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Edited Transcript of PACD earnings conference call or presentation 12-Mar-19 3:00pm GMT

Q4 2018 Pacific Drilling SA Earnings Call

LUXEMBOURG Mar 18, 2019 (Thomson StreetEvents) -- Edited Transcript of Pacific Drilling SA earnings conference call or presentation Tuesday, March 12, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Bernie G. Wolford

Pacific Drilling S.A. - CEO & Director

* Johannes P. Boots

Pacific Drilling S.A. - CFO & Senior VP

* Lisa Manget Buchanan

Pacific Drilling S.A. - Senior VP, General Counsel & Secretary

* Michael D. Acuff

Pacific Drilling S.A. - SVP of Commercial

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Conference Call Participants

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* Beltran Palazuelo Barroso

SANTALUCÍA Gestión S.G.I.I.C., S.A. - Equity Analyst & Equity Portfolio Manager

* Ceki Aluf Medina

Southpaw Asset Management, LP - Partner and MD

* Patrick John Fitzgerald

Robert W. Baird & Co. Incorporated, Research Division - High Yield Desk Analyst

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Presentation

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Operator [1]

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Good day, and welcome to the Pacific Drilling Fourth Quarter and Full Year 2018 Results Conference Call. Today's conference is being recorded.

At this time, I'd like to turn the call over to Lisa Buchanan, Senior Vice President and General Counsel. Please go ahead.

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Lisa Manget Buchanan, Pacific Drilling S.A. - Senior VP, General Counsel & Secretary [2]

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Thank you, Matt, and welcome, everyone, to Pacific Drilling's Fourth Quarter and Full Year 2018 Results Conference Call. Joining me on this morning's call are Bernie Wolford, our CEO; John Boots, our CFO; and Michael Acuff, our Senior Vice President, Commercial.

Before I turn the call over to Bernie, I'd like to remind everyone that any statements we make about our plans, expectations, estimates, predictions or other statements about the future, including those concerning our future financial and operating performance, our earnings expectations and plans and objectives of management for future operations are all forward-looking statements that are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are not guarantees of future performance and are subject to risks and uncertainties. Our actual results could differ materially from any forward-looking statements made during this conference call due to a variety of factors. For information regarding important factors that could cause our actual results to differ from our expectations, we refer you to the Risk Factors sections of our filings with the U.S. Securities and Exchange Commission, which are posted on our website.

Please also note that we use non-GAAP financial measures during this call. You will find the required supplemental disclosures for these measures, including the most directly comparable GAAP measure and associated reconciliation in our results news release, which is available on our website.

I will now turn the call over to Bernie Wolford, Chief Executive Officer of Pacific Drilling.

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Bernie G. Wolford, Pacific Drilling S.A. - CEO & Director [3]

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Thanks, Lisa. Good morning all, and welcome to our earnings call. We continue to approach each day with an unwavering commitment to protect health, safety and the environment and a drive to deliver shareholder value through well-reasoned strategic action. We've made a lot of progress over the last 3 months. While employing a disciplined approach to building backlog, we have delivered our numerous internal initiatives to dramatically reduce our 2019 spend with a focus on cutting overhead, rationalizing our capital programs and enhancing our supply chain processes, all resulting in an anticipated savings of $28 million in 2019 as compared to our pre-emergence business plan. These changes will continue to provide benefit in 2020 and beyond.

The market for sixth- and seventh-generation drillships continue to improve as exemplified by our recent fixtures for the Pacific Santa Ana and Sharav. We continue to see improving demand for our services in the latter part of this year and in the first half of 2020. Oil prices have recovered significantly since December, and recent extensions, new fixtures, tender activity and FIDs point to improving utilization from this point forward. Michael will provide more insight into the current dynamics of the market in his prepared remarks. Plant preference for the most capable drillships, consolidation of competitors and the continued retirement of less competitive units have driven market utilization in our segment to near 80%.

We continue to make capital investments in technology and equipment that in our opinion will bring near-term benefit to the company in terms of relative utilization and returns on our investments. Specifically, we have installed a riser gas handling system on the Pacific Santa Ana and purchased a managed pressure drilling, or MPD, system for the Pacific Khamsin. The riser gas handling system is readily upgradable to a full MPD system and both units have been configured for portability across the fleet.

We have initiated the ramp-up of the Pacific Khamsin from smart stack to hot stack in anticipation of opportunities in the market commencing in the fourth quarter of this year. We can ramp up this and our other smart-stacked rigs at relatively lower costs due to our investments in the maintenance of these units and their crews through the bottom of the cycle.

We were able to buy in rigs back into service at a measured price into a tightening market with industry-leading economic returns. With reference to my earlier comments regarding improvements in our cost structure, we have been able to significantly reduce our negative cash flow at the enterprise level, while preserving our culture and systems for delivering top-tier HSE and operational performance. We have rationalized our capital spending plan to be both more efficient and support better returns.

As to the ongoing Zonda arbitration, we remain optimistic regarding the outcome based on the strength of our case and continue to anticipate a decision by the tribunal in the near future.

I will now turn the call over to John for a review of our fourth quarter results.

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Johannes P. Boots, Pacific Drilling S.A. - CFO & Senior VP [4]

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Thank you, Bernie, and good morning, everyone. As you're all no doubt aware the fourth quarter of 2018 was an eventful quarter for the company. We emerged from Chapter 11 on November 19. Our shares were relisted on the New York Stock Exchange on December 18, and since then, the management team has made substantial progress in realigning our cost structure with current market conditions.

Following our emergence from Chapter 11, the entire leadership team placed heightened emphasis on cost control and optimization, particularly our overhead support costs -- consisting of overhead support costs and G&A. The cost reductions resulting from the organizational and process changes should be evident as 2019 progresses.

These efforts will extend the benefits of our reorganization and better allow us to take advantage of an expected improving market for deepwater drilling services.

Turning to our fourth quarter highlights. The fourth quarter 2018 contract drilling revenue was $59.6 million, which included $2.9 million of deferred revenue amortization. This compared to third quarter 2018 contract drilling revenues of $56.7 million, which included $5.3 million of deferred revenue amortization.

The increase in revenue resulted primarily from the Pacific Bora commencing its contract with Nigerian Agip Exploration Limited, a subsidiary of ENI,

During the fourth quarter, the Pacific Drilling operating fleet achieved rig-related revenue efficiency averaging 99.8%, which was the same during the prior quarter and a full year revenue efficiency of 97.8%, which represents our 13th consecutive quarter of 95% or greater revenue efficiency.

Operating expenses for the fourth quarter of 2018 were $44.8 million compared to $44.2 million in the third quarter 2018.

General and administrative expenses for the fourth quarter were $13.8 million as compared to $10.9 million for the third quarter 2018. This increase in general and administrative expenses was partially due to severance costs for 2 former members of the executive management team.

Adjusted EBITDA for the fourth quarter 2018 was $3.3 million compared to $1.6 million in the third quarter of 2018. Direct rig-related daily expenses for operating rigs, excluding reimbursable costs, was approximately $119,000 for the fourth quarter of '18 and $117,000 for the full year 2018.

Turning to our capital structure and liquidity. We ended the year with a new capital structure reducing our debt from approximately $3 billion to approximately $1 billion. The $1 billion consists of first and second lien notes with the first maturity in October 2023, no amortization payments until the maturity of the first lien debt and no financial maintenance covenants.

Our liquidity balance at the end of the year was approximately $390 million. Excluded from this cash balance is approximately $34 million of cash that is collateralized with a bank to support a temporary imputation bond in Nigeria for the Bora and to support a bank guarantee to Petronas for the Santa Ana. This cash collateral is classified in the balance sheet under other receivable and other assets. We're in the process of securing an unsecured credit line in Nigeria, which would free up most of this cash collateral.

A couple of notes regarding our financial reporting relating to our emergence from Chapter 11. As part of our emergence on the Chapter 11, we adopted fresh-start accounting. I won't go through all the details here as this is rather complex. I refer you to the 20-F, but there's a couple of points that I want to highlight. Fresh-start accounting requires us to revalue most of our assets and liabilities to fair values as of the emergence date. These fair values are directionally in line with the bankruptcy court-approved business plan that we filed in connection with our Chapter 11 proceedings in August of last year, which shows an enterprise value of approximately $2.1 billion. From an accounting perspective, fresh-start accounting essentially treats us like a new company.

Some of the fresh-start accounting adjustments to our assets and liabilities have a onetime impact at the date of emergence and other adjustments will have a recurring impact to future quarters as all of these adjustments are noncash items. As a result of the adoption of fresh-start accounting, our consolidated financial statements subsequent to November 19, 2018, will not be comparable to those on or prior to that date.

As we have previously reported the 2 of our subsidiaries that are involved in the Zonda arbitration with Samsung were not debtors under our court-approved plan of reorganization and did not emerge from Chapter 11 with the rest of our company on November 19.

These 2 entities filed a separate plan of reorganization, which was confirmed on January 30, 2019. Because these 2 entities remain in Chapter 11 proceedings, they are deconsolidated from the financials of Pacific Drilling as a -- as subsidiaries as of November 19 under applicable accounting standards. The assets of these 2 entities consist primarily of the fair value of the arbitration claim and are presented on our 2018 consolidated balance sheet as receivables from any investment in unconsolidated subsidiaries.

The fair value, the valuation of our assets related to the Zonda arbitration is based on the probability weighted model of likely future potential arbitration outcomes. Our claim itself is in excess of $250 million plus interest and associated costs. We expect that the 2 entities will emerge from their bankruptcy proceedings subject to the successful resolution of the Zonda arbitration, will be reconsolidated with our group and become guarantors under our first and second lien notes. If we're unsuccessful in the arbitration, the company expects to liquidate the 2 entities.

Some additional items of notes. On February 22, 2019, our shareholders approved a share repurchase program for a total expenditure of up to $15 million for a 2-year period. We made purchase of shares in one or several transactions in the open market or otherwise; however, we're not obligated to repurchase any specific number of dollar value of our common shares under the program, and the program may be suspended or discontinued at any time. As of today, we have not repurchased any common shares under this program. Yesterday, we posted to our website under the Investor Relations tab new guidance regarding earnings, revenues, costs and CapEx for the first quarter of '19 and the full year 2019.

I would like to highlight a few items. First, any ramp-up costs to reactivate a rig from smart stacks to hot stacks or full operating mode is included in operating expenses, and we currently do not expect any significant reactivation CapEx.

Secondly, interest on our second lien debt is either cash or pick at the election of the company. However, as required by the indenture, the first payment in April this year will be in pick.

Thirdly, the enhancement CapEx range is related to a managed pressure drilling kit plus installation, and lastly, due to the fresh-start accounting, our 2019 results will not necessarily be comparable to 2018. And this includes, for instance, the capitalization of our above-market Sharav contract value, which is classified as an intangible asset on the balance sheet and amortized over the remainder of the contract term through August 2019. Going forward, we expect to update our guidance quarterly.

Finally, later today, we plan to file our annual report on Form 20-F containing our financials, footnotes and other related disclosures.

And with that, I'll turn the call over to Michael.

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Michael D. Acuff, Pacific Drilling S.A. - SVP of Commercial [5]

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Thank you, John, and good morning, everyone. As Bernie stated in his opening remarks, the market for the sixth- and seventh-generation drillships continues to improve. Though the fourth quarter retreat of the oil price influenced the psychology of the equity market, it did not significantly impact the operators' 2019 drilling plans for the offshore deepwater segment.

We continue to see the execution of customers budgeted products as well as consideration for drilling additional incremental wells this year. With the return of the brent oil price to the mid-60s earlier this year, operators continue to expand their offshore plans with new exploration programs and final investment decisions for development projects for 2020 and beyond.

Overall, we're seeing a more positive tone towards deepwater from both the customers drilling and procurement groups as they coordinate their efforts to ensure they have access to the most capable rigs for the first half of 2020.

Looking at the high-specification drillships segment, we see current effective utilization of the marketed fleet near 80% with almost a 10% rise in demand since early fourth quarter of 2018. We currently have 20-plus active high-spec drillship opportunities in-house, which is more than double this time last year.

Based on the current pending contracts and visible demand, we conservatively expect the high-spec utilization to reach the mid to upper 80% level by the fourth quarter of this year. More precisely for the second half of 2019, we believe there are currently only 5 seventh-generation drillships with availability. These projected utilization numbers, along with our view on the future demand in the market, reinforce our belief that we will see substantial day rate improvement starting early 2020.

With respect to the 3 rigs we currently have under contract, we are 79% committed for 2019 with the Bora being the only unit with availability in the second half of the year. We are focused on securing work with the Bora at increasing day rate levels for the remainder of 2019 while maintaining our optionality for the rest of the fleet for the expected market return in 2020.

In some contracts, we have priced options on an escalating basis for the first half of 2020, but are reluctant to price beyond mid-2020 to maintain our upside exposure.

Our expectations for the sector are that fixtures will exceed $250,000 in the second half of 2020. With respect to additional supply being added to the market, we're not overly concerned at this time regarding reactivation of cold-stacked units due to the significant capital investments required.

In the end, we believe these dynamics should allow for appreciable day rate increases for the current marketed fleet. Also, looking for the future, we continue to invest in our fleet with incremental technology and equipment upgrades to maintain our position as the most technically advanced, high-specification fleet in the industry.

The riser gas handling upgrade for the Santa Ana for the Total Senegal contract is the initial and most cost-effective step in advanced well control capability and could be easily upgraded further to full managed pressure drilling.

Additionally, the Pacific Khamsin is being upgraded to become our first fully offsetted MPD rig utilizing the latest technology and will provide our customers greater drilling efficiencies and well control capabilities.

We believe these incremental investments will pay dividends through both increased utilization and higher day rates in the future as more opportunities are requiring some form of managed pressure drilling.

Turning to our fleet and looking at the current activity of the fleet, the Pacific Bora continues its program in Nigeria with Nigerian Agip Exploration Limited, a subsidiary of ENI.

We are currently completing the first well and expect to begin the second well in the next few weeks. There is one additional option well in the current contract, which will take the rig past the mid-year point. We are currently pursuing additional opportunities both within and outside of Nigeria in the Greater African region, which will utilize the rig into the latter part of 2019.

The Pacific Santa Ana is currently preparing for the newly awarded 1 firm well plus 1 option well contracts with Total to explore the deep waters of Senegal and Mauritania. Operations are expected to commence in early April and we'll utilize the rig until July. This is a new and exciting frontier area for the industry, and we're pleased to continue our long relationship with one of our key customers in Total.

Following this work, we will begin the previously announced Phase 2 of Petronas Mauritania permanent abandonment program. This integrated services program in the Chinguetti field is expected to last 360 days, employing several subcontractors under the Santa Ana management umbrella and providing a unique and cost-effective solution for Petronas.

In the U.S. Gulf of Mexico, the Pacific Sharav continues our 5-year contract with Chevron, drilling some of the most challenging and difficult exploration wells in the industry, while continuing to deliver top-tier performance and customer service.

These results and the confidence in the Sharav team were reinforced recently by Chevron with the extension of the contract for an additional firm well plus 3 option wells that would occupy the rig until the third quarter of 2020. We're very excited to continue our long-standing relationship with Chevron as a strategic partner.

Additionally, you may have noted from our recently issued Fleet Status Report that the Pacific Khamsin, one of our high -- 3 high-specification seventh-generation drillships is now being ramped up from smart stack to hot stack status.

To prepare for opportunities we see in the market utilizing a robust readiness plan on top of our unique smart-stacking program, we expect the rig to be fully commissioned and prepared for potential contracts starting in the third quarter of the year. Our marketing efforts for the rig are focused on the more technically demanding opportunities, where the available high-specification floating rig supply is tightening.

The Khamsin with our superior capabilities, 2 BOPs and strong operating performance history is ideal for several of the existing tenders and opportunities currently in the market.

Finally, our third seventh-generation drillship, the Pacific Meltem, continues to be smart-stacked in Las Palmas along with our sixth-generation ships, the Scirocco and the Mistral.

In summary, we're pleased with the developments we're seeing in the market and expect continuous improvement throughout 2019 and end of early 2020.

Should we contract the Khamsin later this year, we would have 4 of 7 rigs working in an improving market with significant exposure to the expected day rate upside in 2020.

With that, I'll turn the call back over to Bernie.

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Bernie G. Wolford, Pacific Drilling S.A. - CEO & Director [6]

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Thanks, Michael. As you've heard, we are in the early stages of an inflation and activity that supports improved utilization and rates for our sector. The company is well positioned to create value based on our operational platform, capital structure, market exposure and quality fleet.

With our restructuring and overhead cost reduction efforts largely behind us, we'll return even more attention to securing work for our available sixth and seventh-gen drillships. We remain committed to delivering exceptional customer service, effective HSE programs and industry-leading performance in order to deliver on the value that Pacific Drilling represents.

With that, I will now hand the call back to the operator and assemble the queue, and then open the call for Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question will come from Patrick Fitzgerald with Baird.

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Patrick John Fitzgerald, Robert W. Baird & Co. Incorporated, Research Division - High Yield Desk Analyst [2]

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How much does it cost to go from smart stack to hot stack or -- of the seventh-gen rigs, is that just the part of a CapEx that's -- I forget the exact wording, but growth CapEx in your guidance?

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Bernie G. Wolford, Pacific Drilling S.A. - CEO & Director [3]

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Thanks for the question, Patrick. This is Bernie. The cost is not in our capital number, it's in our operating cost number. For the smart-stacked rigs the Pacific operates, we have essentially eliminated capital costs from our reactivation cost profile. Certainly, you can't take our guidance as a generality across the sector because many rigs are cold-stacked and require significantly more cost, but in the case of the Pacific Khamsin, it's on the order of $15 million to take the rig from its current state to ready to go to work with full crews, fuel them out at the location and ready to actually start operations.

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Patrick John Fitzgerald, Robert W. Baird & Co. Incorporated, Research Division - High Yield Desk Analyst [4]

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All right, and that's the same on the Meltem if you were to choose to go that route?

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Bernie G. Wolford, Pacific Drilling S.A. - CEO & Director [5]

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It varies from rig to rig. The Meltem is a new rig that has never worked, so the costs will be slightly more. Across the 4 smart-stacked rigs we have, the costs will vary from roughly $10 million to $20 million per unit to ramp those up to be ready to go to work.

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Patrick John Fitzgerald, Robert W. Baird & Co. Incorporated, Research Division - High Yield Desk Analyst [6]

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Okay, great. And could you give me a range on what you're paying for a smart-stacked rig today?

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Bernie G. Wolford, Pacific Drilling S.A. - CEO & Director [7]

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Sure. In terms of our operating value costs, across the 4 smart-stacked rigs lumped together, we're spending roughly $65,000 a day for operating costs, that's broken down $35,000 a day for the mothership or the hotelship, which is the Meltem, and then roughly $10,000 a day for each of the satellite ships that are tied up alongside the dock next to the Meltem.

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Patrick John Fitzgerald, Robert W. Baird & Co. Incorporated, Research Division - High Yield Desk Analyst [8]

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Great. What's the -- what's your view on the timing of the tribunal at this point?

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Lisa Manget Buchanan, Pacific Drilling S.A. - Senior VP, General Counsel & Secretary [9]

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This is Lisa Buchanan. We really don't have any idea, we are expecting it at any time. As we've reported, we had a closing argument hearing last August. So we would certainly expect that in the next couple of months, we would hear an award from the tribunal.

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Patrick John Fitzgerald, Robert W. Baird & Co. Incorporated, Research Division - High Yield Desk Analyst [10]

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Okay. Is there -- is most of the work out there for this -- for the seventh-gen rigs exploration, is that accurate?

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Johannes P. Boots, Pacific Drilling S.A. - CFO & Senior VP [11]

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Well, no, I think there's a combination right now. You've got some development programs that are in the market. But there are also -- as you would say, there is exploration that's starting to come into view. So it is a combination. We're targeting more on the exploration side right now with the Khamsin. But there is both in the market.

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Operator [12]

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(Operator Instructions) And once again, we will hear from Patrick Fitzgerald with Baird.

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Patrick John Fitzgerald, Robert W. Baird & Co. Incorporated, Research Division - High Yield Desk Analyst [13]

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What's your views on M&A at this point, both for you and the industry in general?

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Bernie G. Wolford, Pacific Drilling S.A. - CEO & Director [14]

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For the industry in general, we certainly believe M&A is in that positive. There remain a lot of contractors in the space, and there are certain benefits to scale. So from our perspective, it's a benefit. We have seen a lot of activity recently as you're no doubt familiar with. We believe that perhaps at this stage in the market given the level of activity, we may see a pause in the short term, but we also expect to see increasing evidence of interest on the M&A side as the market provides indications that in fact day rates are improving and utilization is improving and building some confidence in general across the sector.

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Operator [15]

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Our next question will come from Ceki Medina with Southpaw Asset Management.

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Ceki Aluf Medina, Southpaw Asset Management, LP - Partner and MD [16]

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Are you -- do you think you're missing benefits of scale, you have 7 ships and only a portion of them are working, and there are some in West Africa, some in Gulf of Mexico, you are doing well on costs or cost control, do you think a better job can be done by focusing a certain number of rigs in a certain area?

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Bernie G. Wolford, Pacific Drilling S.A. - CEO & Director [17]

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Ceki, thanks for the question. Certainly, as you have additional units in any given geographical area, you do see some small benefits of scale. Offshore-based support costs are incredibly low on a per rig basis right now. We have a very small footprint in Nigeria. And we're able to be very competitive there, and we will have a similarly small footprint in Senegal and Mauritania. In the U.S., we're able to leverage off our corporate office location, and again, have a very small footprint. Pacific is somewhat unique in scale in general, in that there are a few contract drillers in the world that actually have 7 rigs that are so similar to each other. All of ours being Samsung ships with NOV drilling equipment allow us considerable amount of scale in terms of spare parts, training and general operation support. Given a company of our size, we will always have a slightly higher G&A cost per rig given our low scale relative to some of our peers, and that there are certainly some reasons why you see M&A activity in the business focused on identifying those kind of synergies. But otherwise, in general, the answer to your question regarding scale is, we don't feel handicapped, although there is obviously benefits to being larger than we are.

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Ceki Aluf Medina, Southpaw Asset Management, LP - Partner and MD [18]

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(technical difficulty)

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Bernie G. Wolford, Pacific Drilling S.A. - CEO & Director [19]

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Ceki, you're cutting out, we can't hear you, try again.

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Ceki Aluf Medina, Southpaw Asset Management, LP - Partner and MD [20]

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I'm asking about labor inflation. I'm wondering if you were seeing labor inflation as the things [run positive]?

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Bernie G. Wolford, Pacific Drilling S.A. - CEO & Director [21]

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We are not at this stage at all. We've got roughly 85 people assigned to our smart-stacked rigs today, most of those individuals are qualified to work at least 1 level above where they're currently working. And then the market, in general, we don't feel the inflation around the technical skilled crews we have working for us offshore. Primarily because of the disciplined approach that Pacific took to maintaining those crews employed throughout this period, we've had an incredible retention rate with those guys. And we've been able to retain just some top-notch people. So now we're not seeing labor inflation at all at this stage.

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Operator [22]

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Our next question will come from Beltran Palazuelo with SANTALUCÍA.

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Beltran Palazuelo Barroso, SANTALUCÍA Gestión S.G.I.I.C., S.A. - Equity Analyst & Equity Portfolio Manager [23]

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I have 2 questions regarding the $50 million buyback. First of all, what is the management's review of intrinsic value of strategic drilling and the current price per rig against its peers? And then how fast is the plan of that execution of the current buyback program?

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Bernie G. Wolford, Pacific Drilling S.A. - CEO & Director [24]

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Regarding your question on our -- the still value versus enterprise value in our equity [mutual] our Pacific represents a compelling value, given where our equity currently trades. Generally speaking, on a per share value as reflected in our enterprise value, we're sort of in the middle of the pack, which doesn't fully represent the value that our sixth- and seventh-generation fleet represents due to its consistency around the NOV and Samsung platforms and its capability, particularly around the seventh-gen ships. With regard to the timing and the speed at which we will approach the buyback, it will be a very measured pace generally slow and generally limited to a small portion of the typical daily float that's out there.

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Operator [25]

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(Operator Instructions) And with no further questions, I'd like to turn the call back over to Bernie Wolford for any additional or closing remarks.

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Bernie G. Wolford, Pacific Drilling S.A. - CEO & Director [26]

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Thank you very much. Thanks all on the call for your interest in Pacific Drilling. We look forward to delivering on the value we represent and look forward to speaking to you on our next earnings call. See you. Bye-bye.

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Operator [27]

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Once again, that does conclude our call for today. Thank you for your participation. You may now disconnect.