Good day, and welcome to the Contango’s Q4 2020 Earnings Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Wilkie Colyer. Please go ahead..

Good morning, and thank you for joining us for our fourth quarter and full year 2020 earnings call. My name is Wilkie Colyer, and I’m the Chief Executive Officer of Contango.

Joining me this morning on the call are Farley Dakan, the Company’s President; Chad Roller, the Company’s Chief Operating Officer; Joe Grady, the Company’s Chief Financial Officer; and Chad McLawhorn, the Company’s General Counsel.

Hopefully, everyone has had an opportunity to read through this morning’s press release, including the cautionary statements regarding forward-looking information and non-GAAP measures that apply to the statements on this call.

Also, I will make reference to a presentation posted to our website Contango investor presentation and the header on that is company overview, March 2021. So please have that handy, if you’d like to follow along.

Last time we spoke with you in late November, we announced our acquisition of Silvertip on the heels of the merger announcement with Mid-Con Energy Partners.

These acquisitions of low decline, oily assets proved to be very timely, given the recent rise in commodity prices, and our ability to cut field level operating expenses on those assets has further enhanced our baseline return expectations.

I will review our acquisition history later in the call, but we are building a track record of asset purchases at attractive prices, which are complemented by cost cutting and then low-risk capital development. As always, we remain diligent on the hedging front.

For the last three quarters of this year, we have 67% of our forecasted PDP oil production hedged at $54.87 and 60% of forecasted PDP gas production hedged at $2.62. Next year, we are 47% hedged on oil PDP at $50.24 and 57% hedged on GAAP PDP of $2.50. Lastly, we have 50% and 60% of oil and gas hedged in the first two months of 2023.

We expect our realization on oil hedges this year to be moderately higher than what I just mentioned, given that a portion of our oil hedges are colors.

Keep in mind that our forecasted PDP percentage hedge does not include the production we expect to bring online via our high-return capital projects, which I’ll discuss in a moment, or incremental acquisitions. Expect us to continue using hedges as a way to protect our downside in this volatile commodity price environment.

In terms of results, we came in within guidance on production, LOE and G&A for the fourth quarter. While we are certainly proud of that, this quarter was really all about inorganic growth and integration of those assets onto the Contango platform. We are a materially larger company today than we were even a few short months ago.

I’d like to take this opportunity to now turn to the presentation and walk through some slides on our company, strategy and outlook now that the MCEP and Silvertip transactions have closed, and we’ll skip around a little bit.

But starting on Slide 6 in that company overview presentation, if we talked about alignment of incentives, 100 times, it wouldn’t be enough, but that’s really the key tenant of the way we run this company.

Insider ownership is paramount and as you can see, we’re peer-leading in terms of our insider ownership, and I would think at or near the top across the entire industry, but that’s really, really important to have insider ownership in terms of knowing the right way to create long-term value for shareholders.

And there’s really no better way to do it than having high-end better ownership. Recurring Cash G&A, as you know, we always think about salaries and G&A as being something we want to minimize. And so you can see top right, our salaries are on average about 50% of our peer group, and that helps us keep our G&A to enterprise value low.

As you can see, that number is 1.4%.

We think on a percentage basis, we can continue to drive that down as we continue to make acquisitions as a percentage of our enterprise value, just because of the platform that we have allows us to manage incremental assets much more efficiently than someone with less scale or that standing up an operating platform with a single asset.

So we expect to be able to continue to drive that down and really the way that the management team and our employee base would like to get paid overtime or not get paid is going to be based on the performance of our stock. So our executive compensation is heavily weighted towards LTIPs and more specifically PSUs, which are performance share units.

100% of my LTIPs have been in the form of PSUs, and those can be ultimately grants of anywhere from 0 to 3 times the PSU grant, and that’s based on our performance and the stock’s performance versus our peers and on an absolute basis over a multiyear period.

So we think we’ve got the proper alignment of incentives between us managing these assets in the [indiscernible] Turning now to Slide 7.

As you can see, we’ve got now a very diversified asset base, and our focus is predominantly on longer-lived conventional assets, although we do look at unconventional assets, and we will look at other basins other than where we are now.

But really, our key three focus areas will be the Mid-Continent in Oklahoma, the Rockies, specifically Wyoming and then the Permian Basin. These are areas that have been probably the most prolific conventional oil fields in the country over a long period of time.

And we believe in the old vantage of the best place to find oil is where you found it before. So let’s not to say we won’t look at other areas again. We have and will continue to look at other areas, but I think our main focus areas will continue to be these three areas. And we think there’s lots of opportunities to bulk up around those areas.

Slide 8, my focus here is really on liquidity and where existing liquidity is ample for our strategy being that we generate substantial free cash flow, and we’re not a company that’s reliant on borrowing base increases to fund cash flow outspend.

But that being said, we do anticipate a significant increase in our borrowing base value during the spring redetermination. And so that increase in liquidity that we anticipate in conjunction with our free cash flow will be used to acquire additional assets rather than being used to fund cash flow up outspend.

Slide 9, I’d point you to the bottom left quadrant, the PDP decline. So we are forecasting a five-year corporate oil decline at less than 10%, which we believe is a peer-leading metric. That decline importantly involved no capital spending.

So the 10% CapEx spend that you see on the reinvestment rate on the right is also peer leading, but that will really be used to further arrest the decline profile that you’re seeing on the bottom left.

And but that really allows us to do is generate – continue to generate free cash flow without having to spend a lot in capital dollars to further consolidate and use that cash flow to acquire other assets rather than having to use it to keep our production close to flat or EBITDA or whatever metric you want to use.

So we think that’s really important, and that’s really how we’re trying to design the company. Slide 11, this is really, I think, probably the most important slide or second most important slide of this presentation.

And this really, we wanted to give everybody an outline of our track record now that we’ve completed four transactions in the last 15 or 16 months. So first off, a variety of transaction types, as you can see in the M&A dynamic. Will Energy was a bank-owned sale. White Star was a 363 sale that we bought on the quarter our steps.

Mid-Con of the bilateral M&A deal and then Silvertip was a company that reorganized several times, and then it was a bank-owned liquidation following that. Regions, these are obviously the regions that I talked about. And again, while we’ll look elsewhere, this will continue to be the main focus for our company will be these couple of regions.

And then announced purchase price, these are really the headline numbers. And in many cases, those are involved back-dated effective dates and things of that nature. So it’s pretty – there is some pretty purchase price adjustments. But as you can see, those numbers relative to PDP PV-10 and all these asset metrics are also effective date type numbers.

So looking down to the acquisition metrics, the TEV, the PDP PV-10, all below one. And on average, about 0.7 times, but very attractive. And those are all based on the cost structures of the companies when we acquire them, which is important because looking at the performance metrics, we’ve had a lot of success.

Once we’ve acquired these assets at lowering LOE on those assets to make us more efficient and to maximize the value of that PDP.

So on average, that’s been a 21% decrease in LOE per Boe, but I would note that Silvertip, which we’ve only been managing and owned for a matter of weeks now, is obviously less of an LOE drop than we’ve experienced or been able to achieve in the other three transactions. But we expect to achieve further cost savings on those assets as well.

So the punch line down to the bottom with the adjusted purchase price is we spent $281 million on these acquisitions of cash at closing. Cash flow of $48 million, which is lower than we would have anticipated because the acquisitions of Will Energy and White Star were prior to COVID.

So we didn’t have as much cash flow off of those assets as we otherwise would have expected. But even still at year-end – at the end of last year, we still had $572 million of PDP PV-10, the only asset that has any sort of price value that’s material is that the Mid-Con transaction. So that’s really – that $572 million, very close to PDP, PV-10.

So we’ve been able to create about $620 million worth of value out of that $281 million of cash required at closing.

So we think that, that 2.2 times discounted ROI is just – is a very, very attractive metric to look at when you’re not going to take any sort of geological risk or drilling risks that they’re having to take if you you’re having to drill your way into a profit. So we think that’s really important, and we think it’s something that’s repeatable.

And I don’t – we’re not aware of anybody that we in the public realm that has that kind of track record over this period of time. Slide 12. So central Oklahoma was the largest asset acquired in the White Star package, and we were able to cut almost 50% of LOE out of the assets.

And the key here is really shifting the focus of the team from how many sticks or wells can we drill this year to how do we maximize the value of the existing producing wells. So the bottom right shows we were actually able to more than replace production from last year just with cost cuts and with no drilling.

One note I’d make to this is that this is basically running 2019 reserves at March 3 prices and at a strip, which is in pretty steep backwardation. What that does is it really increases the cash flow generation bar and so the near-term pricing increases the discounted cash flow generated bar.

And it decreases really the shape of the curve being backward dated, decreases that LOE reduction bar. So if you looked at this several months ago, it would be much more pronounced in terms of the amount of reserves we were able to replace relative to the cash flow generated.

But nevertheless, a very, very impressive number and one that we’re really proud of and, again, one that we think we can continue to replicate in the future. Slide 13, if 11 is not the most important slide, this may be, but I would say, a combination of the two.

And this is really we wanted to give everyone a sense of how we think about organic development in a low risk way. We have owned MCEP and Silvertip for just over a month, and this is what we’ve decided to spend capital on this year thus far as we’ve been learning more about the assets.

So as you can see, a lot of this is return to production activity on wells that we do not have booked into reserves as well as the Pine Tree asset we acquired via MCEP. And looking at the bottom table, we expect to be able to add $108 million of proved developed reserves for about $10 million of capital spending.

And these are not sexy projects by any means. It’s a lot of $75,000 and $100,000, $150,000 jobs, but they add up and they are highly capital efficient. And that PV-2 investment is really, I would say, the main return metric that we focus on as we think about our business.

So it – this is really what we referenced when we talk about putting some TLC into assets when we acquire them that may have been either neglected or distressed. Slide 15, the opportunity set. While near-term commodity prices have run some in the past few months, we still see substantial opportunities to acquire distressed assets at attractive prices.

Bank and liquidations, pre and post reorder opportunities and bilateral, M&A and A&D are still very large opportunities in the market. We think the opportunity set for consolidation is in the tens of billions. And it’s our opinion that the best way to capitalize on that is via a public company just because the opportunity is so large.

We feel like we have a good head start with the four transactions we’ve executed in the last 16 months and that in the middle of a pandemic, but we plan on keeping our head down and continuing to execute on inorganic and organic opportunities going forward. Thanks for your time this morning and for your interest in Contango.

And with that, operator, I will open up the line for questions..

[Operator Instructions] And we’ll take our first question. Caller, please go ahead..

Good morning, Wilkie. It’s Jeff Robertson. A question on the – two things.

One on the – are you seeing any upward pressure on service prices that affects the capital you’ve outlined for work over projects? And secondly, as the rise in commodity prices created any more urgency with sellers of distressed assets to maybe go ahead and move assets now that prices are higher?.

Thanks for the question, Jeff. So on the first one, we have not seen much service cost inflation. And our view is a lot of that work-over-work we can do in-house. And when you think about it, we really feel like the smaller the job, the more we can protect ourselves against service cost inflation. We certainly do expect to see it.

But I think that’s why a big focus of ours is on proved develop reserves just because I think those are going to see the biggest benefit from the increase in oil prices without seeing the increases in service costs.

So I think owning a bunch of leasehold that you need to go drill horizontal wells on, we’re just not sure you’re going to get a lot better margins on a $20 or $30 higher crude prices once the fracking companies and drilling companies need to recoup some of their costs.

So that’s not a definitive answer, I guess, but that’s how we think about it anyway.

And then I’m sorry, Jeff, what was your second question again?.

Has the rise in commodity prices maybe caused the owners of some of the assets you all target the distressed assets, does it cause them to accelerate their plans to divest those properties now that they can obviously get a theoretically or price based on a higher strip?.

Yes. Good question. I mean, we certainly – we think so. I think that owners – non-natural owners of assets that weren’t designed on those things, we certainly think are more likely to divest now that the strip is a little bit higher, and we’ve made it through COVID. I certainly think that’s the case, but just – we’ll have to see.

We obviously haven’t executed anything since this fairly materialized in oil prices, but that’s certainly our expectation, Jeff..

Last question, if I can. Financing for incremental acquisitions.

How do you think about the right use of equity and debt for opportunities?.

Yes. It’s a very fair question. I mean, the first thing we will have is or we expect to have is a fair amount of liquidity on our revolver post our redetermination. So that’s one use of capital. And as we’ve shown in the past, we’re not afraid to use equity to acquire assets.

Really, at the end of the day, we’re trying to analyze whether or not the acquisition is accretive to the intrinsic value per share for our shareholders. And so if we think it is, we’re going to do the deal. And if it’s not, then we won’t. And it’s really kind of a relative value proposition there.

So we are, again, not afraid to issue equity, but certainly think that at the moment, we are over equitized and we’re comfortable with a little bit more debt on the balance sheet probably just given that. As we stated in the press release, we anticipate year-end leverage at the end of 2021 to be sub half a turn.

And we would anticipate, assuming we do no new deals, being debt-free by Q3 of next year and then a net cash position. So we’re in a really good spot, given our liquidity profile to execute on further incremental acquisitions..

Thanks for taking my question, Wilkie..

Thanks, Jeff..

[Operator Instructions] We’ll now take our next question. Caller, please go ahead..

Good morning.

This is [indiscernible] can you hear me, Wilkie?.

Yes, I can. Good morning..

Good morning. Thank you for doing this call and best of luck with your acquisition efforts. Question number one, I understand the company has a new profile in light of the recent acquisitions that is closed. Could I just kind of confirm some of the numbers I’m looking at in the appendix in terms of the new expected production going forward for 2021.

It seems to be about 20,000 barrels a day, approximately 60% oil mix.

Just want to confirm how far off I am? And then just the other basic numbers in terms of the expected production cost per barrel and what kind of CapEx you have planned to use on these properties?.

Yes. So I don’t think we have given guidance on production for this year. We have given guidance on capital spending. As you could see in the presentation, we’ll have about $10 million of capital spending that’s expected to create that $108 million of proved developed reserves off of the recent acquisitions.

I believe our midpoint of guidance is, what, $14 million or $15 million. So you’ve got another $4 million or $5 million in there that is also a high return, but it’s from legacy Contango assets.

And those are largely the – it’s about half from non-operated wells in Grimes and Zavala counties that are really about the highest rate of return inventory we have in our portfolio. But obviously, we don’t control the timing of that given that it’s non-op. We just signed the AFE when we get it.

And then the other couple of million will be, I believe, some additional projects that we’ve identified on Grizzly’s assets.

So very low capital spending, but expect to create a significant amount of reserves to replace the reserves that will be rolling off during the year, and that’s really before we think our teeth into additional LOE savings at Grizzly, which we think will be additive..

Okay. And just a follow-up, this is a people-related question. You’re suggesting that the operations of the assets have been acquired have been under managed to an extent.

Can you just kind of explain how – what portion of the operating and production staff and geology staff you’re retaining when you’re acquiring these companies because clearly, they need to be operated.

And I’m just wondering what portion of people are being retained and what your – and how effectively are you able to get them to, in essence, change their operation practices to be more return on capital-oriented versus how they were basically overseen beforehand?.

how many wells can we drill this year? And then related to that, how do we maximize our BOE per day or our production? And we really try to flip that on its head and say, let’s not drill any wells until we’re sure about getting the cost structure as efficient as we can at the field. And that’s really a change in mindset.

But when we’re doing that – when you think about development capital spending and drilling a bunch of wells, there’s a lot of geology drilling design, completion design, a lot of land work because we’re trading acreage to kind of block it up. And we can really shift the focus to making sure we’re controlling costs as best we can in the field.

So we tend to keep the majority of the field staff and really want to empower them to make decisions and push those decisions down as far as we can. But in many cases, a lot of the G&A is duplicative.

And because of the change in strategy and the fact that we’re not really a drilling and completion company, we feel like our existing staff is usually pretty sufficient to manage the incremental assets. And really, that’s a big part of the value of the platform, we think, is we already have all that infrastructure.

And so that really helps us grow without having to grow G&A commensurate with the increase in the assets..

Okay.

And just finally, when looking at acquisitions, are there any sort of hidden assets you’re looking for? What I’m alluding to is, at your time at Resolute Energy, one of the benefits you realized there was you took old fields that had been conventionally drilled and you started doing horizontal drilling, which led to a much better realization of higher production reserves.

What I’m wondering is, as you look at new properties, what ways are you looking at them differently in an effort to try and realize additional value that the old or prior owners maybe have not done?.

Yes. I mean, that’s a little bit of the secret sauce. But I do think that we really kind of look at what it is and then try and be not too exacting on what it can be, but I have a decent idea of that when you go in and the number one focus is cutting cost.

And once you do that, we tend to find that it opens up a lot of opportunities that maybe you weren’t even sure existed because you’ve lowered that cost structure in the field. So we – that’s kind of how we approach it..

Great. Listen, best of luck, thank you..

Thank you very much for the call..

And we currently have no further questions..

Great. Well, really appreciate everybody’s time this morning and for your interest in Contango. And if anyone has any follow-up questions, please don’t hesitate to reach out to our team. And we look forward to speaking to you again in May, when we report our first quarter earnings. Everybody, have a great day..

This concludes today’s call. Thank you for your participation. You may now disconnect..