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Edited Transcript of MCF earnings conference call or presentation 8-Nov-18 2:00pm GMT

Q3 2018 Contango Oil & Gas Co Earnings Call

HOUSTON Nov 20, 2018 (Thomson StreetEvents) -- Edited Transcript of Contango Oil & Gas Co earnings conference call or presentation Thursday, November 8, 2018 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* E. Joseph Grady

Contango Oil & Gas Company - CFO & SVP

* Wilkie S. Colyer

Contango Oil & Gas Company - Interim President, CEO & Director

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Conference Call Participants

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* Bradley Barrett Heffern

RBC Capital Markets, LLC, Research Division - Associate

* Michael Dugan Kelly

Seaport Global Securities LLC, Research Division - MD and Head of Exploration & Production Research

* Neal David Dingmann

SunTrust Robinson Humphrey, Inc., Research Division - MD

* Ronald Eugene Mills

Johnson Rice & Company, L.L.C., Research Division - Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by. Welcome to the Contango Oil & Gas Company Third Quarter Results. (Operator Instructions) As a reminder, today's conference is being recorded.

I would now like to turn the conference over to our host, President and CEO, Wilkie Colyer. Please go ahead.

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Wilkie S. Colyer, Contango Oil & Gas Company - Interim President, CEO & Director [2]

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Thanks. Before we begin, I want to remind everybody that the earnings press release and the related discussion this morning may contain forward-looking statements, as defined by the Securities and Exchange Commission, which may include comments and assumptions concerning Contango's strategic plans, expectations and objective for future operations. Such statements are based on assumptions we believe to be appropriate under the circumstances. However, those statements are just estimates, are not guarantees of future performance or results and therefore should be considered in that context.

Good morning, and welcome to Contango's third quarter 2018 earnings call. My name is Wilkie Colyer, and I've been with the company and the President and CEO role since August of this year. I think it's safe to assume that everyone has had time to read through yesterday's press release, so you will learn that it is not my style to read through information already provided, but instead to provide strategic color and strategic thought around those results.

As many of you know, I took over as President and CEO after my former boss and partner, John Goff, became the largest shareholder of the company acquiring just under 19% of the outstanding shares from the largest shareholder in June of this year.

So why do we invest in Contango? The reasons are straightforward. We felt that the company was undervalued relative to the intrinsic value of its assets, and the platform as a public company is very attractive and valuable in an industry undergoing dramatic change. While the expense structure was far out of line relative to the size of the current asset base, we feel that's a fixable problem.

Goff Capital has had a lot of success investing in companies, we believe, are undervalued in industries experiencing various levels of distress, with energy being our primary focus since the downturn in 2014. After acquiring our stake, we found the board very receptive to making significant changes at the company. Accordingly, I became the CEO, and both John and I were elected to the board. While there is much work to do, I am very excited about this opportunity to represent all shareholders and work hard to maximize the value of this company.

Contango was particularly attractive because of the complementary nature of our 2 largest assets, our shallow water Gulf of Mexico asset, being a cash cow that requires minimal incremental CapEx; and our Southern Delaware Basin asset, a growth engine where we can reinvest that cash flow in attractive rates of return.

Having spent a few months on the ground with the team here, we have developed a detailed set of strategic initiatives that we've already begun to implement. First is the opportunities to better align our cost with the size of our company. Despite the strength of our complementary core assets, much of the Gulf of Mexico cash flow has historically been redirected into a cost structure that was designed for a much larger company. I'm working closely with the team to reduce cost without sacrificing the efficiency and safety of our operations. Our immediate target is to cut our cash G&A run rate by at least 1/3 by Q2 of next year. A good example of low-hanging fruit is our office rent, which runs $2.2 million gross and $1.7 million net per year, which we should be able to cut by close to $1.5 million or around 80%. This lease, fortunately, expires in March of next year. As mentioned in the press release, announcing my position, I recommended the CEO salary be reduced by 50%. I think it's important that expense-cutting begin with my position.

Second, we are getting more aggressive about hedging our PDP reserves, particularly in the Gulf of Mexico. Protecting this cash flow is critical to enabling the continued development of other opportunities such as our operations in the Southern Delaware Basin. We have hedged that production aggressively since I arrived, not because it's additive to our borrowing base, but because of it protects our downside.

Third, in addition to focusing on cost-cutting, we need to be smarter about our spending to prioritize return on invested capital. As we continue planning for the 2019 capital budget, we will be laser-focused on the returns our capital dollars generate rather than growth for the sake of growth.

I've been impressed by the operational knowledge and skill set of our team, which continues to make progress in developing our core asset in Pecos County and the Southern Delaware Basin.

During the quarter, we drilled 3 wells in Pecos, the Fighting Ace 2H, the General Paxton 1H and the Ripper State 2H. The Fighting Ace and General Paxton wells targeted the Wolfcamp A while the Ripper State targeted the Wolfcamp B. The General Paxton 1H is the initial well located in the southeastern section of our acreage and had an IP30 of 981 barrels of oil equivalent per day, 79% oil. Given that this is located in an area with lower pressure, we expect a flatter decline on it, and it may end up being our best well to date, although I'd caution it's still early days on this well to be too definitive. This well is spud to TD drill in 21 days, so our ops team continues to chip away incrementally at drill tops.

The Fighting Ace 2H was a below-average well coming in an IP30 of 656 barrels of oil equivalent per day, 71% oil, although it's still early days on this well, too. Finally, in late August, we drilled, but did not complete, our Ripper State 2H well. Recall that our initial plan last time we spoke to you was to drill a River Rattler in the northern part of our acreage. We ultimately decided that a more prudent use of capital would be to drill our Ripper State unit since we still have a few lease obligation wells there, whereas the River Rattler is an area we already know is Tier 1 inventory and is held by production.

On the Gulf of Mexico, we took a noncash impairment on this asset during the quarter, which now align book value on the asset with its PDP value. Recall that we shut in our Dutch Mary Rose field at the end of Q2 to install second-stage compression. The goal was to bring down field operating pressure and, thus, arrest production declines in the field to 10% or less, and initial indications are that it's working. The better we do at minimizing declines at Dutch Mary Rose, the more cash flow we'll have to direct elsewhere.

As we evaluate our diverse portfolio, it's clear that not all of our assets are strategically suited for the company's future. We will be smart sellers though, taking our time to sell at prices that make sense and generate capital to redeploy or create financial flexibility.

A few examples. Madisonville, this is our Eaglebine asset with $20 million roughly in PDP. The acreage is HBP-ed, and there's plenty of undrilled inventory. One of our neighbors in the area is currently fracking the well that we have a small working interest in, and we really haven't seen anyone try enhance completion techniques in the area since the downturn. We're excited to see the results of that well.

San Augustine. This asset is located in the Shelby Trough area of the Haynesville and Burgess Shale play. We have 3,600 acres of leasehold held by production in the county in de minimus PDP. Dimmit and Zavala. Our positions here targets the Georgetown, Buda, Austin Chalk and Eagle Ford formation. It includes about 8,000 acres of leasehold and 2,500 fee mineral acres. Our partner drilled an excellent Georgetown well in Q1 and is showing another well we're involved in currently. Exaro. This is a non-off LLC in the Jonah Field in which we own a 37% interest. The PD10 of the production, net of debt for the LLC, is approximately $25 million, for which we received 0 borrowing base credit.

We are also looking at opportunities to monetize our Delaware Basin infrastructure assets, which are largely undedicated for oil, gas and water. We've invested over $10 million, net to us, in our infrastructure assets there to date.

Finally, we will continue to evaluate opportunities to strategically expand our portfolio wherever we see attractive risk-adjusted returns for shareholders. The insiders of this company, along with many of you listening in, have substantial capital at risk in these strategies and our future. I know of no better way to align the incentives of management with those of shareholders than by eating our own cooking. I personally have a very material part of my network invested in the company's shares. I look forward to maximizing our value, executing on the strategy with the talented team here at Contango going forward.

With that, I'm ready to open the line up to questions. I also have in the room our CFO, Joe Grady; our SVP of Engineering, Steve Mengle; and our SVP of Exploration, Tommy Atkins, to answer any questions that I can't.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from the line of Brad Heffern from RBC Capital Markets.

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Bradley Barrett Heffern, RBC Capital Markets, LLC, Research Division - Associate [2]

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I guess, starting with the Permian, can you talk about how long you anticipate the pause there to go on for and when the Ripper 2H might eventually be completed?

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Wilkie S. Colyer, Contango Oil & Gas Company - Interim President, CEO & Director [3]

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Sure. So we're pausing there in Q4. So that's sort of been decided. And then we're still putting together plans for 2019. But I would say, currently, we're focused on making sure that we drill any lease obligation wells that we have, which are only a couple next year, I believe 3 net wells, and then the Ripper State, the lease obligations there that we have to complete that well by March of 2020. So as we -- it'll be sometime between now and then and we're still sort of making that determination.

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Bradley Barrett Heffern, RBC Capital Markets, LLC, Research Division - Associate [4]

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Okay. Got it. And then on the Gulf, as far as the new reserve estimate goes, can you give that out? I saw the 75 or so at year-end '17. Do you know what that moved to?

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Wilkie S. Colyer, Contango Oil & Gas Company - Interim President, CEO & Director [5]

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Well I don't know the exact number. We've rolled off production, obviously, since first of the year. And we had basically a drop in recover -- net recoverable reserves of about 10 or 11 Bcf. So it's going to be in the 60, 65 range, we see it.

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Wilkie S. Colyer, Contango Oil & Gas Company - Interim President, CEO & Director [6]

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Yes. The PDP is $97 million, $98 million from the Gulf, PDP PV-10.

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E. Joseph Grady, Contango Oil & Gas Company - CFO & SVP [7]

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Yes, yes. From PV-10, yes.

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Wilkie S. Colyer, Contango Oil & Gas Company - Interim President, CEO & Director [8]

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And that's at strip.

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Operator [9]

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Our next question comes from the line of Neal Dingmann with SunTrust.

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Neal David Dingmann, SunTrust Robinson Humphrey, Inc., Research Division - MD [10]

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Comments about the strategic alternatives -- I guess, my question is around the strategic alternatives. Can you talk about just how you and Joe view the quarterly spend, given the other activities you have going on? Do you just -- is it something you just want to maintain a steady-state? Or do you really want to pull back on spending until you decide which you all are going to do?

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Wilkie S. Colyer, Contango Oil & Gas Company - Interim President, CEO & Director [11]

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Quarterly spend in terms of CapEx? Or...

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Neal David Dingmann, SunTrust Robinson Humphrey, Inc., Research Division - MD [12]

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Yes, sir. Just the CapEx, obviously, mostly in the Permian, obviously.

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Wilkie S. Colyer, Contango Oil & Gas Company - Interim President, CEO & Director [13]

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Yes. No. I mean, I think it certainly got to be not totally pulling back. We want to maintain our position out there because we think it's a great asset. But certainly, we're not going to be out spending cash flow by any material amount. So that's kind of how I think about it as we go forward.

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Neal David Dingmann, SunTrust Robinson Humphrey, Inc., Research Division - MD [14]

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Okay. And then plans there, will you test additional zones? I mean, obviously, that latest well not only had, as you said, the flat decline, I mean, the 1,000 a day with almost 80% oil. Obviously looks like a great well in that General Paxton. So I guess, my question is in that play. The focus is in mostly Wolfcamp A and B. Will that continue to be the focus? Or will you continue to test other things?

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Wilkie S. Colyer, Contango Oil & Gas Company - Interim President, CEO & Director [15]

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Yes. At this time, it will be. But we certainly think that the Bone Springs is very interesting. Diamondbacks drilled a couple of shorter laterals pretty close to our acreage with great results there. And so it's certainly inventory that we have and that we like holding onto. And I'd just point out that the lease obligation wells that we're drilling in the Wolfcamp A and B generally hold all zones above it. So by drilling these lease obligation wells, we HBP those Bone Springs zones that we can drill at a future date.

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Neal David Dingmann, SunTrust Robinson Humphrey, Inc., Research Division - MD [16]

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Okay. And then if I can sneak one last one, just on the Gulf. I saw you had the impairment expense. Can you just talk how you view -- I mean, I totally agree with you. It certainly held the cash cow to have. How do you sort of see the decline? Or what -- how do you sort of view this cash cow playing out and continue to be just as strong for the next couple of years? Or maybe any color you could give around how you all view it?

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Wilkie S. Colyer, Contango Oil & Gas Company - Interim President, CEO & Director [17]

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Sure. Again, I mean, it -- the goal of the compression was to slow down the production declines. And thus far, that looks encouraging. If this thing can be a 10% decliner, and we can hedge out that price risk by hedging our gas production, we just view it as a stream of cash flows and sort of nothing more, nothing less. There's not incremental wells we have any plans to drill there. And so it's just -- its cash flow, and that's how we think about it.

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Operator [18]

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Our next question is from Ron Mills with Johnson Rice.

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Ronald Eugene Mills, Johnson Rice & Company, L.L.C., Research Division - Analyst [19]

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Given the -- I think it's a General Paxton well that shut down to the southeast, a little bit lower pressure. Can you talk a little bit how you completed that well? Is this the completion -- do you think some of the completion changes are driving the better than cash flows' results? Or just a little bit more commentary in terms of what you did on that well and what you like, what you think is driving the strong performance?

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Wilkie S. Colyer, Contango Oil & Gas Company - Interim President, CEO & Director [20]

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Well, from a completion perspective, we've been pretty consistent in our completion techniques now for the last 4, 5 wells. So we did not do anything strategically different on the General Paxton. I think it just -- it's the location. We're -- we've moved kind of 2, 3 miles kind of to the east and a little bit south of our existing wells to date. So it's a little bit of an outlier. And we just had better performance overall, better oil cuts. There's some pretty good wells offset to us, et cetera. So we just think it's going to be a good area over there.

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Ronald Eugene Mills, Johnson Rice & Company, L.L.C., Research Division - Analyst [21]

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Okay. And then similar question. In terms of the Fighting Ace, I know you've had pretty variable results in the months kind of -- the year where you've drilled most of your wells. When you do a look back, including that Fighting Ace up there, are you starting to triangulate on some of the characteristics of the wells that have performed better versus the ones that have come in a little bit below expectations to help as you formulate your 2019 and '20 programs?

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Wilkie S. Colyer, Contango Oil & Gas Company - Interim President, CEO & Director [22]

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Yes. I think that's fair to say. I mean, if you look at the well results we've had to date, we've sort of finally drilled across all of our acreage. And that gives us a lot of confidence in our ability to sort of go back in and drill wells at really attractive returns and avoid some that are sort of below par. So no, I mean, we think it's just like anywhere else. There's a learning curve. And so we've sort of moved up the learning curve here out at Pecos County and are excited that we're largely passing the bat.

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Ronald Eugene Mills, Johnson Rice & Company, L.L.C., Research Division - Analyst [23]

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And finally, just a follow-up to Neal's question on the strategic alternatives. Is the Intrepid engagement, is it to evaluate the sales you've talked about? Is it all-encompassing in terms of total strategic alternatives in terms of corporate-type transactions? Or is it more focused on asset sales and advising you through this -- the cost reduction and organization restructuring, if you will? And from a timing standpoint, is it -- do you have any kind of expectation of when you hope to get through that process?

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Wilkie S. Colyer, Contango Oil & Gas Company - Interim President, CEO & Director [24]

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No, but no concrete timing expectations that I can share with you right now. As far as what the scope of the project is and what the scope of our job is, it encompasses anything that we think might be beneficial to shareholders. So just think about it that way.

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Operator [25]

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And our last question is coming from the line of Mike Kelly with Seaport Global.

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Michael Dugan Kelly, Seaport Global Securities LLC, Research Division - MD and Head of Exploration & Production Research [26]

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Wilkie, really great opening comments there. I just wanted to get really some high-level question to you. And it's just how do you and John Goff think about the overall intrinsic value of the company? I'd just be curious on how maybe your sum of the parts framework and how big of an opportunity you think Contango can ultimately be versus roughly the $250 million enterprise value that the company is still -- is currently reflected.

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Wilkie S. Colyer, Contango Oil & Gas Company - Interim President, CEO & Director [27]

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Sure. I mean, look, as I said in my prepared comments, I mean, the -- we think this can be a pretty interesting platform through which to make energy investments in the future. But again, we're -- we are shareholders, first and foremost, so we're looking for whatever the best outcome is for shareholders. So we certainly think there's a -- there's trades that are discount to intrinsic value. And we think reason a big for that is because of sort of a bloated cost structure. So we think removing that bloated cost structure will help the market more accurately reflect the value of our assets. And again, we'll take what the market gives us. But as I mentioned, right now, the A&D market is fairly sluggish. So using this as a platform could be an attractive option.

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Michael Dugan Kelly, Seaport Global Securities LLC, Research Division - MD and Head of Exploration & Production Research [28]

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Got it. Okay. Appreciate that. And you did -- you kind of rattled off some of the assets that you think may be underappreciated, that could also be better suited in somebody else's hands. Is there anything, if you look across the portfolio, where you really see that the current market isn't giving any credit? Wall Street's given no credit for it in your portfolio, but I think maybe to industries, it should be worth quite a bit more? Just kind of curious on kind of those bigger delta-type bomb that we could see in the portfolio.

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Wilkie S. Colyer, Contango Oil & Gas Company - Interim President, CEO & Director [29]

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Yes, sure. I mean, again, clearly, there are assets that we have that we think are -- they're better suited in other's hands, and particularly some of these where we've drilled very few wells, but HBP-ed the acreage, so that we haven't sort of blend through a bunch of the inventory. And so that kind of stuff's valuable in the right hands and in the right A&D market. So we're evaluating those options. But I like I said, we're not -- we're going to be smart sellers of assets, and we're not going to sell stuff. I don't want to paint myself in a box and say we're going to sell X, Y and Z because then everybody knows that. So we'll sell at the right prices in the right environment.

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Operator [30]

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We do have a follow-up from Ron Mills.

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Ronald Eugene Mills, Johnson Rice & Company, L.L.C., Research Division - Analyst [31]

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Wilkie, just a follow-up on Mike's question. Especially post-Gulf of Mexico breakdowns and the Eaglebine breakdowns, do you have an updated PV-10 and -- for the assets? And of that, do you have a breakdown between PDP and total approved?

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E. Joseph Grady, Contango Oil & Gas Company - CFO & SVP [32]

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We'd show at year-end.

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Wilkie S. Colyer, Contango Oil & Gas Company - Interim President, CEO & Director [33]

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Yes, we'll have that at year-end.

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Operator [34]

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And there are no other questions in queue. Please continue.

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Wilkie S. Colyer, Contango Oil & Gas Company - Interim President, CEO & Director [35]

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All right. Well, if that's it, I appreciate everyone's time, everyone's interest in the company and look forward to getting back to work over here. So again, thanks for your time and look forward to talking to you again next quarter. Bye.

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Operator [36]

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Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation and for using AT&T Teleconference Service. You may now disconnect.