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Edited Transcript of PACD earnings conference call or presentation 4-Dec-18 4:00pm GMT

Q3 2018 Pacific Drilling SA Earnings Call

LUXEMBOURG Jan 11, 2019 (Thomson StreetEvents) -- Edited Transcript of Pacific Drilling SA earnings conference call or presentation Tuesday, December 4, 2018 at 4:00:00pm 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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* Addison Amer

* James Knowlton Wicklund

Crédit Suisse AG, Research Division - MD

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Presentation

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Operator [1]

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Good day, and welcome to the Pacific Drilling Third Quarter 2018 Earnings Call. Today's conference is being recorded.

At this time, I would like to turn the conference over to Lisa Buchanan, Senior Vice President and General Counsel. Please go ahead, ma'am.

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

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Thank you, Ryan, and welcome everyone to Pacific Drilling's Third Quarter 2018 Earnings 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.

Also note that we use non-GAAP financial measures during this call. You will find the required supplemental disclosure 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 Pacific's third quarter earnings call. Before I review our recent emergence from Chapter 11, the current state of the market and our strategic focus, I would like to take a moment to introduce myself. I'm humbled to step into the role of CEO and look forward to working with Pacific's team of dedicated professionals, our investors, and with all of you on the phone today. I'm an industry veteran and love the business. Despite as many challenges, the deepwater drilling business offers an incredible opportunity for a disciplined and committed management team to make a real difference in creating value, especially against a backdrop of improving fundamentals. I will bring the benefits of my experience and relationships to the company, along with my energy, personal values and sound judgment. Regarding personal values, none stand higher than honesty and integrity, an unwavering commitment to protect health, safety and environment and a drive to deliver shareholder value through well-reasoned strategic action. I've been with the company for 2 very active weeks. My initial observations have confirmed the capabilities of the organization, the commitment of our shareholders and our strong client relationships. These attributes magnify the competitive advantages of our modern standardized, high specification ultra-deepwater fleet.

Given that this is our first earnings call in almost 2 years, I want to highlight some major events and accomplishments over the recent past. On November 19, we emerged from Chapter 11 with a solid capital structure, a strong cash position and a disciplined capital allocation strategy, all supported by the resources and capacity to compete with our larger peers. It was a long road for the company, but I'm proud to point out that throughout the process, we maintained an unwavering focus on operational safety, revenue efficiency and execution for our clients. With regard to our capital structure, John will provide additional details in his prepared remarks. Clearly, the Chapter 11 process has placed significant demands on our team, but with the restructuring now behind us, we cannot be happier with the timing. We now have the opportunity to focus on our core business in an improving market.

Regarding the market, just a week ago, we started operations for ENI Nigeria, and are well placed for additional opportunities in the near term. Those that follow the company will be aware of the 2 letters of award from an undisclosed client first reported on June 18. These 2 commitments recently expired as the conditions to move ahead were not met by the client. We view this as a positive development for the company as the opportunities in the market for those seventh-generation rigs have improved substantially since those agreements were signed. Despite the recent weakness in oil price, the combination of global demand growth, production decline rates, promising lease sales and compelling changes to the deepwater development value chain, each and all bode well for the industry in 2019 and beyond. Michael will provide more insight into the current dynamics of the market in his prepared remarks with follow-up in Q&A.

As to the competitive landscape, client preference for the most capable drillships, consolidation of competitors and the continued retirement of less competitive units are steadily driving towards a balance in our high specification segment of the deepwater market. In addition to the dramatic reduction in our rig operating cost over the last 4 years, we're now turning our focus to further improvements in the efficiency and competitiveness of our cost structure. We will preserve our legacy of delivering top-tier HSE and operational performance for our clients, while assuring that our support organization is focused and purposeful in our spending and investment decisions. To succeed in this market, we must first be competitive. This includes cost efficiency, but more importantly, building on our strong relationships with existing clients, while leveraging our assets and operations platform to expand our client base. The company's smart-stacking approach to rig preservation and readiness is proving to be among the most cost-effective in the industry. Through the use of shared resources, we're providing continuous maintenance and regulatory class compliance. In so doing, we avoid capital investment requirements when returning rigs to service. Through this process, we stand ready to bring rigs back into service within short time frames and at industry-leading economic returns. With the Bora's recent return to work and a firm commitment for the Santa Ana mid-2019, we now turn our eye to filling in gaps and improving our backlog with a disciplined, appropriate in a tightening market. We will continue to leverage our experience in West Africa, Brazil, and the U.S. Gulf of Mexico to make meaningful improvements in our revenue base in areas where we have existing capabilities and infrastructure.

As to the ongoing Zonda arbitration, we completed a 4-week evidentiary hearing in February of this year and a 3-day hearing in August for closing submissions. We are now waiting on a tribunal to issue its award, which we expect during the first half of 2019. We remain optimistic regarding the outcome of this arbitration based on the strength of our case.

I'll now turn the call over to John for a summary of our capital structure and a review of our third 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. I will begin by providing some information about the recently completed balance sheet restructuring process as our near-term priorities, followed by a high-level overview of our third quarter financials. There is no doubt the last 12 to 13 months have been quite eventful on the financial side. We've emerged from Chapter 11, we have an entirely new capital structure with new owners and new debts, and we're in the process of adopting fresh-start accounting that I will expand on.

Beginning with the restructuring process, we emerged on November 19 with a new capital structure, reducing our debt from approximately $3 billion to approximately $1 billion. Our new debt now consists of $750 million in first-lien debt maturing in October 2023 with an 8.375% coupon plus $274 million in second-lien debt maturing in April 2024 with a coupon of 11% in cash or 12% payment in times at the election of the company. Furthermore, we will not have any debt amortization payments until the maturity of the first-lien debt, and our new debt doesn't have any financial maintenance covenants. Our liquidity balance as of the emergence date was approximately $401 million, excluding any cash that will remain on the balance sheets in escrow to settle Chapter 11 related fees and expenses, which we expect to happen during the remainder of 2018. Also, excluded from this cash balance is $28 million of cash that is collateralized with the bank to support a temporary imputation bond in Nigeria for the Bora. The restructuring has resulted in a strong capital structure with a net debt of approximately $600 million or $85 million per vessel. The restructuring also resulted in a new ownership structure. In addition, we currently have $75 million in new common shares outstanding and have issued approximately 7.5 million common shares to a wholly owned subsidiary, which are reserved for issuance under the management incentive plan.

With the adoption of fresh-start accounting, in the third quarter 6-K that we plan to file later today, we have included third quarter pro forma financials as if we would have emerged from Chapter 11 as of September 30, 2018. As part of fresh-start accounting, most of our assets and liabilities will be revalued to fair values as of the emergence date. These fair values are directionally in line with the court-approved business plan that we filed with the court in August of this year. All the relevant assets and liability valuations are preliminary and may change for evaluation changes between September 30, 2018 reporting date and the emergence dates. 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 dates.

As to the trading of our shares, we have applied to be relisted on the New York Stock Exchange. We anticipate to begin trading under the PACD ticker once approved. A press release will be issued when the process has been completed.

Regarding the third quarter highlights. Third quarter 2018 contract drilling revenue was $56.7 million, which included $5.3 million of deferred revenue amortization. This compared to second quarter 2018 contract drilling revenue of $66.6 million, which included $5.9 million of deferred revenue amortization. The decrease in revenue resulted primarily from a lower number of days under contract for the Pacific Santa Ana. During the third quarter, the Pacific Drilling operating fleet of drillships achieved rig-related revenue efficiency averaging 99.8% compared to 98.7% for the second quarter and a year-to-date revenue efficiency of 98.6%. This represents our 12th consecutive quarter of 95% or greater revenue efficiency.

Operating expenses were $44.2 million compared to $56 million in the second quarter 2018. The decrease in operating expenses was primarily the result of Pacific Santa Ana completing its contract on May 7, 2018.

General and administrative expenses for the third quarter were $10.9 million as compared to $12.9 million for the second quarter 2018. Adjusted EBITDA for the third quarter 2018 was $1.6 million compared to negative $2.5 million in the second quarter 2018.

Direct rig-related daily expenses for operating rigs, excluding reimbursable costs was in the range of $100,000 to $130,000 year-to-date in 2018. This range depends on the geographical operating area. We continue to focus on cost-cutting efforts. To date, our efforts yielded a 34% reduction in operating expenses from $178,000 per day during the height of the market in 2014 to an average of approximately $118,000 per day year-to-date in 2018.

Later today, we plan to file our quarterly report on Form-6K containing our financials, footnotes and other related disclosures. Should you have any additional questions, please do not hesitate reaching out to me or our Treasurer, Kurt Niemietz.

And with that, I will 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. Looking at the offshore drilling industry, the most significant underlying driver of our business is the price of oil. Brent crude has generally traded at or above $60 per barrel over the past 11 months and well above the low seen during the downturn that began back in 2014. Despite the recent volatility in the price, we still believe the long-term oil price outlook for the offshore industry is positive and the general sentiment has improved. This is based on several factors, including the continued global oil demand growth of around 1.5% annually as well as the major reduction in upstream capital spending by the oil companies, both international and national over the past 4 years. The reduction in capital budgeting has delayed the final investment decision on several significant development projects as well as minimize most new exploration campaigns. Ultimately, these decisions will impact the supply of oil and the future price as current production continues to decline at a rapid rate -- pace. We predict this lack of investment will create a significant challenge over the next several years in bringing required additional long-term supply to the market. Given the competitiveness of the deepwater value chain now compared to the other segments of the industry, we believe, once coupled with sustained price stabilization, they will be the drivers for increased offshore exploration and development drilling activity in the future, in particular, for the high specification deepwater drillships, such as ours.

Turning to the high specification floating rig market. We begin to see renewed interests from customers for the first quarter of 2018 as the level of tendering increased significantly. This pace of demand has continued throughout the year, and we are well ahead of last year in terms of the number of inquiries with 66 received -- tenders received to date versus 28 tenders in 2017, and the resulting deepwater contract fixtures are up over 25%. The level of activity going forward is expected to continue as many customers are turning their focus back offshore in search of larger reservoirs and significant production growth. Today, we see most of the customer inquiries targeting the fourth quarter of 2019 as well as the first half of 2020 with all requiring or preferring the highest specification ultra-deepwater drillships for their programs, like those in the Pacific fleet.

Looking at the supply side, we continue to be oversupplied in the deepwater segment with the current marketed fleet sitting at around 60% utilization. However, if you focus in on higher specification or sixth and seventh-generation segment of the fleet, we estimate that approximately 76% of the marketed high-spec fleet is either currently contracted or spoken for in the first half of 2019. We see this trend continuing as customers are requiring the most technically capable rigs in the market. We predict that this targeted demand growth will lead to a more balanced market for the higher specification rigs throughout 2019, setting the stage for significant dayrate appreciation above the today's level starting in 2020. Additionally, as consolidation of the competitors continues in the industry, we believe, we will see an additional scrapping of less capable deepwater rigs impacting the supply side further. Based on this view of a more balanced high-spec drillship market in 2019, we are focused on securing work for our active units for the remainder of 2019, while maintaining significant optionality for the 2020 through 2022 time frame. This is reflected in our bidding, where we have begun pricing work beyond 2019 in line with the expected utilization at that time.

Looking at the current activity of the Pacific fleet. The Pacific Bora last week started its one well plus 2 option well contract in Nigeria with Nigerian Agip Exploration Limited, a subsidiary of ENI. We're excited for the Bora to return to work in Nigeria, where she has worked her entire life and is known for her strong safety and drilling performance. Speaking with the customer, we expect that one, if not both, of the option wells could be exercised, keeping the Bora occupied into May or June of next year. As well, we are currently pursuing additional opportunities in the West Africa region that would follow the ENI work and utilize the rig into the latter part of 2019.

The Pacific Santa Ana is currently warm stacked offshore Las Palmas after recently completing Phase 1 of the Petronas' Mauritania Chinguetti field abandonment ahead of schedule. As we have previously announced, the customer has already exercised their prized options for Phase 2 of the abonament program, starting around mid-next year, which is expected to occupy the Santa Ana for approximately 360 days or until mid-2020. We have also been in detailed discussions with another customer to utilize the rig starting in March, potentially bridging the gap to the Petronas program. We hope to have something more definitive to report soon on this opportunity.

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 seen to date. The Sharav contract runs to August 2019, and we remain optimistic that we will continue working with Chevron thereafter. We'll update you accordingly as we have more information to share.

Finally, the Pacific Khamsin and Pacific Meltem continue to be smart-stacked in Las Palmas, with the other 2 smart-stacked rigs, the Scirocco and the Mistral. As Bernie noted in his comments, the previously announced LOA have expired, and we are currently marketing the rigs worldwide. However, our efforts are particularly focused on the more technically demanding opportunities in the Gulf of Mexico, where the available high-spec floating rig supply is tightening.

In Khamsin, with our superior technology capabilities, 2 BOPs and strong performance history doing exploration work is ideal for several of the existing tenders and opportunities in both the U.S. Gulf of Mexico and Mexico. Most of these projects are scheduled to start in the second half of 2019 or the first half of 2020.

And with that, I will 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 have heard, the company is well positioned to create compelling value based on our operational platform, capital structure, market exposure and quality ultra-deepwater fleet. We are personally invested in our HSE performance and committed to delivering exceptional customer service through both traditional and integrated service models, each designed to provide industry-leading value while reducing project management complexity for our clients. In closing, I would like to reiterate our commitment to delivering on the value that Pacific Drilling represents.

I will now hand the call back to the operator and open the call for the Q&A segment.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We'll take our first question from [Eric Rummeso] with [Clarksons].

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Unidentified Analyst, [2]

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I just have a follow-on question on the Khamsin and the Meltem. The expiration of the LOA, does this mean that you are now potentially negotiating new terms with the counterpart? Or are you just marketing these rigs towards other potential clients?

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

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Thanks, Eric. We are marketing the rigs with other potential clients at this stage and no longer subject to any ongoing discussions relative to the letters of award.

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Unidentified Analyst, [4]

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Okay. So it's fair to assume that, that deal is off that you will not work with the previous counterpart?

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

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That is correct.

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Unidentified Analyst, [6]

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Okay. And also I know this is early stage, but is it possible to get any kind of ballpark guidance on G&A cost going forward?

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

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Our plan is to issue that guidance in the first quarter during our next call. We have a lot of work yet to do on the budget, and we're looking at the opportunities before us and making sure that everything is well aligned. So we won't be providing any guidance in today's call.

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Unidentified Analyst, [8]

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All right. And then the last one is just more on geographies. And you're mentioning the U.S. GOM, West Africa and also Brazil. With Brazil, if you were to win a contract for just 1 rig, would that make sense to, I think, from a cost perspective? Or would that be a narrower the targets are, I mean, remember 2 rigs, for example?

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Bernie G. Wolford, Pacific Drilling S.A. - CEO & Director [9]

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We would not limit ourselves to having to have 2 rigs to win work in that area. Clearly, we always benefit from a scale in any region. With our past experience in Brazil, we're well placed to operate a low-cost platform down there. Saying low-cost and the word Brazil in the same sentence can be challenge. But with the recent influx of the majors and the new lease holdings down there, I think, there's some real opportunities, and we would certainly operate a 1-rig operation down there.

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Operator [10]

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(Operator Instructions) We'll take our next question from Radi Sultan with Crédit Suisse.

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James Knowlton Wicklund, Crédit Suisse AG, Research Division - MD [11]

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This is Jim Wicklund, I'm sorry, in for Radi. John, I have a question. Do you said you had taken your daily operating costs down, and I think, it was 34% from $177,000 to an average of $118,000. What were the biggest chunks of that reduction?

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Johannes P. Boots, Pacific Drilling S.A. - CFO & Senior VP [12]

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So let's say roughly a reduction of $60,000. It's a mixture between personnel expenses, maintenance expenses and other operating expenses. Clearly, personnel expenses is a vast majority of that or I would say more than 50%, but it's really a combination of each and every component in our operating expenses.

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James Knowlton Wicklund, Crédit Suisse AG, Research Division - MD [13]

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Are labor -- is labor -- go ahead, Bernie.

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

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A good part of that personnel expense relates to the premiums we were paying related to retention and things during the heat of the market, Jim.

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James Knowlton Wicklund, Crédit Suisse AG, Research Division - MD [15]

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That was going to -- kind of be my follow-up. Are you seeing any personnel wage inflation in the current market? And how soon would it take for you to actually see that? Since this is a global market, it's not just U.S. But I mean, are you seeing any wage inflation at this point?

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Bernie G. Wolford, Pacific Drilling S.A. - CEO & Director [16]

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We're certainly not seeing it at this point, Jim. Speaking to when we might see it, I believe, each of the -- each of our peers are kind of well positioned to put 1 or 2 more units back to work before they start to feel that pressure, particularly that many of our peers and ourselves still have some depth in the various positions that are competent and ready for promotion. Beyond that, I think, if you see another 10-plus units go back to work in ultra-deepwater segment, you will start to see a little pressure on recruitment. I don't know that, that will directly translate into pressure on wages at that stage, more likely that would come at a later stage.

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James Knowlton Wicklund, Crédit Suisse AG, Research Division - MD [17]

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That's what's called one of those high-class problems, I think. So this improvement, John...

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Bernie G. Wolford, Pacific Drilling S.A. - CEO & Director [18]

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We would love to have that problem.

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James Knowlton Wicklund, Crédit Suisse AG, Research Division - MD [19]

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There you go. So John, this improvement should be pretty sticky, right? That was my point.

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Johannes P. Boots, Pacific Drilling S.A. - CFO & Senior VP [20]

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Yes. I mean, I think at some points if the market is going to return to full utilization, there is going to be pressure in labor market, but for the foreseeable future until we get to that point, I think a lot of these cost savings are -- will be maintained.

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Operator [21]

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(Operator Instructions) We'll take our next question from Addison Amer with BlackRock.

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Addison Amer, [22]

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Could you please elaborate a little bit more on the letter of awards that expired and maybe some additional detail on what happened and strategics around that?

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Bernie G. Wolford, Pacific Drilling S.A. - CEO & Director [23]

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Sure. Those letters of awards, we never did disclose the counterparty. The counterparty was obligated to secure a certain funding in order to be able to finance the program and execute on the commitment in the letters of award. Our understanding is that ultimately, they were not able to secure that hurdle, and therefore, the letters of award expired based on the termination date that was preset in the letters, which then freed up those assets for other opportunities.

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Addison Amer, [24]

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And I guess where are you right now on getting those rigs working with the early 2019?

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Michael D. Acuff, Pacific Drilling S.A. - SVP of Commercial [25]

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Yes. So -- this is Michael here. We're pursuing several opportunities as I mentioned in my notes, in particular on the Khamsin, that will kind of be in the focus forward. But both rigs are currently being bid again. We're looking worldwide, but the best fit for those rigs are in the Gulf of Mexico because of their really high specification and the work requirements that you see here in this basin. And so I think we'll update you as we go forward, probably less -- probable that we get it early '19, but it's targeting towards mid-'19 for those rigs.

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Operator [26]

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This concludes the Q&A session. I will now turn the conference back over to Bernie Wolford.

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Bernie G. Wolford, Pacific Drilling S.A. - CEO & Director [27]

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Thanks, everyone, for your interest today. We will be out on the road shortly, telling our story and look forward to seeing all of you out there. Appreciate you dialing in, and we'll close the call now. Thanks.

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Operator [28]

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Thank you. Ladies and gentlemen, thank you for joining today's conference call. The call has now concluded. Please disconnect your phones and have a great day.