Pacific Drilling's (PACD) CEO Christian Beckett on Q1 2014 Results - Earnings Call Transcript

May. 6.14 | About: Pacific Drilling (PACD)

Pacific Drilling SA (NYSE:PACD)

Q1 2014 Results Earnings Conference Call

May 06, 2014, 10:00 a.m. ET

Executives

Amy Roddy – VP, IR

Christian J. Beckett – CEO

Paul T. Reese – CFO

Analysts

Darren Hicks – Evercore Partners

Dave Wilson – Howard Weil

Devin Geoghegan – Nexus Asset Management LLC

Ian Macpherson – Simmons & Company

Darren Gacicia – Guggenheim Securities, LLC

Teresa Fox – Stone Harbor Investment Partners

Steven Karpel – Credit Suisse

Andreas Stubsrud – Pareto

Jeffrey Schwarz – Metropolitan Capital

Mike Urban – Deutsche Bank

Operator

Good day, and welcome to the Pacific Drilling First Quarter 2014 Results Conference Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Amy Roddy. Please go ahead.

Amy Roddy

Thank you, Steve and welcome everyone to Pacific Drilling’s first quarter 2014 earnings conference call. Joining me on this morning’s call are Chris Beckett, our CEO and Paul Reese, CFO.

Before I turn the call over to Chris, I would like to remind everyone that any statements we make about our plans, expectations, estimates, predictions or other statements about the future, including but not limited to those concerning future, financial and operating performance, revenue efficiency, operating cost, contract backlog, day rates, rig downtime, market outlook, contract commencement dates and duration, options and extensions, new build delivery cost and base, capital expenditures, the timing and payment of any distribution and plans and objectives of management for future operations are all forward-looking statements.

These statements are not guarantees of future performance and are subject to risks and uncertainties. Our filings with the US Securities and Exchange Commission, which are posted on our website, discuss the risks and uncertainties in our business and industry and other factors which could prevent us from realizing the outcome of any forward-looking statements. Our actual results could differ materially from any forward-looking statements made during this conference call.

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 press release, which is available on our website.

I’ll now turn the call over to Chris Beckett, Chief Executive Officer of Pacific Drilling.

Chris Beckett

Thank you Amy and thanks everyone for joining us. I am pleased to be able to again report strong results for the quarter from our established fleets and good progress from the shakedown of our fifth drill ship. I want to start today with an overview of our operational performance. Then I'll discuss the status of our yet to be delivered new build rig. I'll address a few comments to the state of the market and our contracting activities, including the extensions of the Pacific Bora and the Scirocco and then I'll turn the call over to Paul to discuss the financial results.

So starting with operations, for the fifth consecutive quarter, we’ve reported an increase in revenue to a new company record of $225.6 million. EBITDA also topped $100 million for the first time, coming in at a $100.9 million. And our first four rigs continued to deliver strong operational performance. However, we still have room to improve. And we experienced more challenges during the initial months of Pacific Khamsin’s operations than we expected. We are very disappointed that we actually had to pull the BOP three times to address various issues.

And what we believe the newest generation of Shaffer control systems will deliver greater reliability in time, the first few systems delivered which include that on the Pacific Khamsin are clearly requiring incremental shake down efforts versus the old design.

We’ve worked very closely with NOV to address the start up issues and we are very pleased that Khamsin achieved a 100% revenue efficiency in April. So whilst we can’t guarantee that we won’t experience any further issues, we believe that we got the major problems behind us. Pacific Santa Ana successfully completed the first subsea test with the MaxLift pump, which is the key enabling technology for DGD and we expect to use the system in drilling mode to drill a section of the current well.

So moving onto our new builds. We look forward to the addition of the Pacific Sharav to our fleet in the US Gulf of Mexico later this year and we are anticipating delivery of the rig within the next two weeks, pending the closeout of a few punch items. Now obviously we are becoming ever more vigilant about our construction oversight and our rig acceptance criteria and the quality checks associated with key equipments since the shipyard still remains challenged to deliver these drill ships on time and to our standards. But we are confident that Sharav will be delivered very shortly.

Pacific Meltem’s naming ceremony is in two weeks and we expect to take delivery of that rig in the third quarter. And finally, Samsung laid the keel on the Pacific Zonda, our eighth rig on time on April 21, and continues to forecast delivery at the end of March 2015, although we wouldn’t be surprised if that slipped a week or two.

So as we’ve discussed before, we are focused on mobilization planning in order to minimize the time from delivery, when we make our final payments to first revenues. And we’ll continue to be focused on meeting delivery criteria to ensure that we are getting a complete functional rig before we take delivery.

Turning now to the market. Although, the first quarter saw an increase in bidding activity, that activity hasn’t translated into signed contracts yet. The market is very short of data points to indicate what day rates are today, and that’s clearly creating a lot of uncertainty.

There are a significant number of older fifth generation rigs which we expect to provide low cost competition for some of the lower specification market requirements. And it’s often difficult to determine in advance which opportunities will truly require high specification rigs and how our clients will evaluate the benefits of these latest generation rigs such as those in our fleet.

But what is – is that 2014 is going to continue to be a challenging market under the 2015 supply and demand balance, the flow looks just as challenging making forward day rates even harder to forecast.

We also note there appear to be only three to four modern high specification ultra-deepwater units available to work in 2014. So we’ve got a very limited high spec competition in the market for the drilling requirements starting in ’14 and that gives us a degree of confidence.

Although prices remain at levels which satisfy investment criteria for the large majority of ultra-deep water opportunities and an increase in proportion of the demand is the development work, which benefits the most from the enhanced capabilities in the newest rigs. We’ve confident that the limited high spec supply will be absorbed into the market in 2014. Given the attractive build cost for our most recent rig orders, we expect attractive returns of these rigs into the market, even if day rates did not match the 600,000 we have recently secured.

Industry fundamentals still support our strategy of building and operating a dedicated high specification drill ship fleets with strong attention to customer service and operation excellence. And infact the recent developments support that focus and strategy even more.

So what does this mean for our fleet in the near-term? Well, as expected, Total exercised the option to extend the Pacific Scirocco for two additional years at the pre-negotiated day rate of approximately 500,000 a day. The rig is now committed to January 7th of 2017.

Our conditional commitment for Pacific Bora remains in place. And although we are frustrated by the process required to receive the necessary approvals and we are prepared to market the rig to other opportunities if necessary, we don’t expect to go down that path given that we have a planned well program in front of the rig which stretches into 2017 and we are going to continue to work with Chevron to support them in obtaining the necessary approvals.

Ongoing discussions regarding the extension of the Pacific Mistral are obviously continuing to drag on. Petrobras is certainly pushing hard on rates and negotiations continue for the extension of, we believe, nine rigs that are due for renewal in 2015. We can’t say at this time where the rates are going to end up or how long the process is going to take, but we are actively pursuing other opportunities for that rig as well.

We continue discussions on Pacific Meltem, which is one of the few remaining new builds with 2014 availability to start work. We are still confident that the rig will be contracted before delivery and we are very focused today on contracting the fleet that we have. With that focus on the current fleet, we will continue to defer additional fleet growth until we have more visibility on the market and we place the Pacific Meltem. But despite these uncertainties, we are still very well positioned in 2014 and 2015, almost 78% of our fleet is covered proved by contract towards the end of 2015 and so we are confident in our forward forecast.

So to wrap up, I’d say that despite the challenging market today, we are well positioned to be successful for every phase of the cycle. I’m very proud of the Pacific team. We’ve built a successful company that we have envisaged at inception and we are focused on the near-term challenges and opportunities, specifically contracting available capacity in ’15 and optimizing rig delivery and startup. We believe we have the right strategy in fleets and the team in place to continue to excel.

Now I’m going to turn it over to Paul to discuss the financial details.

Paul T. Reese

Thank you, Chris and good morning, everyone. As Chris mentioned, our fleet delivered a fifth consecutive quarter of increasing revenue and an EBITDA in excess of $100 million for the first time with expenses in line with our forecast.

Our net income was $22.2 million or $0.10 per diluted share, as compared to $25.7 million, or $0.12 per diluted share in the fourth quarter and $15.1 million, or $0.07 per diluted share, in the first quarter 2013.

Contract drilling revenue for the first quarter was $225.6 million as compared to $200.5 million during the fourth quarter. The increase in revenue was mainly due to the full quarter contribution of Pacific Khamsin.

Revenue efficiency for the first quarter was 82.7% as compared to fourth quarter revenue efficiency of 95.6%. As Chris discussed, our revenue efficiency decreased primarily as a result of Pacific Khamsin shakedown which reduced our fleet of average revenue efficiency by more than 10%. It is worth noting that the calculation of fleet average revenue efficiency is disproportionately affected by Khamsin’s revenue efficiency since the day rate is substantially higher than the current average day rate of our other rigs. Revenue efficiency was also negatively impacted by the required export and reimport of the Scirocco, which was completed in January.

Contract drilling expenses for the first quarter were $111 million, which included $13.2 million of deferred expenses, $8.4 million for shore-based and other support costs, and $6.7 million of reimbursable expenses. The full quarter of operations on Pacific Khamsin drove the $20.3 million quarter-on-quarter increase, which included an increase in amortization of deferred costs of $2.9 million and $1.1 million increase in shore-based and support costs required to support a third rig in Nigeria.

Rig-related operating expenses per day, excluding reimbursable costs, averaged $183,800 per day in the first quarter as compared to $176,200 for the prior quarter. This increase was in line with our expectations and was primarily as a result of annual compensation increases for offshore personnel which were instituted on January 1.

General and administrative expenses for the first quarter decreased slightly to $12.5 million as compared to $13 million for the fourth quarter. This decrease is the result of our continued focus on managing overhead cost at an appropriate level for our fleet size.

EBITDA for the first quarter was $100.9 million, translating into an EBITDA margin of 44.7%. As we’ve mentioned before, we consider EBITDA margin an important metric of operational performance as it measures the combined effect of day rates, operational uptime and operating cost management. Consequently, we are not satisfied with our EBITDA margin in the first quarter. Our margin was negatively impacted by the start-up challenges on Pacific Khamsin but our objective is to continue improving this metric in 2014 and onwards as we add more new rigs with higher day rates and complete shakedown on those rigs as we increase day rates on currently operating rigs and as we benefit from the more efficient use of our fixed cost structure in doubling the size of our operating fleet.

I will now turn to our financing and capital investment programs. Interest expense in the first quarter was $26 million as compared to $25.8 million for the fourth quarter. Since the beginning of the year, we’ve had strong collections from our clients, resulting in cash flow from operations for the quarter of $122.8 million. As a result as of March 31st, our cash balance stood at $236.5 million. Our total outstanding debt at the end of the quarter was $2.4 billion with an undrawn capacity on our two credit facilities of $1.1 billion.

During the first quarter, we invested $88.8 million in our fleet, of which $58.9 million related to the construction of our newbuild drillships. Capitalized interest was $15.1 million and the balance of the expenditures primarily related to fleet spares and client reimbursed asset upgrades for our operating rigs. These upgrades are partially or fully reimbursed by our customers. We estimate the remaining capital expenditures require to complete construction of our three newbuild drillships and continue to build up our fleet spares to be approximately $1.4 billion, excluding capitalized interest and client-reimbursed asset upgrades. We expect to cover these capital expenditures with a combination of our existing cash balances, future operating cash flows, undrawn capacity on our existing credit facilities and additional financing.

Regarding our Board of Directors recommendation for cash distributions to shareholders in 2015, our annual general meeting is scheduled for this coming Monday, May 12th. We will issue an announcement of the vote results following the meeting.

Finally, I’d like to discuss updates to our guidance for 2014. This guidance is also summarized in our press release issued yesterday. As we stated in our May fleet status report, which was posted this past Thursday, we expect revenue efficiency for the second quarter of 2014 to range between 91% and 95%. We reiterate our revenue efficiency guidance of 89% to 93% for the full year 2014. These ranges include our expectations for unplanned downtime as well as planned events mainly related to export and reimport of rigs in Nigeria, which were completed in the first quarter of this year. It also reflects the impact of inspections across the fleet as well as the introduction of the Khamsin, Sharav and Meltem into the fleet.

We reiterate our other guidance provided with our fourth quarter and full year 2013 results press release. I would like to note that our full year 2014 expectations for SG&A remain consistent with our guidance. We expect to see an increase in the second quarter as compared to first quarter primarily as a result of annual compensation increases for corporate staff which were implemented on April 1st. We will also continue to grow the organization as we prepare for the addition of our remaining three newbuilds to our operating fleet.

We have also updated our investor toolkit including an interest expense schedule. This resource is posted on our Web site under Investor Relations in the section titled Quarterly and Annual Results.

And with that, I’ll turn the call back to Amy.

Amy Roddy

Thank you, Paul. Steve, we are now ready to begin the question and answer portion of the call.

Question-and-Answer

Operator

(Operator Instructions) Our first question is from Darren Hicks from Evercore. Your line is open.

Darren Hicks - Evercore Partners

Hi, good morning.

Christian J. Beckett

Good morning, Darren.

Darren Hicks - Evercore Partners

As you look to secure projects that require the most modern and highly specified rigs going forward, how many of your current projects would you say fit that criteria?

Christian J. Beckett

I would say they all fit that criteria today. You know, the drivers for one thing, that high specification rig, are a little bit different in each case but the rigs we have working in Nigeria, it’s a function of the logistics capabilities of the rig, the ability to operate with limited support, number of beds, deck space, and so on. In the Gulf of Mexico, it’s more a function of having the greatest lifting capacities and mud capacities and so on, obviously upgrades to DDD. So I would say that all of the program that we currently have contracts on demanded those high spec rigs and in particular where they were focused on developments and production drilling.

Darren Hicks - Evercore Partners

Okay. Thanks. And can you give us an idea – I mean, you mentioned that three or four rigs are with high spec capability are available in ’14, can you kind of give us an idea of how many projects are out there in relation to those three-four rigs?

Christian J. Beckett

Yeah, it’s always a little hard to tell because at the end of the day how are clients going to interpret the benefits to them of the latest generation rig is a little bit company specific, but by our estimate there are five or six projects visible today that would benefit significantly and economically from those latest generation rigs. So within the – we tend to take a more new ones view of the market I think than most of our peers because we are one asset class. And when we consider that asset class, we think that the market is actually pretty well balanced to undersupply.

Darren Hicks - Evercore Partners

And then one more if I may, you mentioned your frustration with the Pacific Bora extension process and you’re willing to market the rig elsewhere if necessary. Would you be willing to look outside of Nigeria or you’re really trying to focus on that region?

Christian J. Beckett

Well, I think there’re some benefits left to keep that rig in Nigeria. She is fully staffed. She meets the local content requirements. We’ve done a lot of work to train up and develop and promote Nigerian local staff and so I’d certainly – our primary focus will be to keep it busy in Nigeria. Our primary focus is to keep it on the contracted zone, and I don’t want this to be overblown. It’s – we will – obviously, we’re not going to be willing to sit around and have the rig go away but we don’t expect that to be the issue. I mean this rig is optimized for the work it’s doing. We have a visible well program in front of it. Clearly, Chevron wants to get this done as well. It’s just taking longer than we would hope, but I think the approval process in Nigeria has always been a bit elastic and we’re not the only guys out there who have seen delays in this process, so, yeah, it’s part of the business.

Darren Hicks - Evercore Partners

Hey, great. Thank you very much.

Operator

Next question is from Dave Wilson from Howard Weil. Your line is open.

Dave Wilson - Howard Weil

Hey, good morning, everyone. Thanks for taking my question. Chris, just a follow-up on the Bora, it looks like from your fleet status report last week that the lawyers added a little bit more to that footnote and I know you just addressed it. But is there a timing around this or a deadline associated with the extension that when it has to get approved?

Christian J. Beckett

The rig – I mean the letter of commitment we have is open-ended.

Dave Wilson - Howard Weil

Okay.

Christian J. Beckett

I mean look – you know, this thing is – I know is getting blown out of proportion. I should point out that yes, we added the language to the footnote but it was largely because we signed the contract which is a firm extension for the Scirocco and we wanted to clarify that there was a difference between them.

Dave Wilson - Howard Weil

Sure, okay. Thanks for that. And then regarding the Meltem, I appreciate the commentary in the press release and in the opening remarks about you guys remaining confident that you’re going to have a contract prior to delivery. So as you get closer to that date, I would imagine that’ll give us less time to prepare for customer specifics and local content renewals if applicable. I was just wondering how we should think about this rig actually going on (indiscernible) for modeling purposes. Would that be a mid to late fourth quarter or more conservatively push it out to the first quarter of 2015?

Christian J. Beckett

It’s a late fourth quarter, Dave.

Dave Wilson - Howard Weil

Okay, great. I’ll put it in for that. All right guys, this does it for me. I’ll turn the call back over.

Christian J. Beckett

Thanks Dave.

Operator

Our next question is from Devin Geoghegan from NAM. Your line is open.

Devin Geoghegan - Nexus Asset Management LLC

Hi, thanks for the time you gave today, guys, appreciate it. Just wanted to follow up on the comments about the Petrobras or the Brazil situation, I know you guys would be willing to move it out of market. There’re just some rumors today that Petrobras is on the verge of signing some new extensions at 450 a day for about three years through 2018, wanted to found out if you guys can comment on that situation at all and where else that rig might go?

Christian J. Beckett

You’re talking about signing some of the extension rigs or signing rigs outside of that process?

Devin Geoghegan - Nexus Asset Management LLC

There’s rumors out today I guess that the three of the rigs that are in country got extensions for three years at 450 a day and then just given your comment that you’re looking at further opportunities, just wondering on what you could comment on, I guess the possible rumors being true and where else that rig might find work?

Chris Beckett

There are a lot of rumors around right now, but that was the right ---- frankly I can’t give you any more insight into that than any of the other people who are making those rumors right. I know Petrobras is pushing very hard to get it reduced, right. We are evaluating our willingness to make them part way. If it doesn’t get extended, we have other irons in the fire as it were, that rig is on contract until February of next year. So we think we’ve got plenty of time to find alternative work if we’re unable to resolve things with Petrobras, but frankly if we don’t sign an extension with them today, then we’ll have another conversation tomorrow, that’s the nature of this process. It’s being going on for years and there’s no particular agency to close about now.

Devin Geoghegan - Nexus Asset Management LLC

Got you. Okay, thank you sir.

Operator

Our next question is from Ian Macpherson from Simmons. Your line is open.

Ian Macpherson - Simmons & Company

Thanks. Chris, what do you think the demand elasticity will be with lower day rates, I would presume the Gulf of Mexico might be into the market that has the most potential additional demand from independent E&P companies that will be opportunistic with lower day rates? Do you see that as it is a potential movement in the market by the second half of this year or do you think that, that’s going to take more time for those [dominoes] to fall?

Christian J. Beckett

Yeah, Ian, I mean my sense is that all the companies did move relatively quickly on smaller shallow water show the lead time programs and they can be somewhat elastic. I think the ultra-deep water high spec space tends to be relatively inelastic. But I would also say that I don’t think that oil prices are in a position that that’s causing anyone to pull back. I think we’ve seen some delays in projects as clients have re-evaluated their development criteria and plans in terms of the specific designs, that when they use in terms of their wells and the infrastructure that they are putting in place. You know I think that we have started to see them, then come out of that cycle and get ready to move forward again. So, I think if you see a pick up and we would anticipate seeing a pick up like this year early next year, it’s more on the back of what has been done for the last 12 to 18 months then it is on some change in external influences going forward.

Ian Macpherson - Simmons & Company

Okay. Sorry to [flog] a dead horse on the Bora issue. It seems like night times out of ten, the constipation and contract awards of Nigeria is attributed to political accretion. And that’s why I think we’ve heard with these recent rig contract as well, that there is a -- the election cycle could be an impediment to getting contracts approved. Is there anything to do from your perspective that that is the case in the elections are to enter early next year, is there a plan B for getting the Bora somehow through that by this August?

Christian J. Beckett

Yeah I mean, I don’t think this has got anything to do with political issues or license cycles. You know it’s not a regulatory government approval we are waiting on, its generals local partner. And they have their own processes and cycles. They have had some changes internally that have slowed some things down. So, I don’t think this is election related, it’s just…

Ian Macpherson - Simmons & Company

Got it.

Christian J. Beckett

Taking longer than we would hope. Can’t give you any more comment than that.

Ian Macpherson - Simmons & Company

Got it. Thanks and good luck.

Operator

Our next question is from Darren Gacicia from Guggenheim Securities, LLC. Your line is open.

Darren Gacicia - Guggenheim Securities, LLC

I wanted to ask, you mentioned a pick up in bidding activity in some of your prepared remarks. You know can you just kind of expand on a little bit, is that request coming in for bids, is that – is there some change in tendering that maybe happening, what’s your outlook on how that may look over the next say 12 to 18 months?

Christian J. Beckett

Yeah, I mean I think we’ve seen a pick up in the level of interest from clients in – in large part, I would say so far it’s been so the market enquiries, testing the market to understand availability which is like I think that takes much longer to convert into contract, but is normally a precursor to the clients actually coming back.

I mean, this is – I would say at the end of the day the drilling market has always been highly driven by sentiments, close to necessarily fundamentals and I think that what we are starting to see is clients perceive that way too attractive, and they need to start coming back and securing the requirements of ’15. I think those are few as I mentioned earlier the opportunities in ’14 that will get closed out before the end of the year and then we’ll see when the budgets come through.

But, I think given the fundamentals oil prices stay strong, and the supply demand tends that as we hope it will, then I think ’15 we’ll begin to see the recovery. But you know in terms of specific opportunities and locations, I don’t think we are at that point yet.

Darren Gacicia - Guggenheim Securities, LLC

Got it. And so, as you look at you mentioned kind of ’15 budgets and looking above where the market is and do you think that the day rate environment or the kind of infrastructure CapEx element of projects is what may kind of drive projects from go to no go? And how do you see that sort of revolving at the moment?

Christian J. Beckett

Yeah, I mean I don’t think that the drilling day rate influence is a go no, go decision that’s evolving. That’s you know we are not at the end of the day enough of the total cost to influence, whether the client was supposed to do that. But I think what we’re clearly seeing is the revision on CapEx and development plans and designs, and that’s really going to be the fundamental driver as we go forward as clients get comfortable that they have reevaluated their plans and want to start moving again. Obviously, if they can get a better day rate, they’re going to be happy about it but I don’t think it’s a decision criteria for moving forward.

Darren Gacicia - Guggenheim Securities, LLC

But do you – but I think what I kind of read from it is obviously we’ve heard some things over the course of this earning season about kind of rework of some of the project economics looking at the infrastructure spend. You’re talking about sort of least – an increase – in the number of increase in terms of just general availability. Would you say that the availability increase kind of translate in a 12-month basis or an 18-month basis, what is a rule of thumb on that or is there – and maybe not a rule of thumb on that in terms of how to think about what that indicator is telling us?

Christian J. Beckett

I’ll be honest, I don’t think there’s a rule of thumb on it but you know our sense is – we start to see pickup in levels of interest in plants in Q1 then I would expect that to start converting into real tender opportunities and contract awards in the 12- to 18-month timeframe.

Darren Gacicia - Guggenheim Securities, LLC

Great. Thanks for the color. Appreciate it.

Christian J. Beckett

Thanks.

Operator

Thank you. Your next question is from Teresa Fox from Stone Harbor. Your line is open.

Teresa Fox - Stone Harbor Investment Partners

Thank you. You have mentioned you had problems on the Khamsin, the BOP (audio gap) and I was wondering if that new BOP is on the Sharav and the Meltem and how you are perhaps preparing to address those issues on those newbuilds?

Christian J. Beckett

Yes, simple answer, yes, that BOP design is on all of the last four rigs, so it’s on Sharav, Meltem and Zonda. The Khamsin was one of the first three or four rigs to be – to have that design of control system installed, and we spent a lot of time and effort both before we went out and in the field since we’ve started to try and use it for real, identifying issues and addressing them. All of those fixes have been applied to the Sharav BOP before we take delivery. So we’re not anticipating the same sort of experience with Sharav when she comes out, but the nature of these things is – you know, they take some shakedown. And they’ve taken more shakedown than we would like on Khamsin, but no, we are not anticipating the same sort of experience on Sharav or Meltem, or Zonda for that matter.

Teresa Fox - Stone Harbor Investment Partners

Okay. Thank you.

Christian J. Beckett

Thanks.

Operator

Our next question is from Steven Karpel from Credit Suisse. Your line is open.

Steven Karpel - Credit Suisse

Good morning.

Christian J. Beckett

Good morning.

Steven Karpel - Credit Suisse

You know maybe comment on – in your press release you talked about the work, and I know this has kind of been taken up a little bit, but the fifth generation competition. So maybe talk about it two-fold. One is the general retirements in the market, so it’s probably sub-fifth generation. And then, secondly, just trying to understand what you’re referring to and what you’re seeing in terms of the type of work that’s being done and then how you think about where the deferments of capital are in terms of is it sub-sixth generation or in what not? I guess I’m trying to get a bigger picture, what type of projects is out there?

Christian J. Beckett

Yeah, so I think if a client has an ultra-deepwater project, they have – and it is in relatively shallow geology. If it’s a very deep well, if it’s a lower tertiary Gulf of Mexico well, it needs a sixth generation direct capacity, just in terms of the weight of casing strings and so on. So then it’s a requirement for sixth gen. I think if you’re in a slightly less demanding market then the client can theoretically use a fifth generation rig for that work or they can use a sixth generation rig. The sixth generation rigs typically going to bring more efficiencies, it’s going to build a complete work in less time and potentially safer. It will have a bigger BOP, more safety redundancy built in and more lifting capacity and bulk capacities and so on. And all of that will allow the project to be developed faster. At the end of the day, the client makes their own determination as to whether the economic benefit from saving time and therefore saving spread cost and other associated cost offsets whatever the incremental day rate is for using a sixth gen unit. But clearly there’s a strong economic reason for paying a premium for sixth gen rig versus a less capable rig. But frankly, it’s – across the board in any program that’s moving into the development phase likely is going to be stead towards a latest generation rig.

Steven Karpel - Credit Suisse

Right. And I guess I’m just trying to understand – maybe just to follow to that, when you’re competing now on projects, your sixth gen, are you competing primarily against other sixth gens now or can you maybe segment what you’re going after – we can talk some of the specific projects that you’ve gone after but maybe I would comment on some of the rumors. In terms of fifth versus sixth and what the contracts that you’ve lost, is maybe the way to say it, are those being won by what generation and whatnot?

Christian J. Beckett

So we’re clearly focusing on marketing efforts on the opportunities that will show the greatest benefit with the sixth gen rig and ideally on programs that you can’t do with a fifth gen rig. You know, there’s no question that some of our peers are going to be highly competitive in terms of their pricing with their all the fifth gen fleet. They telegraph that very clearly. And it that would, it doesn’t make much sense for us to try and compete with them on price, we are not going to do that. But so we are going to basically bid on those programs where you have to have a sixth gen which is a preference for us, although you strongly prefer a sixth gen because of all the incremental benefits and that’s where you wanted to pay a premium for it.

I don’t want to get into the names of specific projects, but we are clearly focusing our marketing efforts on a segment of the ultra-deep water demand not on the entirety of it.

Steven Karpel - Credit Suisse

Okay. And the last you say that is between I guess between now and Zonda, how many projects have you see available obviously that changes overtime, but as you look today how many projects do you see available that fits that criteria?

Christian J. Beckett

Yeah, I mean I’m not going to again give detail on the project names, but our overall view of the demand between now and the Zonda delivery is that supply and demand is still reasonably well balanced, but that’s obviously determined by very heavily by the specific coming of those projects. We still believe that the market is going to be healthy, but competitive between now and then. And so in other words, the demand side looks pretty similar to the supply side and in terms of growth.

Steven Karpel - Credit Suisse

Right

Christian J. Beckett

And to give you a specific numbers and this is in our investor presentation. You know our expectation is that by the end of ’15 there is going to be something like 176 ultra-deep water rigs in the market, of that 67 or so are going to be high spec. There’s going to be something like 193 projects, we believe by individual demands for rigs, so the demand is going to exceed the supply, but that can slide a little bit in time, and frankly so it’s in the supply side.

So I pointed earlier, you know you got 67 low spec rigs and 98 high spec rigs and the 11 what we considered for the upgrades from fourth-gens. So the market, ’15 is going to be the first year while we see the market, where the majority of the market is actually ultra high spec rigs rather than the lower spec older rigs. But we still see the demand for those rigs exceed the absolute number of ultra-deep water rigs and it’s more than double the number of high spec rigs. So this won’t give us some comfort, but we’ll still be able to secure good contracts for [class] of rigs as they come available.

Steven Karpel - Credit Suisse

Thank you.

Operator

And our next question is from Andreas Stubsrud - Pareto. Your line is open

Andreas Stubsrud - Pareto

Oh my first question is related to financing of Meltem. In the senior secured credit facility, are there any requirements on the length of the contract, potential contract for Meltem to get the financing related to the senior secured credit facility?

Christian J. Beckett

Yes, it needs to be a minimum of one year.

Andreas Stubsrud - Pareto

Okay. So my follow up question was actually to Chris. But then I assume your goal is to get a minimum of one year contract rigs and that’s what you are looking for in terms of when you are talking about the specific projects?

Christian J. Beckett

I would say, our goal is to get a longer term contract than one year, but our minimum requirement is a one year contract.

Andreas Stubsrud - Pareto

Okay, good. The other thing is that Chris you are talking about these increase in activity. And can you help us a little bit about the regions? Are you talking about Gulf of Mexico or Africa, when you are saying that there is some increased activity in the first quarter?

Christian J. Beckett

I think we are starting to see some increase in market enquiries and rig availability, request from clients frankly on a global basis. Gulf of Mexico, we’ve actually seen some stuff come to the full tender. West Africa and Nigeria, we still see a couple of projects that have been moving into the commercial phase right now. Brazil is what it is, there are opportunities obviously the renegotiation with Petrobras, but there are also some of the ISEs starting to come back in and look for rigs available with the ’15 start for some of their new exploration program in the north of Brazil or even down in Uruguay. We are seeing demand interest in the Mediterranean and in Southeast Asia. So, it is – it’s not really concentrated in one area, it’s just a general uptick in the level of interest from clients about availability of these rigs.

Andreas Stubsrud - Pareto

Okay. Great. Thank you, that’s all from me.

Christian J. Beckett

Thanks. Thank you.

Operator

Our next question is from Jeffrey Schwarz from Metropolitan Capital. Your line is open.

Jeffrey Schwarz - Metropolitan Capital

Hey there, Chris and Amy and Paul. Thanks for taking the call. Chris, you guys are pretty early on laid out the philosophy of operating in three basins for I guess the diversification purposes. Brazil isn’t the easiest place to operate with Petrobras although sometimes there are other opportunities at the moment we only have one rig operating there. I was wondering if you could give a little bit of your thinking on the notion of either leaving Brazil and therefore potentially only operating in two basins and how that integrates with some of the tax issues that we have with not having a majority of our rigs in the Gulf and also as it pertains to be the investment that we've made in infrastructure in Brazil?

Christian J. Beckett

Yes, I will try and answer that Jeffrey I think the simple answer is we have as you said We have invested in infrastructure and we’ve trained people and built a very capable office in Riyadh, we'd like to continue using it and our first preference is to stay in the Brazilian market to the extent that we can't do that at economically attractive rates we would move the rig outside of the market that's not the baseline intent. We said previously our preference will be to have two rigs working out of that office if we could because it's basically staffed up to support that and that we would prefer if we had two rigs that we had a diversity of clients between those two rigs. So that none of that has changed as a fundamental view point. If we can’t secure attractive work in Brazil, then yes, we would be willing to pull the rig out. I would say that if we did that we would be looking to do so by opening up a new area instead. I think we have a view that those are sort of [three-basin] minimum -- is where we want to be in terms of where we are operating, so that we have some diversity across our operating locations. But as we said before, with an attempt to co-locate rigs so that we get and take advantage of the infrastructure.

So I’m not sure that answers your questions. One comment on the -- comment about the US, I mean there is no restrictions on how many rigs that we can put into the US or not?

Jeffrey Schwarz - Metropolitan Capital

All right.

Christian J. Beckett

Yes, our structure works perfectly fine even if we add further rigs to the fleet and potentially even have a majority of our fleet based in the US Gulf.

Jeffrey Schwarz - Metropolitan Capital

Okay, thank you. I did not realize that. I had thought that you couldn’t have more than half of them here. So, just a follow on Chris, should I hear that as although your clear preference would be to re-contract the Mistral with Petrobras that if you were to, if you couldn’t do that on sufficiently attractive economic terms, the fall back would be to be looking to contract a rig into a third basin.

Christian J. Beckett

I would say that if you want to fourth rank things and that these priorities can always change. But it would be to renew the rig at an attractive rate and the contract is on and it is set up for working for Petrobras and so on. In the absence of doing that, it would be to keep the rig in South America and maybe in Brazil but with a different client. And in the absence of that, it would be to look to move it to a different region.

But we are not looking to pull out of Brazil at this point, it is unquestionably a challenging place to work especially with the largest client there, but it’s also a big and important market to us. So we would like to stay.

Jeffrey Schwarz - Metropolitan Capital

Thanks very much.

Christian J. Beckett

Thanks.

Operator

(Operator Instructions) Our next question is from Mike Urban from Deutsche Bank. Your line is open.

Mike Urban - Deutsche Bank

Thanks good morning. Just had one question last, Chris, you guys said from very early stage obviously focused on organic growth and you know on your build assets and having a consistent fleet and repeatable process and all that kind of like fun stuff. Given the, I don’t know if turmoil is the right word, but certainly weakness, in a lot of the offshore drilling market and more specifically offshore drilling stocks, any change on that view as it pertains to M&A opportunities, I guess, on either side of the equation?

Christian J. Beckett

Look, I think our base preference is to stick – you know, as we’ve said before, stick with the same drilling equipment and maintain the synergies across the fleet in that standpoint. We’ve said previously, that doesn’t mean it has to be the same shipyard but we would try and – to the greatest extent possible, stick to the same equipment suppliers and manufacturers. Organic growth is – at this point still looks to be the most attractive source of growth available. Although, we certainly wouldn’t rule out willingness to look at M&A opportunities or individual rig acquisition opportunities if the price is right. But we’re really not seeing a lot of pressure on shipyard prices. So building from scratch is still the lowest cost way to grow the fleet. And I think that would still therefore be our – the primary focus. But we’re obviously looking at those opportunities where they come up and where we could acquire existing rigs if they fit the criteria of being highest spec and similar equipment sets to our existing fleet.

Mike Urban - Deutsche Bank

Do you think there are any assets like that out there; you know maybe the price, the asking price, hasn’t come down. Anybody dangling things out there, testing the market at this point? Or we haven’t seen enough distress so far?

Christian J. Beckett

Look I think there’s clearly assets available out there that are lowest spec and we’re not particularly interested in those. There are some high spec units that are – I think there’s some interest with the current owners to sell them. But at this point I don’t think the price – the bid-ask price has been close. That may happen over time, but today we’re not seeing anything that’s particularly attractive.

Mike Urban - Deutsche Bank

All right. So presumably still kind of asking a premium to newbuild cost for something that’s further along in the pipeline?

Christian J. Beckett

Yes.

Mike Urban - Deutsche Bank

Okay, that’s all for me. Thank you.

Christian J. Beckett

Thanks.

Operator

And we have no further questions at this time.

Amy Roddy

Okay, thank you everyone for participating in Pacific Drilling’s first quarter 2014 results conference call. I will be available after the call to answer any further questions. Thank you.

Operator

This concludes today’s program. You may now disconnect and have a wonderful day.

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