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Edited Transcript of PACD earnings conference call or presentation 14-May-19 3:00pm GMT

Q1 2019 Pacific Drilling SA Earnings Call

LUXEMBOURG May 28, 2019 (Thomson StreetEvents) -- Edited Transcript of Pacific Drilling SA earnings conference call or presentation Tuesday, May 14, 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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* Eirik Røhmesmo

Clarksons Platou Securities, Inc., Research Division - Research Analyst

* Lukas Daul

ABG Sundal Collier Holding ASA, Research Division - Analyst

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Presentation

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Operator [1]

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Good day, and welcome to the Pacific Drilling First Quarter 2019 Results 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.

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

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Thank you, operator. And welcome everyone to Pacific Drilling's First Quarter 2019 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 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, our beliefs and estimates regarding our relative valuation in the market, our market outlook, including our views of future contract dayrates and our business strategies 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 future -- our actual results could differ materially from any forward-looking statements made during this 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 section of our filings with the U.S. Securities and Exchange Commission, which are posted on our website.

(technical difficulty)

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Operator [3]

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Ladies and Gentlemen, please bear with us. We are experiencing some technical difficulties and will be back shortly.

Please go ahead.

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Lisa Manget Buchanan, Pacific Drilling S.A. - Senior VP, General Counsel & Secretary [4]

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Thank you. 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 [5]

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Thanks, Lisa. Good morning all, and welcome to our earnings call. We have made notable progress on the road to cash breakeven since our last call. First and foremost are the start of operations on the Pacific Santa Ana for Total and Senegal, exercise of the first option by ENI for the Bora and the contract win with Equinor for the Khamsin in the U.S. Gulf of Mexico.

Each of these is an important positive for us in terms of revenues, backlog and margin. The Equinor work, in particular, supports our ramp-up of the Pacific Khamsin, demonstrates our ability to respond to complex technical requirements and offers the opportunity to deliver exceptional performance to a new and important plan. Under the Equinor contract, we will be providing a managed-pressure drilling system, along with other integrated services, including casing running, ROV and cuttings handling, for which we will receive additional compensation in the form of adders to our base dayrate.

The ramp-up of the Khamsin is progressing on schedule and budget. We anticipate departing Las Palmas for the U.S. Gulf of Mexico in July and are on track to bring the rig back to service for $15 million. This excludes $4 million for Equinor contract specific items. As the first of our smart-stacked rigs to be returned to service, this relatively low reactivation cost demonstrates the benefits of our innovative approach to maintenance on our smart-stacked rigs.

We continue to see strong indicators of improving demand for sixth- and seventh-generation drillships. Utilization has improved with approximately 87% of the marketed units under contract. Further improvement is expected over the next 3 to 6 months as award decisions are announced for the approximately 8 tenders outstanding for this time period. Recent oil price stability and client discussions for programs not yet in the market provide additional support for our view that both utilization and rates will continue to improve.

We are well positioned in terms of opportunities and assets to put additional units to work in early 2020. The Pacific Scirocco, a high-spec sixth-generation drillship and the Pacific Meltem, our uncommitted seventh-generation drillship, are both competitive, high-specification units that are being well maintained. Our current cash cost to maintain these units is relatively low, which affords us the opportunity to target opportunities that are potentially more attractive in terms of rates and durations and in turn supportive of our objectives in this first leg of an improving market.

Complementing our improved revenue outlook is the work we have done to reduce cost. We have reduced combined G&A and operation support costs by over $10 million on an annualized basis. I'm particularly proud of the progress our team continues to make to structurally reduce our procurement cost. Our efforts in supply chain management have netted more than $6 million in savings year-to-date.

I'm also very proud of our leadership team. Following the restructuring, we have emerged as a well-integrated team tightly focused on delivering safe, cost-efficient and productive operations to our clients. Our world-class offshore and operations support teams delivered 98.1% revenue efficiency in the first quarter while delivering wells in the U.S. Gulf of Mexico and Nigeria and preparing the Pacific Santa Ana for work for Total in Senegal.

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.

Turning to our relative valuation. The quality of our drillship fleet is as good or better than that of many of our peers. Despite this, we believe our equity trades at a significant discount to our peers when valued on the basis of enterprise value per rig. Our enterprise value calculation implies a still value of approximately $215 million per rig, which is well below the implied values for sixth- and seventh-generation ships of our most comparable peers, recently in a range of $280 million to $300 million per rig. Although many factors outside our control impact equity prices, this implies a significant valuation gap in our equity.

The $215 million per rig for our fleet is calculated as our net debt plus the market value of our equity minus our backlog margin and minus the $205 million receivable carried on our balance sheet related to the Zonda arbitration. With our asset quality and earnings power, we believe this gap in valuation will close as we secure additional work.

All in all, this first quarter represents a great start of the year, where we have demonstrated the strength of our platform by securing work with another world-class client, improving our cost basis and delivering on our strategy to preserve liquidity, all while incrementally securing backlog in sync with an improving market. No doubt there is more work to do, but clearly, we are off to a good start. I will now turn the call over to John for a review of our first quarter operating results.

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Johannes P. Boots, Pacific Drilling S.A. - CFO & Senior VP [6]

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Thank you, Bernie. And good morning, everyone. As Bernie mentioned, the first quarter of 2019 was a positive one for the company in many respects. I would like to highlight the financial successes in a bit more detail.

We achieved a strong revenue efficiency of more than 98% and a positive EBITDA. We kept a close lid on costs and capital expenditures, which we expect to continue for the rest of the year. We have adjusted our support-cost structure to align it with the current market conditions and reduce these costs by over $10 million on an annualized basis.

Our supply chain group continues to identify and implement structural savings. We continue to add backlog, and we closed the quarter with a strong liquidity position of $354 million. Also since the beginning of the year, we have been very active sharing these successes and the value of our platform with the investment community.

Turning to our first quarter highlights. Compared to our guidance posted on March 11 this year, our first quarter revenues were at the high end of the guided range. Our first quarter revenue efficiency was above the guidance, and first quarter costs were in the middle or at the low end of the guided ranges.

First quarter '19 contract drilling revenue was $65.9 million, which included $3.4 million in reimbursable revenue and $0.6 million of deferred revenue amortization. This compared to fourth quarter 2018 contract drilling revenue of $59.6 million, which included $1.4 million in reimbursable revenue and $2.9 million of deferred revenue amortization.

The increase in revenue resulted primarily from the Pacific Bora operating for the full quarter under its contract with Nigerian Agip Exploration Limited, a subsidiary of ENI, compared to only a portion of the period in fourth quarter 2018. During the first quarter, the Pacific drilling operating fleet achieved rig-related revenue efficiency averaging 98.1%, which represents our 14th consecutive quarter of 95% or greater revenue efficiency.

Operating expenses for the first quarter 2019 were $52.3 million compared to $44.8 million in the fourth quarter 2018. Included in operating expenses are reimbursable costs, shore-based costs, other operating support costs and amortization of deferred costs. The increase in operating expenses was primarily due to the costs of the Pacific Santa Ana ramping up to commence its contract with Total E&P in Senegal.

General and administrative expenses for the first quarter were $11.2 million as compared to $13.8 million for the fourth quarter 2018. The decrease in general and administrative expenses was primarily due to the impact of a heightened emphasis on cost control and process optimization.

Adjusted EBITDA for the first quarter 2019 was $4.3 million compared to $3.3 million in the fourth quarter 2018. Direct rig-related daily expenses for operating rigs, excluding reimbursable costs, was approximately $118,000 per day for the first quarter of '19, which we continue to believe as industry-leading operating costs especially in the context of our strong operational performance.

Turning to our capital structure and liquidity. Our $1.047 billion in debt consists of our 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 quarter was $354 million. Excluded from this cash balance is approximately $34 million of cash that is collateralized with banks to support a temporary importation 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.

With regards to the Zonda arbitration, our total claim is in excess of $300 million consisting of approximately $180 million in installment payments plus owned or furnished equipment, wasted costs and interest. Of this, we recorded a receivable of $205 million on our balance sheet as a result of fresh-start accounting, which represents an estimated fair value based on a probability rated model of potential arbitration outcomes.

Turning to our guidance. We've posted our updated guidance for the second quarter and the full year 2019 on our website at pacificdrilling.com.

For the second quarter of '19, we're guiding as follows: revenues in the range of $72 million to $77 million, revenue efficiency of 95%, operating expenses in the range of $52 million to $57 million, G&A expenses in the range of $10 million to $12 million, depreciation expense in the range of $27 million to $29 million, amortization expense of $32 million and interest expense in the range of $24 million to $26 million. For the full year 2019, our guidance remains unchanged. We're guiding as a follows: revenue efficiency of 95%, operating expenses in the range of $235 million to $255 million, G&A expenses in the range of $37 million to $41 million, depreciation expense in the range of $110 million to $115 million, amortization expense of $85 million, interest expense in the range of $95 million to $98 million, sustaining CapEx in the range of $10 million to $15 million and enhancement CapEx in the range of $28 million to $23 million (sic) [$33 million], which includes a managed-pressure drilling package plus installation.

Any ramp-up costs to reactivate a rig from smart stacks to hot stacks or full operating mode is included in operating expenses. For the Khamsin reactivation, we will incur such ramp-up operating expenses, but we do not expect any CapEx associated with the ramp-up.

In closing, we generated positive EBITDA and added backlog in the quarter while continuing to control our rig and support costs and closely managing our liquidity. 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 [7]

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Thank you, John. And good morning, everyone. The global floater market continues to develop as expected, and we see further improvement in the second half of 2019 and into 2020.

With the recovery in oil prices already starting take hold late in the first quarter, the recent Brent rally to mid-$70 per barrel is a tailwind for the market and our customers. The firming of the fundamentals and the stability in the commodity price have customers choosing to drill additional wells in various regions around the world. This push in demand is particularly evident in the sixth- and seventh-generation high specification segment. Many predicted a large number of roll-offs from contracts later this year, but we're seeing the opposite, with customers exercising their options to extend the current contracts and retain access to the highest specification equipment available. The number of operator FIDs, or final investment decisions, have doubled since last year, which is a strong positive signal.

Another significant metric to note is the mix between exploration and development drilling in the market. The amount of exploration drilling has increased to over 50% of the floating drilling activity, which is a positive indicator for future development drilling. This search to find new oil was taking place in various areas such as Northwest Africa, Mexico, the equatorial margin areas of Guyana and Suriname as well as the U.S. Gulf of Mexico. We also know there are several large development programs coming to the market later this year for 2020 and 2021 starts in Ghana and Mozambique that will require several additional high-specification units. Given where we are today with the current activity and visible demand, it continues to look promising for the future of the high-specification drilling.

Digging a bit deeper into the numbers for the sixth- and seventh-generation drillship segment, we see effective utilization of the marketed fleet near 87% with 70 high-spec drillships currently on contract. A significant rise in demand in the last 6 months continues as more than 15 high-spec drillship opportunities are in the active procurement stage or soon to come to market with 10 expected to start in 2020.

Looking at the active supply in the various regions of the Golden Triangle, we see that there are 3 drillships available today in the Gulf -- the U.S. Gulf of Mexico, 1 unit currently idle in West African coast and 1 drillship in Brazil. The visible demand and limited supply in the various regions reinforces our beliefs that we will see substantial dayrate improvements starting in 2020 as high-specification utilization exceeds 90%. This bodes well for our 7-rig fleet, of which 3 are 2.5 million pound rigs, 4 ships that are full-dual activity and 4 units with 2 BOPs.

One example of the demand and expected dayrate increases is our recent announcement of the Pacific Khamsin contract with Equinor for exploration drilling in the U.S. Gulf of Mexico starting fourth quarter this year. This was a tender from late last year that we were awarded based on the high-specification rig proposed but more importantly, our experience with the Sharav in the U.S. Gulf drilling the most challenging wells in the world.

The contract is for 1 firm well with 3 escalating priced options for 2020 and beyond. We believe this award confirms several aspects of our strategy and the current state of the market: one, that we can economically return our well-preserved rigs to work in a condition that is attractive to our customers; two, our unique fleet and record of strong performance are very competitive in the market and on this basis, we have achieved a new partnership with a world-class customer; and three, customers are reacting to market dynamics and are willing to accept escalating pricing for 2020 and beyond.

Looking forward, we continue to make small incremental return-generating investments to our fleet that maintain our position as the most technically advanced, high-specification fleet in the industry. One example was the recent-enhanced digital services agreement, which will increase our efficiency and marketability to the customers with no capital cost to Pacific.

Regarding the contractual status of our fleet, I spoke earlier about the new Pacific Khamsin contract expected to commence in October. This contract along with the recent extension on the Pacific Sharav speaks to the strong performance that Pacific Drilling delivers to our customers daily. The Sharav was extended in the first quarter for an additional 1 well plus priced options for an additional 3 wells that would commit the rig into the second half of 2020 with Chevron.

ENI also exercised an option on the Pacific Bora to drill a second well and continue its development program in Nigeria. The current contract contains 1 additional option well, which would take the rig through July. Meanwhile, we continue to pursue additional opportunities in Nigeria and West Africa for follow-on work.

As Bernie stated, the Pacific Santa Ana has commenced the 1 firm well plus 1 option well contract with Total to explore the deep waters off of Senegal and Mauritania. Total is currently expected to utilize the rig until sometime in August. Following this work, we will transition to Phase 2 of the Petronas permanent abandonment program in the Chinguetti field in Mauritania.

With respect to the smart-stacked rigs, we continue to look for the right opportunities to employ the Meltem, Scirocco and Mistral. With the Scirocco's low ramp-up costs and ability to quickly reenter the market as a dual-activity, high-specification unit, we believe that may be the next to return. The Meltem, which is our highest-spec unit and one of the latest-generation drillships in the world, will give us an opportunity to leverage the expected demand and higher pricing predicted in 2020 for a unit of its superior capability.

In general, we continue to be pleased with developments we are seeing in the market and expect steady improvement throughout 2019 and into 2020. With 3 smart-stacked rigs available, we are well positioned to take advantage of an improving market. And with that, I will now turn the call back over to Bernie

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Bernie G. Wolford, Pacific Drilling S.A. - CEO & Director [8]

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Thanks, Michael. As you've heard the market is inflecting to the positive, and we are well positioned to benefit from these opportunities.

To a person, we are committed to providing exceptional customer service, effective HSE programs and industry-leading performance to deliver 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 will now take our first question from Eirik Røhmesmo of Clarksons.

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Eirik Røhmesmo, Clarksons Platou Securities, Inc., Research Division - Research Analyst [2]

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Sure. I just want to touch on the Equinor contract and the integrated services. I mean is it possible to quantify how much more revenue you'll get on top of the dayrate revenue in terms of percentage terms or something similar?

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

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Well, we have not disclosed the additional revenue that we expect to get for the integrated packages. Generally, with regard to managed-pressure drilling, it's at the high end of a typical range that we have seen in the market to date, so in the sort of $25,000 to $30,000 range. For the services beyond that, each of those are on the order of -- well, sorry, in aggregate, the combined additional is on the order of $30,000 per day for the ROV, casing running and cuttings handling.

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Eirik Røhmesmo, Clarksons Platou Securities, Inc., Research Division - Research Analyst [4]

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All right. Good. And lastly, just also touching on the reactivation costs on the Khamsin. You mentioned $15 million with $4 million being sort of contract specific. But then out of the $11 million, will that incur regular OpEx on top of that? Or is the $11 million more of an all-in cost?

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

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I'm not sure what you referenced to the $11 million. The $15 million that we provided as the guidance of expected cost includes all expenses associated with the reactivation. That includes curing, maintenance, et cetera.

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Operator [6]

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We will now take our next question from Lukas Daul of ABG.

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Lukas Daul, ABG Sundal Collier Holding ASA, Research Division - Analyst [7]

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Looking at the tender pipeline that you have been referring to, would you sort of discuss how it shapes up in terms of duration? Are we sort of looking still at a well-based contract with multiple options? Or are we moving into a sort of a situation where some of the work really becomes term work?

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Michael D. Acuff, Pacific Drilling S.A. - SVP of Commercial [8]

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Yes. Lukas, it's Michael. So we're starting to see that transition happen. Currently in the spot market, of course, I think most things are 1 to 2 well-type situations. But looking into the pipeline, we're starting to see everything from 1-year term to even up to 2-year terms that we expect to come to the market fairly soon. These of course are for more development-oriented programs. But there are some actual exploration programs that we see that could be 3, 4, 5 wells, which would then extend out beyond a year for the most part. So I would say from a mix standpoint, I think as we look forward, probably 30% to 40% are more of the shorter term and then 60% to 70% are more long-term development or longer-term exploration programs. So we are seeing that transition today in the market.

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Lukas Daul, ABG Sundal Collier Holding ASA, Research Division - Analyst [9]

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Okay. That's good. And then in terms of pricing, I mean you referred sort of to gradual improvements in pricing as we sort of look at work starting in 2020 and beyond. But are we sort of approaching a point on the utilization curve where you should sort of see a step-up or I would say, quite a significant step-up in pricing as we sort of move from that cash OpEx level to somewhere closer to cash breakeven because you hit that utilization threshold, which is necessary for that?

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Bernie G. Wolford, Pacific Drilling S.A. - CEO & Director [10]

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In general, we believe that we're going to see a gradual improvement in rates for the shorter-term work but that as you see commitments for medium- and longer-term work, you're going to see sort of that step-up in rates that would be more indicative of the threshold we're soon to be reaching with respect to utilization. And so it's very much market dependent around near-term availability in particular basins and again, so the shorter-term work, a gradual step-up as opposed to extended or longer-term work, seeing more meaningful rate increases on the basis of just the lack of availability through those periods and the expectation for required rates of returns to justify investments in units.

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Michael D. Acuff, Pacific Drilling S.A. - SVP of Commercial [11]

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Yes. And Lukas, one thing I would -- I think I would potentially change your view on is today, we're not in the cost breakeven kind of level. I think we've already moved on past that into the kind of mid- to higher 100s. So we're coming up from a higher 100s level I think going forward rather than historically where we saw some of the lows back 3 to 6 months ago in the market.

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Lukas Daul, ABG Sundal Collier Holding ASA, Research Division - Analyst [12]

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Okay. So in general sort of would you see I would say potential for further upside if we think about some of the announcement that we have seen from peers -- from your peers recently? Is that just the sort of a first stepping stone of, let's say, in the right direction?

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Michael D. Acuff, Pacific Drilling S.A. - SVP of Commercial [13]

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Again, to Bernie's point, I think it really depends on the timing. We don't think those markers were out of the norm. But as we go further, we see more upside potential in the market. Okay?

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Lukas Daul, ABG Sundal Collier Holding ASA, Research Division - Analyst [14]

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Okay, okay.

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Operator [15]

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(Operator Instructions) It appears there are no further questions.

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

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No further questions in the queue. Please conclude the call. Thank you very much for your interest in Pacific Drilling today.

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Operator [17]

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Ladies and gentlemen, this concludes the call. Thank you for your participation. You may now disconnect.