
              
              $67.72
      - $109.20


Average
              
              PriceCalendar
      Year
              
              Volumes
      (MMBtu)
              
              Price
      per MMBtu
              
              Range
      per MMBtuOctober
      - December 2008
              
              837,071
              
              $                   8.13
              
              $6.85
      - $9.102009
              
              3,167,142
              
              $                   8.06
              
              $6.85
      - $10.182010
              
              2,840,859
              
              $                   7.87
              
              $6.85
      - $9.732011
              
              2,127,316
              
              $                   8.01
              
              $6.85
      - $8.702012
              
              1,579,736
              
              $                   8.02
              
              $6.85
      - $8.70




In July
2006, we entered into natural gas basis swaps to receive floating NYMEX natural
gas prices less a fixed basis differential and pay prices based on the floating
Waha index, a natural gas hub in West Texas. The prices that we receive for our
natural gas sales follow Waha more closely than NYMEX. The basis swaps thereby
provide a better match between our natural gas sales and the settlement payments
on our natural gas swaps. The following table summarizes, for the periods
indicated, our NYMEX natural gas basis swaps currently in place as of November
7, 2008, through December 31, 2010.




BasisCalendar
      Year
              
              Volumes
      (MMBtu)
              
              Range
      per McfOctober
      - December 2008
              
              355,500
              
              ($0.84)2009
              
              1,320,000
              
              ($0.68)2010
              
              1,200,000
              
              ($0.57)
  Page
28


On March
30, 2007, we entered into natural gas liquids swaps to hedge the impact of
volatility in the spot prices of natural gas liquids. On September 7, 2007,
we entered into additional natural gas liquids swaps. These swaps hedge the spot
prices for ethane, propane, iso-butane, normal butane and natural gasoline
tracked on the Mont Belvieu, Non-Tet OPIS exchange. The following table
summarizes, for the periods indicated, our Mont Belvieu, Non-Tet Opis natural
gas liquids swaps currently in place as of November 7, 2008, through December
31, 2009.





Average
              
              PriceCalendar
      Year
              
              Volumes
      (Gal)
              
              Price
      per Gal
              
              Range
      per GalOctober
      - December 2008
              
              1,582,035
              
              $                   1.27
              
              $0.66
      - $1.622009
              
              2,265,480
              
              $                   1.15
              
              $1.15




On June
24, 2008, Legacy entered into a NYMEX West Texas Intermediate crude oil
derivative collar contract that combines a put option or “floor” with a call
option or “ceiling”. The following table summarizes the oil collar contract
currently in place as of November 7, 2008, through December 31,
2012.





Average
              
              AverageCalendar
      Year
              
              Volumes
      (Bbls)
              
              Floor
              
              Ceiling2009
              
              75,400
              
              $               120.00
              
              $                 156.302010
              
              71,800
              
              $               120.00
              
              $                 156.302011
              
              68,300
              
              $               120.00
              
              $                 156.302012
              
              65,100
              
              $               120.00
              
              $                 156.30


Investing
Activities — Acquisitions and Capital Expenditures




Legacy’s
cash capital expenditures were $151.4 million for the nine-month period
ended September 30, 2008. The total includes $133.1 million for
acquisition of oil and natural gas properties in the COP III Acquisition and
several small acquisitions and $18.3 million of development
projects.




Legacy’s
cash capital expenditures were $98.3 million for the nine-month period
ended September 30, 2007. The total includes $88.0 million for the
acquisition of oil and natural gas properties in five acquisitions and $10.3
million of development projects.




We
currently anticipate that our drilling budget, which predominantly consists of
drilling, re-completion and re-fracture stimulation projects will be
$27.0 million for the year ending December 31, 2008. Our remaining
borrowing capacity under our revolving credit facility is $98.5 million as
of November 7, 2008. The amount and timing of our capital expenditures is
largely discretionary and within our control, with the exception of certain
projects managed by other operators. We may defer a portion of our planned
capital expenditures until later periods. Accordingly, we routinely monitor and
adjust our capital expenditures in response to changes in oil and natural gas
prices, drilling and acquisition costs, industry conditions and internally
generated cash flow. Matters outside our control that could affect the timing of
our capital expenditures include obtaining required permits and approvals in a
timely manner and the availability of rigs, casing and tubing and labor crews.
Based upon current oil and natural gas price expectations for the year ending
December 31, 2008, we anticipate that we will have sufficient sources of
working capital, including our cash flow from operations and available borrowing
capacity under our credit facility, to meet our cash obligations including our
planned capital expenditures of $27.0 million and planned annual cash
distributions of $60.9 million for the year ending December 31, 2008.
However, future cash flows are subject to a number of variables, including the
level of oil and natural gas production and prices. There can be no assurance
that operations and other capital resources will provide cash in sufficient
amounts to maintain planned levels of capital expenditures.





On
September 24, 2008, Legacy entered into a participation agreement with Black Oak
Resources, LLC committing up to $20 million over three years to jointly invest
in and develop oil and natural gas properties. Unless Black Oak Resources, LLC
were to increase the $110 million of equity commitments initially committed or
enter into a borrowing relationship, Legacy’s obligations are expected to be in
the range of $8 million over the next three years.




Page
29




Financing
Activities





Our
Revolving Credit Facility




At the
closing of our private equity offering on March 15, 2006, we entered into a
four-year, $300 million revolving credit facility with BNP Paribas as
administrative agent. On October 24, 2007, the maximum credit amount was
increased to $500 million as part of the Third Amendment to the credit
agreement. Our obligations under the credit facility are secured by mortgages on
more than 80% of our oil and gas properties as well as a pledge of all of our
ownership interests in our operating subsidiaries. The amount available for
borrowing at any one time is limited to the borrowing base, currently at $383.76
million, which was initially set at $130 million and was increased on
October 6, 2008 to $383.76 million pursuant to the Fifth Amendment. The
borrowing base is subject to semi-annual re-determinations on April 1 and
October 1 of each year. Additionally, either Legacy or the lenders may,
once during each calendar year, elect to re-determine the borrowing base between
scheduled re-determinations. We also have the right, once during each calendar
year, to request the re-determination of the borrowing base upon the proposed
acquisition of certain oil and gas properties where the purchase price is
greater than 10% of the borrowing base. Any increase in the borrowing base
requires the consent of all the lenders and any decrease in the borrowing base
must be approved by the lenders holding 66 2/3% of the outstanding aggregate
principal amounts of the loans or participation interests in letters of credit
issued under the credit facility. If the required lenders do not agree on an
increase or decrease, then the borrowing base will be the highest borrowing base
acceptable to the lenders holding 66 2/3% of the outstanding aggregate principal
amounts of the loans or participation interests in letters of credit issued
under the credit facility so long as it does not increase the borrowing base
then in effect. Outstanding borrowings in excess of the borrowing base must be
prepaid, and, if mortgaged properties represent less than 80% of total value of
oil and gas properties evaluated in the most recent reserve report, we must
pledge other oil and natural gas properties as additional
collateral.




We may
elect that borrowings be comprised entirely of alternate base rate (ABR) loans
or Eurodollar loans. Interest on the loans is determined as
follows:




•
            with
      respect to ABR loans, the alternate base rate equals the higher of the
      prime rate or the Federal funds effective rate plus 0.50%, plus an
      applicable margin between 0% and 0.50%, or•
            with
      respect to any Eurodollar loans for any interest period, the London
      interbank rate, or LIBOR, plus an applicable margin ranging from and
      including 1.50% and 2.125% per annum, determined by the percentage of
      the borrowing base then in effect that is
drawn.




Interest
is generally payable quarterly for ABR loans and on the last day of the
applicable interest period for any Eurodollar loans.




Our
revolving credit facility also contains various covenants that limit our ability
to:




•
            incur
      indebtedness;•
            enter
      into certain leases;•
            grant
      certain liens;•
            enter
      into certain swaps;•
            make
      certain loans, acquisitions, capital expenditures and
      investments;•
            make
      distributions other than from available cash;•
            merge,
      consolidate or allow any material change in the character of its business;
      or•
            engage
      in certain asset dispositions, including a sale of all or substantially
      all of our assets.




Our
credit facility also contains covenants that, among other things, require us to
maintain specified ratios or conditions as follows:




•
            consolidated
      net income plus interest expense, income taxes, depreciation, depletion,
      amortization and other similar charges excluding unrealized gains and
      losses under SFAS No. 133, minus all non-cash income added to
      consolidated net income, and giving pro forma effect to any acquisitions
      or capital expenditures (“EBITDA”), to interest expense of not less than
      2.5 to 1.0;•
            debt
      to EBITDA of not more than 3.75 to 1.0 as amended on October 6, 2008,
      pursuant to the Fifth Amendment; and•
            consolidated
      current assets, including the unused amount of the total commitments, to
      consolidated current liabilities of not less than 1.0 to 1.0, excluding
      non-cash assets and liabilities under SFAS No. 133, which
      includes the current portion of oil, natural gas and interest rate
      swaps.




Page
30




If an
event of default exists under our revolving credit facility, the lenders will be
able to accelerate the maturity of the credit agreement and exercise other
rights and remedies. Each of the following would be an event of
default:




•
            failure
      to pay any principal when due or any reimbursement amount, interest, fees
      or other amount within certain grace periods;•
            a
      representation or warranty is proven to be incorrect when
      made;•
            failure
      to perform or otherwise comply with the covenants or conditions contained
      in the credit agreement or other loan documents, subject, in certain
      instances, to certain grace periods;•
            default
      by us on the payment of any other indebtedness in excess of
      $1.0 million, or any event occurs that permits or causes the
      acceleration of the indebtedness;•
            bankruptcy
      or insolvency events involving us or any of our
    subsidiaries;•
            the
      loan documents cease to be in full force and effect as a result of our
      failing to create a valid lien, except in limited
      circumstances;•
            a
      change of control, which will occur upon (i) the acquisition by any
      person or group of persons of beneficial ownership of more than 35% of the
      aggregate ordinary voting power of our equity securities, (ii) the
      first day on which a majority of the members of the board of directors of
      our general partner are not continuing directors (which is generally
      defined to mean members of our board of directors as of March 15,
      2006 and persons who are nominated for election or elected to our general
      partner’s board of directors with the approval of a majority of the
      continuing directors who were members of such board of directors at the
      time of such nomination or election), (iii) the direct or indirect
      sale, transfer or other disposition in one or a series of related
      transactions of all or substantially all of the properties or assets
      (including equity interests of subsidiaries) of us and our subsidiaries to
      any person, (iv) the adoption of a plan related to our liquidation or
      dissolution or (v) Legacy Reserves GP, LLC ceasing to be our sole
      general partner;•
            the
      entry of, and failure to pay, one or more adverse judgments in excess of
      $1.0 million or one or more non-monetary judgments that could
      reasonably be expected to have a material adverse effect and for which
      enforcement proceedings are brought or that are not stayed pending
      appeal; and•
            specified
      ERISA events relating to our employee benefit plans that could reasonably
      be expected to result in liabilities in excess of $1.0 million in any
      year.




At
September 30, 2008, Legacy was in compliance with all financial and other
covenants of the credit facility.








Off-Balance
Sheet Arrangements




None.





Critical
Accounting Policies and Estimates




The
discussion and analysis of our financial condition and results of operations is
based upon the condensed consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires us to make
estimates and assumptions that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. Certain accounting policies involve judgments and uncertainties
to such an extent that there is a reasonable likelihood that materially
different amounts could have been reported under different conditions, or if
different assumptions had been used. Estimates and assumptions are evaluated on
a regular basis. Legacy based its estimates on historical experience and various
other assumptions that are believed to be reasonable under the circumstances,
the results of which form the basis for making judgments about the carrying
values of assets and liabilities that are not readily apparent from other
sources. Actual results may differ from these estimates and assumptions used in
preparation of the financial statements. Changes in these estimates and
assumptions could materially affect our financial position, results of
operations or cash flows. Management considers an accounting estimate to be
critical if:




•
            it
      requires assumptions to be made that were uncertain at the time the
      estimate was made, and•
            changes
      in the estimate or different estimates that could have been selected could
      have a material impact on our consolidated results of operations or
      financial condition.




Page
31




Please
read Note 1 of the Notes to the Condensed Consolidated Financial Statements
here and in our annual report on Form 10-K for the period ended December 31,
2007 for a detailed discussion of all significant accounting policies that we
employ and related estimates made by management.




Nature of Critical Estimate
Item:  Oil and Natural Gas Reserves — Our estimate of
proved reserves is based on the quantities of oil and natural gas which
geological and engineering data demonstrate, with reasonable certainty, to be
recoverable in future years from known reservoirs under existing economic and
operating conditions. LaRoche Petroleum Consultants, Ltd., annually prepares a
reserve and economic evaluation of all our properties in accordance with SEC
guidelines on a lease, unit or well-by-well basis, depending on the availability
of well-level production data. The accuracy of our reserve estimates is a
function of many factors including the following: the quality and quantity of
available data, the interpretation of that data, the accuracy of various
mandated economic assumptions, and the judgments of the individuals preparing
the estimates. For example, we must estimate the amount and timing of future
operating costs, severance taxes, development costs, and workover costs, all of
which may in fact vary considerably from actual results. In addition, as prices
and cost levels change from year to year, the economics of producing the
reserves may change and therefore the estimate of proved reserves also may
change. Any significant variance in these assumptions could materially affect
the estimated quantity and value of our reserves. Despite the inherent
imprecision in these engineering estimates, our reserves are used throughout our
financial statements. Reserves and their relation to estimated future net cash
flows impact our depletion and impairment calculations. As a result, adjustments
to depletion rates are made concurrently with changes to reserve
estimates.




Assumptions/Approach
Used:  Units-of-production method to deplete our oil and
natural gas properties — The quantity of reserves could significantly
impact our depletion expense. Any reduction in proved reserves without a
corresponding reduction in capitalized costs will increase the depletion
rate.




Effect if Different Assumptions
Used:  Units-of-production method to deplete our oil and
natural gas properties — A 10% increase or decrease in reserves would have
decreased or increased, respectively, our depletion expense for the three-month
period ended September 30, 2008 by approximately 10%.




Nature of Critical Estimate
Item:  Asset Retirement Obligations — We have certain
obligations to remove tangible equipment and restore land at the end of oil and
gas production operations. Our removal and restoration obligations are primarily
associated with plugging and abandoning wells. We adopted Statement of Financial
Accounting Standards (“SFAS”) No. 143, Accounting for Asset Retirement
Obligations, effective January 1, 2003. SFAS No. 143
significantly changed the method of accruing for costs an entity is legally
obligated to incur related to the retirement of fixed assets (“asset retirement
obligations” or “ARO”). Primarily, SFAS No. 143 requires us to
estimate asset retirement costs for all of our assets, adjust those costs for
inflation to the forecast abandonment date, discount that amount using a
credit-adjusted-risk-free rate back to the date we acquired the asset or
obligation to retire the asset and record an ARO liability in that amount with a
corresponding addition to our asset value. When new obligations are incurred,
i.e. a new well is drilled or acquired, we add a layer to the ARO liability. We
then accrete the liability layers quarterly using the applicable period-end
effective credit-adjusted-risk-free rates for each layer. Should either the
estimated life or the estimated abandonment costs of a property change
materially upon our quarterly review, a new calculation is performed using the
same methodology of taking the abandonment cost and inflating it forward to its
abandonment date and then discounting it back to the present using our
credit-adjusted-risk-free rate. The carrying value of the ARO is adjusted to the
newly calculated value, with a corresponding offsetting adjustment to the asset
retirement cost. Thus, abandonment costs will almost always approximate the
estimate. When well obligations are relieved by sale of the property or plugging
and abandoning the well, the related liability and asset costs are removed from
our balance sheet.




Assumptions/Approach
Used:  Estimating the future asset removal costs is difficult
and requires management to make estimates and judgments because most of the
removal obligations are many years in the future and contracts and regulations often
have vague descriptions of what constitutes removal. Asset removal technologies
and costs are constantly changing, as are regulatory, political, environmental,
safety and public relations considerations. Inherent in the estimate of the
present value calculation of our AROs are numerous assumptions and judgments
including the ultimate settlement amounts, inflation factors, credit adjusted
risk-free rates, timing of settlement, and changes in the legal, regulatory,
environmental and political environments.




Effect if Different Assumptions
Used:  Since there are so many variables in estimating AROs, we
attempt to limit the impact of management’s judgment on certain of these
variables by developing a standard cost estimate based on historical costs and
industry quotes updated annually. Unless we expect a well’s plugging to be
significantly different than a normal abandonment, we use this estimate. The
resulting estimate, after application of a discount factor and some significant
calculations, could differ from actual results, despite our efforts to make an
accurate estimate. We engage independent engineering firms to evaluate our
properties annually. We use the remaining estimated useful life from the
year-end reserve report by our independent reserve engineers in estimating when
abandonment could be expected for each property. We expect to see our
calculations impacted significantly if interest rates continue to rise, as the
credit-adjusted-risk-free rate is one of the variables used on a quarterly
basis.




Page
32




Nature of Critical Estimate
Item:  Derivative Instruments and Hedging Activities — We
periodically use derivative financial instruments to achieve a more predictable
cash flow from our oil, NGL and natural gas production by reducing our exposure
to price fluctuations. Currently, these transactions are swaps whereby we
exchange our floating price for our oil, NGL and natural gas for a fixed price
with qualified and creditworthy counterparties (currently BNP Paribas, Bank of
America, KeyBank and Wachovia). Our existing oil, NGL and natural gas swaps are
with members of our lending group which enables us to avoid margin calls for
out-of-the money mark-to-market positions.




We do not
specifically designate derivative instruments as cash flow hedges, even though
they reduce our exposure to changes in oil, NGL and natural gas prices and
interest rate changes. Therefore, the mark-to-market of these instruments is
recorded in current earnings. We use market value statements from each of our
counterparties as the basis for these end-of-period mark-to-market adjustments.
We currently have engaged a third-party provider to calculate an independent
mark-to-market statement to evaluate the reasonableness of our counterparties’
statements. When we record a mark-to-market adjustment resulting in a loss in a
current period, these unrealized losses represent a current period
mark-to-market adjustment for commodity derivatives which will be settled in
future periods. As shown in the tables above, we have hedged a significant
portion of our future production through 2012. As oil, NGL and natural gas
prices rise and fall, our future cash obligations related to these derivatives
will rise and fall.





Recently
Issued Accounting Pronouncements





In
September 2006, the FASB issued Statement of Financial Accounting Standards No.
157, Fair Value
Measurements. Statement No. 157 defines fair value as used in numerous
accounting pronouncements, establishes a framework for measuring fair value in
GAAP and expands disclosure related to the use of fair value measures in
financial statements. We adopted the statement effective January 1, 2008 and the
adoption did not have a significant effect on our consolidated results of
operations, financial position or cash flows. See Note 6 for other disclosures
required by Statement No. 157.





In
December 2007, the FASB issued Statement of Financial Accounting Standards No.
141 (revised 2007), Business
Combinations (“SFAS 141(R)”), which replaces FASB Statement No. 141. SFAS
141(R) establishes principles and requirements for how an acquirer recognizes
and measures in its financial statements the identifiable assets acquired, the
liabilities assumed, any non-controlling interest in the acquiree and the
goodwill acquired. The Statement also establishes disclosure requirements that
will enable users to evaluate the nature and financial effects of the business
combination. SFAS 141(R) is effective for acquisitions that occur in an entity’s
fiscal year that begins after December 15, 2008, which will be the Partnership’s
fiscal year 2009. The impact, if any, will depend on the nature and size of
business combinations we consummate after the effective date.





In
December 2007, the FASB issued Statement of Financial Accounting Standards No.
160, Non-controlling Interest
in Consolidated Financial Statements – an amendment of ARB No. 51 (“SFAS
160”). SFAS 160 requires that accounting and reporting for minority interests
will be re-characterized as non-controlling interests and classified as a
component of equity. SFAS 160 also establishes reporting requirements that
provide sufficient disclosures that clearly identify and distinguish between the
interests of the parent and the interests of the non-controlling owners. SFAS
160 applies to all entities that prepare consolidated financial statements,
except not-for-profit organizations, but will affect only those entities that
have an outstanding non-controlling interest in one or more subsidiaries or that
deconsolidate a subsidiary. This statement is effective as of the beginning of
an entity’s first fiscal year beginning after December 15, 2008, which will be
the Partnership’s fiscal year 2009. Based upon the September 30, 2008 balance
sheet, the statement would have no impact.





In March,
2008, the FASB issued Statement of Financial Accounting Standards No. 161, Disclosures about Derivative
Instruments and Hedging Activities (“SFAS 161”). SFAS 161 amends and
expands the disclosure requirements of FASB Statement No. 133, Accounting for Derivative
Instruments and Hedging Activities. SFAS 161 requires disclosures related
to objectives and strategies for using derivatives; the fair-value amounts of,
and gains and losses on, derivative instruments; and credit-risk-related
contingent features in derivative agreements. This statement is effective as of
the beginning of an entity’s fiscal year beginning after December 15, 2008,
which will be the Partnership’s fiscal year 2009. The effect on the
Partnership’s disclosures for derivative instruments as a result of the adoption
of SFAS 161 in 2009 will depend on the Partnership’s derivative instruments and
hedging activities at that time.




Item 3. 
Quantitative and Qualitative Disclosure About Market Risk.




The
primary objective of the following information is to provide forward-looking
quantitative and qualitative information about our potential exposure to market
risks. The term “market risk” refers to the risk of loss arising from adverse
changes in oil and natural gas prices and interest rates. The disclosures are
not meant to be precise indicators of expected future losses, but rather
indicators of reasonably possible losses. This forward-looking information
provides indicators of how we view and manage our ongoing market risk exposures.
All of our market risk sensitive instruments were entered into for purposes
other than speculative trading.




Page
33




Commodity
Price Risk




Our major
market risk exposure is in the pricing applicable to our oil and natural gas
production. Realized pricing is primarily driven by the spot market prices
applicable to our natural gas production and the prevailing price for crude oil
and NGLs. Pricing for oil, NGLs and natural gas has been volatile and
unpredictable for several years, and we expect this volatility to continue in
the future. The prices we receive for production depend on many factors outside
of our control, such as the strength of the global economy.




We
periodically enter into, and anticipate entering into derivative transactions in
the future with respect to a portion of our projected oil, NGL and natural gas
production through various transactions that mitigate the risk of the future
prices received. These transactions may include price swaps whereby we will
receive a fixed price for our production and pay a variable market price to the
contract counterparty. Additionally, we may enter into put options, whereby we
pay a premium in exchange for the right to receive a fixed price at a future
date. At the settlement date we receive the excess, if any, of the fixed floor
over the floating rate. These derivative transactions are intended to support
oil, NGL and natural gas prices at targeted levels and to manage our exposure to
oil, NGL and natural gas price fluctuations. We do not hold or issue derivative
instruments for speculative trading purposes.





As of
September 30, 2008, the fair market value of Legacy’s commodity derivative
positions was a net liability of $95.5 million based on NYMEX near month
prices of $100.64 per Bbl and $7.72 per MMBtu for oil and natural gas,
respectively. As of December 31, 2007, the fair market value of Legacy’s
commodity derivative positions was a net liability of $82.3 million based
on NYMEX near month prices of $95.98 per Bbl and $7.48 per MMBtu for oil and
natural gas, respectively. As of October 31, 2008, the NYMEX near month prices
for oil and natural gas were $67.81 per Bbl and $6.78 per MMBtu, respectively.
As a direct result, the net liability related to the fair market value of
Legacy’s commodity derivative positions decreased by $137.5 million to a net
asset position of $42.0 million. The oil, NGL and natural gas swaps for 2008
through December 31, 2012 are tabulated in the tables presented above under
“Item 2.  Management’s Discussion and Analysis of Financial Condition
and Results of Operations — Cash Flow from Operations.”





Interest
Rate Risks




At
September 30, 2008, Legacy had debt outstanding of $231 million, which
incurred interest at floating rates in accordance with its revolving credit
facility. The average annual interest rate incurred by Legacy for the nine-month
period ended September 30, 2008 was 5.07%. A 1% increase in LIBOR on
Legacy’s outstanding debt as of September 30, 2008 would result in an
estimated $0.2 million increase in annual interest expense as Legacy has entered
into interest rate swaps to mitigate the volatility of interest rates through
November of 2011 on $214 million of floating rate debt to a weighted-average
fixed rate of 3.45%.





Item 4T. 
Controls and Procedures.




We
maintain disclosure controls and procedures (as defined in Rules 13a-15(e)
and 15d-15(e) promulgated under the Securities Exchange Act of 1934, or the
“Exchange Act”) that are designed to ensure that information required to be
disclosed in Exchange Act reports is recorded, processed, summarized, and
reported within the time periods specified in the rules and forms of the SEC and
that such information is accumulated and communicated to our management,
including our General Partner’s Chief Executive Officer and Chief Financial
Officer, as appropriate, to allow timely decisions regarding required
disclosure. Any controls and procedures, no matter how well designed and
operated, can provide only reasonable assurance of achieving the desired control
objectives.




Our
management, with the participation of our General Partner’s Chief Executive
Officer and Chief Financial Officer, has evaluated the effectiveness of the
design and operation of our disclosure controls and procedures as of
September 30, 2008. Based upon that evaluation and subject to the
foregoing, our General Partner’s Chief Executive Officer and Chief Financial
Officer concluded that our disclosure controls and procedures were effective to
accomplish their objectives.




Our
General Partner’s Chief Executive Officer and Chief Financial Officer do not
expect that our disclosure controls or our internal controls will prevent all
error and all fraud. The design of a control system must reflect the fact that
there are resource constraints and the benefit of controls must be considered
relative to their cost. Because of the inherent limitations in all control
systems, no evaluation of controls can provide absolute assurance that we have
detected all of our control issues and all instances of fraud, if any. The
design of any system of controls also is based partly on certain assumptions
about the likelihood of future events and there can be no assurance that any
design will succeed in achieving our stated goals under all potential future
conditions.




There
have been no changes in our internal control over financial reporting that
occurred during our fiscal quarter ended September 30, 2008, that have
materially affected, or are reasonably likely to materially affect, our internal
control over financial reporting.




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PART
II – OTHER INFORMATION





Item 1.  LEGAL
PROCEEDINGS





Although
we may, from time to time, be involved in litigation and claims arising out of
our operations in the normal course of business, we are not currently a party to
any material legal proceedings. In addition, we are not aware of any legal or
governmental proceedings against us, or contemplated to be brought against us,
under the various environmental protection statutes to which we are
subject.





Item 1A.  RISK FACTORS





Because we
distribute all of our available cash to our unitholders and as a result of
recent disruptions in the financial markets, our future growth may be
limited.





Since we
will distribute all of our available cash as defined in our partnership
agreement to our unitholders, our growth may not be as fast as businesses that
reinvest their available cash to expand ongoing operations. Further, since we
depend on financing provided by commercial banks and other lenders and the
issuance of debt and equity securities to finance any significant growth or
acquisitions, the recent disruptions in the global financial markets and the
associated severe tightening of credit supply may prevent us from obtaining
adequate financing from these sources, and, as a result, our ability to grow,
both in terms of additional drilling and acquisitions, may be
limited.





The recent
disruptions in the financial markets, the substantial restrictions and
financial covenants of our revolving credit facility and any negative
redetermination of our borrowing base by
our lenders could adversely affect our
business, results of operations, financial condition and our ability to
make cash
distributions to our unitholders.





We depend
on our revolving credit facility for future capital needs. Our revolving credit
facility limits the amounts we can borrow to a borrowing base amount, determined
by the lenders in their sole discretion. As of November 7, 2008, we had $98.5
million available for borrowing under our revolving credit facility under
existing commitments from our lenders. Due to recent disruptions and steep
declines in the global financial markets and generally severely tightening
credit supply, lenders under our revolving credit facility may decrease our
borrowing base, may not increase the borrowing base to indicated levels or at
all, or such lenders may not honor their pro rata share of existing
total commitments, which may significantly reduce our available borrowing
capacity and, as a result, materially adversely affect our financial condition
and ability to pay distributions to unitholders.





Additionally,
our revolving credit facility restricts, among other things, our ability to
incur debt and pay distributions, and requires us to comply with certain
financial covenants and ratios. Our ability to comply with these restrictions
and covenants in the future is uncertain and will be affected by the levels of
cash flow from our operations and events or circumstances beyond our control,
such as the recent disruptions in the financial markets. Our failure to comply
with any of the restrictions and covenants under our revolving credit facility
could result in a default under our revolving credit facility. A default under
our revolving credit facility could cause all of our existing indebtedness to be
immediately due and payable.





We are
prohibited from borrowing under our revolving credit facility to pay
distributions to unitholders if the amount of borrowings outstanding under our
revolving credit facility reaches or exceeds 90% of the borrowing base, which is
the amount of money available for borrowing, as determined semi-annually by our
lenders in their sole discretion. The lenders will redetermine the borrowing
base based on an engineering report with respect to our oil and natural gas
reserves, which will take into account the prevailing oil and natural gas prices
at such time. Any time our borrowings exceed 90% of the then specified borrowing
base, our ability to pay distributions to our unitholders in any such quarter is
solely dependent on our ability to generate sufficient cash from our
operations.





Outstanding
borrowings in excess of the borrowing base must be repaid, and, if mortgaged
properties represent less than 80% of total value of oil and gas properties used
to determine the borrowing base, we must pledge other oil and natural gas
properties as additional collateral. We may not have the financial resources in
the future to make any mandatory principal prepayments required under our
revolving credit facility.





The
occurrence of an event of default or a negative redetermination of our borrowing
base could adversely affect our business, results of operations, financial
condition and our ability to make distributions to our unitholders.




In
addition to the other information set forth in this report, you should carefully
consider the factors discussed under, “Item 1A. Risk Factors” in our Annual
Report on Form 10-K for the year ended December 31, 2007, which could materially
affect our business, financial condition or future results.  The risks
described in our Annual Report on Form 10-K for the year ended December 31, 2007
are not the only risks we face.  Additional risks and uncertainties not
currently known to us or that we currently deem to be immaterial also may
materially adversely affect our business, financial condition and/or operating
results.




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Item 2. 
Unregistered Sales of Equity Securities and Use of Proceeds.





None.





Item 3. 
Defaults Upon Senior Securities.





None.





Item 4. 
Submission of Matters to a Vote of Security Holders.





None.








Item 5. 
Other Information.





None.




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Item 6. 
Exhibits.




The
following documents are filed as a part of this quarterly report on Form 10-Q or
incorporated by reference:






Exhibit
      Number
            Description3.1
            Certificate
      of Limited Partnership of Legacy Reserves LP (Incorporated by reference to
      Legacy Reserves LP’s Registration Statement on Form S-1 (File
      No. 333-134056) filed May 12, 2006,
      Exhibit 3.1)3.2
            Amended
      and Restated Limited Partnership Agreement of Legacy Reserves LP
      (Incorporated by reference to Legacy Reserves LP’s Registration Statement
      on Form S-1 (File No. 33-134056) filed May 12, 2006,
      included as Appendix A to the Prospectus and including specimen unit
      certificate for the units)3.3
            Amendment
      No.1, dated December 27, 2007, to the Amended and Restated Agreement of
      Limited Partnership of Legacy Reserves LP (Incorporated by reference to
      Legacy Reserves LP’s Current Report on Form 8-K (File No. 001-33249) filed
      January 2, 2008, Exhibit 3.1)3.4
            Certificate
      of Formation of Legacy Reserves GP, LLC (Incorporated by reference to
      Legacy Reserves LP’s Registration Statement on Form S-1 (File
      No. 333-134056) filed May 12, 2006,
      Exhibit 3.3)3.5
            Amended
      and Restated Limited Liability Company Agreement of Legacy Reserves GP,
      LLC (Incorporated by reference to Legacy Reserves LP’s Registration
      Statement on Form S-1 (File No. 333-134056) filed May 12,
      2006, Exhibit 3.4)4.1
            Registration
      Rights Agreement dated June 29, 2006 between Henry Holding LP and
      Legacy Reserves LP and Legacy Reserves GP, LLC (the “Henry Registration
      Rights Agreement”) (Incorporated by reference to Legacy Reserves LP’s
      Registration Statement on Form S-1 (File No. 333-134056) filed
      September 5, 2006, Exhibit 4.2)4.2
            Registration
      Rights Agreement dated March 15, 2006 by and among Legacy Reserves
      LP, Legacy Reserves GP, LLC and the other parties thereto (the “Founders
      Registration Rights Agreement”) (Incorporated by reference to Legacy
      Reserves LP’s Registration Statement on Form S-1 (File
      No. 333-134056) filed September 5, 2006,
      Exhibit 4.3)4.3
            Registration
      Rights Agreement dated April 16, 2007 by and among Nielson &
      Associates, Inc., Legacy Reserves GP, LLC and Legacy Reserves LP
      (Incorporated by reference to Legacy Reserves LP’s Quarterly Report on
      Form 10-Q (File No. 001-33249) filed May 14, 2007, Exhibit
      4.4)10.1*
            Participation
      Agreement dated as of September 24, 2008, between Legacy Reserves
      Operating LP and Black Oak Resources, LLC10.2
            Purchase,
      Sale and Contribution Agreement dated September 5, 2008, by and among Cano
      Petroleum, Inc., Pantwist, LLC and Legacy Reserves Operating LP
      (Incorporated by reference to Legacy Reserves LP’s Current Report on Form
      8-K (File No. 001-33249) filed October 7, 2008, Exhibit
    10.2)31.1*
            Rule 13a-14(a)
      Certifications (under Section 302 of the Sarbanes-Oxley Act of
      2002)31.2*
            Rule 13a-14(a)
      Certifications (under Section 302 of the Sarbanes-Oxley Act of
      2002)32.1*
            Section 1350
      Certifications (under Section 906 of the Sarbanes-Oxley Act of
      2002)




* Filed
herewith




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37


LEGACY RESERVES
LP
 SIGNATURE
 Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.


LEGACY RESERVES LP
                
                By: Legacy Reserves GP, LLC, its General
      PartnerDate:
      November 7, 2008
              By:
              /s/ William
      M. MorrisWilliam
      M. MorrisVice
      President, Chief Accounting Officer
                and Controller (On behalf of the Registrant
                and as Principal Accounting Officer)






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