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Executives

Lisa Ciulka - Vice President, Investor Relations

Lyle Whitmarsh - Chief Executive Officer

Brent Conway - President

Lesley Bolster - Chief Financial Officer

Analysts

Brodie Woods - AltaCorp Capital

Andrew Bradford - Raymond James

Jamie Murray - Desjardins

Trinidad Drilling Ltd. (OTCPK:TDGCF) Q1 2013 Earnings Conference Call May 9, 2013 11:00 AM ET

Operator

Good morning, my name is Lisa and I will be your conference operator today. At this time, I would like to welcome everyone to the Trinidad Drilling Limited first quarter results conference call. (Operator Instructions) Thank you. Miss Lisa Ciulka, you may begin your conference.

Lisa Ciulka

Thank you and thanks for joining us today. We will be discussing Trinidad Drilling Limited's first quarter 2013 financial and operating results which were released last night. A full copy of the MD&A and financial statements along with a presentation outlining the quarter highlights are available on your website at trinidaddrilling.com. Our full first quarter results are also available at sedar.com.

Please note that during the call we will be discussing forward-looking information relating to various areas of our business, including but not limited to, the completion of rig construction programs on a timely and economic basis; the assumption that Trinidad's customers will honor their take-or-pay contracts; the ability for Trinidad to attract and retain qualified crew to operate their rigs; assumptions respecting capital expenditure programs by oil and gas exploration and production companies and other expectations about future events or performance. Such information and statements involve known and unknown risks, uncertainties and other factors that may cause actual results or events to differ materially from those anticipated in such forward-looking information or statements. And you are cautioned to not unduly rely on such forward-looking statements. For a copy of our full forward-looking disclaimer, please refer to the disclaimer included in last night's press release and our MD&A.

To discuss our results, our view on the drilling sector and Trinidad's opportunities going forward, are Lyle Whitmarsh, Chief Executive Officer; Brent Conway, President; and Lesley Bolster, Chief Financial Officer. I will now turn the call over to Lyle.

Lyle Whitmarsh

Thank you, Lisa, good morning everybody. Trinidad had solid first quarter results despite the softening industry conditions that carried over from the second half of last year. Our Canadian division reported strong profitability in the quarter as the impact of the new builds we have been adding over the past 12 months flow through to the bottom line.

The strength in Canada offsets some of the lower activity we saw in the U.S. division, particularly on our less modern equipment. Overall, our first quarter results exceeded our internal expectations and our outlook for the remainder of 2013 has improved from our last earnings call a few months ago. Firstly, I would like to review our past quarter's performance and then I will give you an overview of what we are seeing in the industry and what indications look like for the reminder of the year.

In the first quarter, industry utilization levels lowered compared to the same quarter last year, largely due to uncertainty around commodity prices which caused oil and gas producers to take the cautious approach to their drilling program. Natural gas prices have improved to date in 2013, but while the improvement generates more cash flow for our customers, it has not been enough to generate a significant switch back to natural gas targets.

During the first quarter, Trinidad's revenue totaled $247 million, down 5% from the same quarter last year but up 18% from the fourth quarter of 2012. Revenue decreased year-over-year as a result of lower operating days in the U.S. and international operations, reflecting lower industry demand. This impact was partly offset by higher day rates across the company. The busy winter drilling season in Canada and its associated higher activity levels drove increased revenue generation when compared to the fourth quarter of 2012.

Operating income, net percentage or operating margin was 43% in the first quarter, in line with the first quarter of 2012 and up from 40% in the fourth quarter of 2012. Strong results in the Canadian division led to solid operating profitability in the first quarter. Adjusted EBITDA was $85 million in the quarter, down from $92 million in the first quarter last year, but up from $63 million in the fourth quarter of 2012. Adjusted EBITDA was lower than the same quarter last year due to a lower contribution from the U.S. and international operations.

However, adjusted EBITDA increased from the fourth quarter as a result of higher activity in Canada due to winter drilling. Net earnings were $33 million or $0.27 per share in the quarter, in line with $34 million in the same quarter last year, but up from a loss of $12 million in the fourth quarter of 2012. Net earnings in the fourth quarter were lower as a result of an impairment expense recorded on property and equipment, partly offset by a gain on the sale of property and equipment and the lower income taxes at year-end.

Now let's turn more specifically to our Canadian operations. In the first quarter, day rates increased by $1,195 per operating day compared to the same quarter last year. Day rates increased year-over-year largely as a result of six new high performance rigs that have been added over the past year. These rigs generate higher day rates and increased the division's average day rate. When compared to the fourth quarter of 2012, day rates lowered by $789 per operating day because of the change in the active rig mix. During the busy winter drilling period, we had more rigs operating including the shallow and less modern rigs. These rigs tend to generate lower day rates and reduce the average day rate for the quarter.

Utilization levels in the first quarter were down from the same quarter last year. Producers were slow to start up rigs in the new year and uncertain commodity prices led to a delay in some drilling programs. Despite the weaker conditions, we were able to maintain a higher activity level than the industry with utilizations at 73%, 15 percentage points above the industry average. Trinidad's activity was also more stable, showing only a 4 percentage drop from the same quarter last year versus an industry drop of 7 percentage points. Our ability to outperform our peers quarter after quarter and even in weaker market conditions, reflects the high quality and top performance of our fleet and our strong contract position.

Another where Trinidad is able to stand out from its competitors is in our ability to crew out equipment. During the busy period over the winter, we were able to put virtually all of our rigs in Canada to work. Not only does that show that all our equipment is relevant in today's market, but also that we are able to attract, train and employ enough crew members to operate our equipment, an impressive achievement for a large Canadian driller.

Operating margins strengthened in our Canadian operations to 48% in the first quarter, up from 45% in the same quarter last year, as a result of higher day rates and lower repairs and maintenance cost. When compared to the fourth quarter of 2012, operating margin increased from 39% due to lower repair to maintenance cost in the current quarter and a write-down in inventory in the manufacturing division that lowered the margins in the fourth quarter.

The first quarter is typically the busiest quarter for our coring rigs as they take advantage of frozen ground conditions and improve access to the Oil Sands project. This year our coring rates generated lower revenue than the previous year as uncertainty in commodity prices led to lower activity level. During the first quarter, we added one new rig to our Canadian fleet. Work on the rig began in 2012 and was completed in early 2013. The rig AC 1500 horsepower triple rig, now operating in the Duvernay under a five-year take-or-pay contract.

It is currently breakup in Canada, a time when activities typically drop. The industry active rig count currently sits at approximately 122 rigs, 9% lower than this time last year. How quickly we are able to get the rigs back to work at this time of the year is largely weather dependent. High levels of snow in Saskatchewan and Manitoba may delay our return to work in these parts of the provinces. However, Alberta and BC appear to be fairly typical of other years. Trinidad has only five rigs that maybe impacted by these weather conditions.

We have begun to sign up equipment for the summer drilling month, although a number of the customers continue to take the wait and see approach making it difficult to get a clear picture of overall expected activity level. We believe that our larger, high performance rigs will continue to generate solid activity and revenue. The shallower, less modern assets which make up a small portion of our fleet, could continue to see weaker demand unless we see increasing commodity prices. The strong margins we achieved in the first quarter may come down slightly during the second and third quarter as some of the repairs and maintenance costs that were delayed from the first quarter are performed.

Overall, we expect margins in our Canadian operations to be relatively in line with those achieved last year. Our customers continue to be focused on oil or liquids rich plays and any dry gas drilling remains very limited. We have seen increasing interest in the number of plays that could provide potential LNG plants in British Columbia with supply, particularly from national oil companies and large international oil and gas producers. Such plays as the Montney, Horn River, Duvernay and Fort Liard are seeing increased interest. The growing interest includes the use of both existing and newly constructed equipment.

Trinidad's experience at building and operating deep, technically advanced rigs, positions us well to participate in these activities as it unfolds. Trinidad currently has a approximately 55% of its Canadian fleet under long-term take-or-pay contract which helps protect our revenue stream from some of the volatility present in the spot market. Now let's turn to our U.S. and international operations.

In the first quarter, day rates increased by US$789 U.S. per operating day compared to the same quarter last year. Day rates increased mainly as a result of the change of in rig mix, with high performance rigs making up a higher proportion of the active rigs in the current quarter. When compared to the fourth quarter, day rates remained relatively unchanged, down US$102 per operating day in the first quarter. In addition, we had zero rigs on standby during the current quarter as rigs had been put back to work. We currently have one, only one rig in the U.S. on standby.

Like Canada, we saw a reduction in activity in the overall industry at our U.S. division in the first quarter. Trinidad's utilization lowered to 72% in the current quarter compared to 90% in the same quarter last year and 77% in the previous quarter. Older style equipment has been particularly impacted by the softening demand. As more modern equipment competes for work previously done by less modern rigs, it becomes more difficult to find work for the older equipment. This style of equipment makes up a small portion of our fleet causing Trinidad to be less impacted by this change than the industry as a whole.

Operating margin decreased in the quarter to 38% from 42% in the same quarter last year, and from 40% in the fourth quarter. We took advantage of the lower activity levels during the quarter and completed maintenance work that had not been possible in the prior periods. We currently have approximately 75% of our U.S. fleet operating and see opportunities in the second half of the year to put additional rigs back to work. We expect that the margins will improve from what we saw in the first quarter as we move through the year. However, we anticipate that that may average slightly lower than what we saw in this division last year.

We expect that repairs and maintenance cost will remain slightly higher than the last year as we repair and recertify rigs that have been working steadily for the past several years. While market conditions were softer in the U.S., Trinidad's modern, highly contracted fleet provides more stable activity and revenue generation than the industry as a whole. Our customers continued to be committed to our equipment and we currently have approximately 55% of our U.S. and international fleet under long-term take or pay contract.

Our Mexican operations are continuing to perform well. These rigs have been steady contributors to Trinidad's results for the past few years. They provide solid revenue and operating margins that are comparable to our U.S. operations and we expect that to continue. We have been assessing opportunities to expand our Mexican operations over the past few months and continue to work with new and existing partners to evaluate this divisional work. As always, we take the contract term seriously, ensuring we are rewarded for any additional risk and that our assets and people are safeguarded.

Moving to our U.S. barge operations. Conditions in the barge market have remained strong. Day rates in the first quarter were up US$3950 per operating day from the same quarter last year, reflecting the ongoing demand for high quality equipment. When compared to the fourth quarter, day rates lowered US$1172 per operating day. The reduction in day rates was driven by a completion work taken on in the current quarter. This style of work tends to generate lower day rates. Utilization in the quarter was strong at 92% compared to 80% for the same quarter last year and 84% in the fourth quarter.

We expect that both day rates and utilization will remain firm in this division for the remainder of the year. Trinidad continued to show strong safety performance in the first quarter. While the company as a whole remained well above industry levels, two of our divisions stood out in the quarter. Our Canadian division managed to maintain its strong safety standard, while also training new workers and ramping up activity levels for winter drilling operations. In addition, our rig manufacturing division had a zero incident level on a rolling 12-month period. This is an exceptional achievement and shows how good process and culture that promotes safety can achieve important goals such as this.

In the first quarter, we spent $17 million on capital expenditures. During the quarter we completed one rig build and worked on the one remaining rid from our 2012 construction program. We expect that this rig will be added to our Canadian operations by the end of the second quarter. For the full year of 2013, we budgeted capital expenditures of $70 million to $80 million. In addition to the completion of the 2012 rig builds, this includes maintenance capital and some upgrades to existing equipment. We are currently reviewing additional upgrades of our equipment that would meet an increased level of request from customers. These upgrades would be done in conjunction with the contract term and/or increased day rate.

The type of work we are reviewing includes top drives, increasing mud pumping capacity, and adding additional automation to existing rigs. At this date, we are evaluating different options and expect we will be able to provide a more firm update with our second quarter results. We do not currently have any additional new rigs scheduled to be built in 2013. However, we are participating in the bidding for new equipment in both Canada and the U.S. The opportunities in Canada are particularly promising, however, we are not able to share any of the details at this time. If successful in our biddings, we may choose to build a small number of new rigs in 2013, but as always, only if we can agree on contract terms that meet our internal hurdle rates.

And rigs we did build in 2013, would likely not be for delivery until 2014 due to long lead items for certain parts and construction time. Overall, including upgrades and new build contracts, we remain committed to meeting our leverage targets and expect to be very selective in these opportunities we choose to pursue. At the end of the quarter, our total debt to EBITDA was 1.92 times, slightly up from 1.91 times at the end of the year. We did in fact repay additional debt during the quarter, however, a movement in the U.S./Canadian foreign exchange rate affecting our U.S. dollar senior note offset this repayment and resulted in a slight increase to the ratio.

We have remained committed to our debt reduction strategy for the past few years and have repaid over $200 million in debt and lowered our total debt to EBITDA ratio from 3.6 times at its peak in early 2008. Our long-term target is to maintain total debt to EBITDA of either side of 1.5 times and I believe this target is clearly achievable. Part of our strategy is to maintain contract base that protects a portion of our revenue stream from the (inaudible) cyclical of the industry. This strategy allows us to participate in the upside of the market when pricing increases, while limiting the impact on the down cycle. We currently have approximately 55% of our total fleet under long-term take or pay contract with an average term of approximately 1.5 years remaining.

To date in 2013, we have seen conditions that are weaker than this time last year but still remain steady. We are seeing indications for improved activity, both in Canada and the U.S. for the second half of the year and expect to have strong results for the year. There is also the potential that we could increased demand for our drilling equipment if natural gas continues to strengthen. Our modern, high-tech equipment, solid contract base and growing financial flexibility position us well to have a more stable activity and EBITDA level than the industry as a whole.

Looking further out, Trinidad's growing free capital position and lower leverage will allow us to take advantage of expansion opportunities both within North America and internationally. Before I conclude this portion of our call, I would like to take a moment to thank the people of Trinidad who have worked so hard to help us achieve our goals this quarter and for the past several years. We continue to strive for new goals and reach new milestones that make Trinidad a stronger and more profitable company and that positions us well for the future.

Together, I believe that we have prepared Trinidad well the coming years and I am confident that Trinidad will perform strongly through the future challenges and opportunities we encounter. Thank you for listening. I would now like to pass the call back to the operator and take any questions that may be on the line.

Question-and-Answer Session

Operator

(Operator Instructions) And your first question comes from the line of Brodie Woods from AltaCorp Capital. Your line is open.

Brodie Woods - AltaCorp Capital

So, just a couple quick questions. Just on the bidding you talked about there for Northeast BC and the LNG related stuff. I understand, obviously, you guys are going to try and be fairly secretive about it, but just wondering can you tell us a range of how many bids you have in there? Is it two to five, or five to seven, can you quantify that at all?

Lyle Whitmarsh

Well, I think the total package, and it kind of varies from different operators. For us, we are looking for between two and four.

Brodie Woods - AltaCorp Capital

Two and four, okay.

Lyle Whitmarsh

Yeah. And it kind of depends. I think that there will be a blend in there just depending on the size, obviously. There is some fairly large rigs, I think that the industry as a whole is aware of and that might be a factor, that’s why I have given you a little bit a range there.

Brodie Woods - AltaCorp Capital

Okay. And so those would be larger ones, kind of 1500 horse, and will those be pad designs as well?

Lyle Whitmarsh

Yeah. They may be very -- they would be in the 1.2 million plus (inaudible) load range. So very large, probably some of the largest rigs that we have seen in the industry in Canada.

Brodie Woods - AltaCorp Capital

Okay. That's perfect. And then moving to the U.S., again on rig inquires. Would you say that quarter-over-quarter you have seen an increase in inquiries?

Lyle Whitmarsh

Yeah. I think we started -- the first indicators were certainly, the rigs, I think we mentioned even in the last call, we noticed there was a little bit more demand and throughout the since the last call more inquiries. I think that’s reflective in the fact that we have less rigs currently sitting on standby. And I think that was kind of our first leading indicator that gave us a feel that rigs were up and fired, and now we continue to see some incremental requests for rig drilling opportunities in the U.S. So we have taken it as a positive and it's not for sure a full phone ringing type scenario but we are taking advantage of this opportunity to put some incremental rigs back into work at reasonable rates.

Brodie Woods - AltaCorp Capital

Okay. That's helpful. And then same idea just on the tech specs. So would you be looking at walking systems and pads and those would be kind of higher horsepower rigs as well, or is it sort of the range?

Brent Conway

Yeah, I think they are all, I would say, million pounds style rigs. 1500 to 2000 horsepower. The thing that changes as Lyle said, most of the high-spec equipment is working and what's happened is there has been some assets, plays that have actually switched hands. We have seen some of the big producers and the producers that are coming in are looking to drill up these plays with the modern high spec equipment and they see the value in that. So that’s all good news for us. So they are looking to try and add high-spec equipment and they are willing to do it on contracts which is certainly more promising than where we were say six months ago, for sure.

Brodie Woods - AltaCorp Capital

Okay. That's perfect. And then just changing gears a little bit, just on the upgrades in the $70 million to $80 million CapEx program. Approximately how many rigs would that relate to?

Brent Conway

It's hard to lay that out for the whole fleet. It's probably, I don’t know, if I was going to pick a number maybe 15 to 20 rigs that are in the works for either pump upgrades or top drives, moving systems or something. In some cases it may be complete center pieces where we are trying to upgrade. So it's kind of spread throughout the fleet depending on where we think we can get paid for it, to be honest.

Brodie Woods - AltaCorp Capital

So just kind of making them a bit more relevant for today's drilling environment?

Lyle Whitmarsh

Yeah, I think where we are seeing it is, we are seeing that fairly broad-based across the entire industry and I think across the entire fleet. I think as an industry the focus has really been on efficiencies. I think that they are very focused on that and I think it's important to say that we see that their willingness to support the capital there is generally there in most cases. And that’s an opportunity for Trinidad obviously to work outside on these spot market rigs and even some of the existing rigs to either extend and/or secure some better terms. And we believe that's happening throughout the industry and I think that’s trend is going to continue well into the second half of 2013 and operators do focus on that efficiency factor. And I think they are very focused on that. So that’s an opportunity that Trinidad needs to respond to and definitely I think it's in the best interest of the shareholder.

Operator

(Operator Instructions) Your next question comes from the line of Andrew Bradford from Raymond James. Your line is open.

Andrew Bradford - Raymond James

There's a few moving parts in the U.S. and I want to make sure I understand what happened there, because the day rate sequentially went a little bit lower, utilization went a little bit lower. And often what we see is this high grading effect, but that was mitigated to some extent by fewer rigs on standby. So I'll just cut to the chase with the question, then. Was it a case that your higher spec rigs did they get -- was the day rate fairly consistent quarter-to-quarter or did that move down as well?

Brent Conway

I don’t think necessarily the day rates -- I think the day rates flattened out on that style of equipment and I think as they put that stuff back to work, we are seeing that the bottom of the market is probably behind us. And the big thing that impacted margins a little bit on the U.S. side had more to do with the maintenance side and trying play catch up on a little of that. But certainly from a market standpoint, we are seeing signs of that. The bottom of the market we think is certainly getting better in the U.S. then they were, say the last six or eight months.

Lyle Whitmarsh

I think so, Andrew. I think as well in some of the areas that we were looking to put the rigs back to work, some of the rigs that were moving out on that spot market that we were definitely seeing some pressure for sure. I think as our industry and as whole they had grew well aware that there was tough competition and limited amount of ability to get rigs up and running. So I think we are a little bit more patient waiting for just a little bit better of day rate and I think we are starting to see them now. And I think we are seeing more stability there now. So I think that’s why are seeing some of these rigs back to work. But definitely on the spot market in certain areas and I think where we are seeing that also is that we are seeing on everything from high- tier one style rigs right down, where I think we added some color to that as well in the class where we are seeing, obviously the industry is talk about it, and it is where we are seeing the high-spec rates come in and actually put pressure. And in some cases this plays out even a lower spec rate at lower pricing. So I think we have kind of filtered through that as an industry in most of the areas and now I think we are back to looking at stable to better range as we move forward into '13, basically on some more demand.

Andrew Bradford - Raymond James

Okay, perfect. With all of the press releases over the past 24 hours, it's been like drinking from a fire hose. Did you say anywhere along the way there what the impact on the US margin was of some of that advanced -- or some of that catch-up R&M?

Lesley Bolster

Really, Andrew the actual amount of R&M that we spent in the quarter was pretty consistent with what we spent in the previous quarter. It's just that the revenue number was down. So when you take it as a percentage of impact the margins will....

Brent Conway

And Andrew, for just so, the work we have been doing there as well in lot of the rigs -- and a lot of them rigs have been out since 2005 so they are starting. This is part of a consistent, ensuring our long-term shareholder value is also parting to make sure them that we keeping them well serviced and updated. So this has given us a little bit of a chance and time to cycle through the yard and actually get them ready. And that’s really what we have been focused on is trying to insure that we are getting that rigs in, because some of those rigs have been out running 350 days well into, 2005 as they deployed. So we are taking advantage of this time now to make sure that safety standards and some upgraded on them as we get prepared to put them back out on long-term.

Andrew Bradford - Raymond James

That's perfect, thanks. And my last question and then I will turn it back is, just relates to your debt target. So you've advertised for a while that you are looking to get to 1.5 debt to trailing, and I guess what I'm curious about here is that Trinidad is coming up to a crossroads fairly soon, at least by my arithmetic. Seems to suggest that you are going to get to a point where all you have outstanding in terms of your debt are your notes. So your ability to repay debt is going to come down to either you start paying back those notes or redeeming those notes, or you are going to start amping up your capital spend rate or your dividend, or some combination of those things. So, how are the discussions going around the boardroom now as you start to close in on that point?

Lyle Whitmarsh

You are pretty good at math, Andrew. I think as an ongoing conversion that we have around the boardroom table right now there is a lot of opportunities that we are evaluating. And obviously what we have been talking about for the last three, four years, is the ability to get to free cash flow and get to a growth profile that allows us to do what we do best, and that’s just around the corner. So that’s something that we will continue to evaluate. There is opportunities in Canada, there is opportunities in the U.S., and there is international opportunities. So it will allows us to put capital to work and add value. So we are just going to pick the best ones and pursue those and to the extent that they aren’t there, which right now we don’t see that as being a problem but to the extent that they aren’t there, then we will look at some of those other options. And it's something that we talk about with the board every quarter. So right now the opportunities look like we will have the ability to put that extra cash or that free cash flow to work.

Operator

(Operator Instructions) We do have a question that has queued from Jamie Murray from Desjardins. Your line is open.

Jamie Murray - Desjardins

I just wanted to ask quickly about the barge market. I mean, obviously, good utilization there. What's the outlook for that for the rest of the year? Do you think prices might be able to move out a little bit more, are you guys looking to add some capital in that area?

Lyle Whitmarsh

I think when we look at the barge market currently, we hit kind of, what I would almost called plateau where down there we have seen in increase but everybody has been watching as the margins and utilization. Utilization has always been high but I think we have seen a nice increase in utilization -- sorry, in margins as we have been reporting our quarters. I think where we are today is the majority of the rigs in the fleet are now operating, and we are just now starting to see some backlog of demand where most of the barges have one to two wells behind them. Of course in that business, most of the long vision you get or the contract base you get is usually done either well by well or it's actually three wells. So the vision we are seeing now is we are actually starting to get a backlog on not only the Trinidad units but also as an industry. That’s why we got to where we are in the pricing today. We haven’t seen a real deflection point to higher than where we are today, but if some more demands comes on for incremental assets, I think we can expect the margins to go up. But right now we are just, I think we are fairly comfortable where we are. We are looking at probably stable to slight increases as we go through the reminder of the year unless there is an increase in demand which at that point will put even more pressure on the existing rates. So we are pretty comfortable where we are right now. We would like to think that we can see some increases but we certainly don’t see huge increase at this point until we see another deflection point which would be just some more increase. But it's been a nice increase to where we are. We like where the ranges have moved and I don’t know if we are 100%, would be committed to make our internal hurdle just yet at where we are with the margins. But it certainly is moving in the right direction and gives us a positive note to evaluate in amongst our options for adding shareholder value. So we will continue to evaluate it but we don’t see a huge spike at this time.

Jamie Murray - Desjardins

Okay. That's great. And just one more on the Canadian operating income percentage. Sorry, I might have missed this in the call, but can you quantify, just on a percentage basis, how much the lower repairs and maintenance expense helped your income in that division?

Brent Conway

It was around $2.5 million in the quarter.

Lesley Bolster

But to be clear we expect that will totally even out under the full year that that might even get spread in Q2 and Q3.

Operator

And we have no further questions in queue. I will turn the call back to Lisa Ciulka.

Lisa Ciulka

Thank you, operator. And thank you for taking the time to participate in our call. We look forward to talking to you again in the future.

Operator

And this concludes today's conference call. You may disconnect.

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