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Executives

Amy Roddy - Director of Investor Relations

Christian Beckett - Chief Executive Officer, Executive Director

William Restrepo - Chief Financial Officer

Analysts

Darren Hicks - Evercore Partners

Mike Urban - Deutsche Bank

Andreas Stubsrud - Pareto

Dave Wilson - Howard Weil

Lukas Daul - SEB Investment Bank

Anders Bergland - Platou Markets

Darren Gacicia - Guggenheim Securities

Pacific Drilling SA (PACD) Q32012 Earnings Call November 8, 2012 10:00 AM ET

Operator

Good day, ladies and gentlemen and welcome to the Pacific Drilling third quarter 2012 earnings results conference call. As a reminder, today's call is being recorded.

At this time I would like turn the conference over to the Director of Investor Relations, Amy Roddy. Please go ahead, ma'am.

Amy Roddy

Thank you, Lea, and welcome, everyone, to Pacific Drilling's third quarter 2012 earnings conference call. Joining me on this morning's call are Chris Beckett, our CEO and William Restrepo, 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, dayrate, market outlook, contract commencements and durations, new build delivery cost and dates, capital expenditures 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 U.S. 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.

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

Chris Beckett

Thanks, Amy, and good morning, everyone. Thanks for joining us today.

Before William provides the details of our financial results, I want to discuss our operational performance during the quarter and the rigs and the highlights of the company including the status of our rigs under construction, as well as last night's financing announcement, before closing the comments with the ongoing strength of the market, for the rigs and its impact on our contracting activities.

The third quarter of 2012 reflected both the challenges which can occur during the startup of a new drillship and also the sort of operational performance that we are targeting from our more mature rigs. Our revenue for the quarter was $172.0 million and our operating fleet of four drillships achieved an average revenue efficiency of 83.1% which is in line with the guidance we provided at the end of the second quarter.

During our last earnings call, we discussed downtime during the third quarter on the Pacific Santa Ana as a result of damage to blowout preventer sealface. In addition to those repairs to the BOP, the rig experienced nine days of unpaid downtime during the quarter for other issues which were more characteristic of typical rig shakedown. The total downtime on the Santa Ana during the quarter reduced the revenue efficiency by about 14.1% for the fleet as a whole.

However, I would like to take this opportunity to recognize the outstanding work by the Santa Ana's crew. In the course of these repairs, they pulled the BOP more times in the first few months of operations than most rigs pulled a BOP over an entire year. Yet, throughout this challenging period, the crew has performed extremely professionally, managed these challenges very well. The rig is now drilling ahead and is performing very well.

Turning to the other rigs in our fleet. During the quarter, our other three operating rigs exceeded our operational targets. The Pacific Bora, which in August reached one year milestone for work under client contract without a lost time incident, averaged about 97.8% revenue efficiency for the quarter. The Pacific Scirocco, which began its second six months of operations at the beginning of the quarter, achieved an exceptional revenue efficiency of 99.5%. The Pacific Mistral, which began its second six months of operations in August, had an average revenue efficiency of 94.1% in the face of a very challenging work environment.

Although these rigs continue to perform extremely well and we believe the Santa Ana will soon head its stride as well, we have not yet seen our direct rig operating cost reach a level consistent with our expectations. I will let William discuss this in more detail but I would like to emphasis that reached our revenue efficiency targets we will now focus on operating cost as we work to balance quarterly operations for our clients and asset maintenance and cost management.

Moving to our rigs under construction. Since our last conference call, our rig construction program continues to progress as planned. In mid July, we launched the Pacific Khamsin. On October 24, we cut steel for our seventh rig, the Pacific Meltem. We are on track to lay the steel for the Pacific Sharav in early December and all of our new builds are on target for substantially on time and on budget delivery.

In September, we extended the exploration of our option for further drillship to December 15 of this year. If exercised, delivery of that rig would be in the first quarter of 2015. However, as we have discussed previously, financing requirements are a key consideration when planning the expansion of our fleets. William will discuss the status of our broader financing plans in a moment but I will highlight that last night we announced the proposed private offering by one of our indirect, wholly owned subsidiaries of $500 million in senior secured notes due in 2017.

Due to the restrictions on marketing of this type of offering we can't say anymore about it during this call but I can say that the proceeds from the offering are intended to fund the remaining construction payments on the Pacific Khamsin. Securing financing for the remaining construction payments on Khamsin is one of the areas of consideration in our decision for whether to exercise the option for an eighth rig.

I will now turn to the state of the market for ultra-deepwater rigs and the state of its contract discussions for our uncommitted rigs. During the third quarter, we saw significant improvement in the price of crude, with brent moving from a low point in the $90 a barrel at the beginning of the quarter to the recent levels of above $110 per barrel. Even at the low end of the range, these crude prices are in excess of those necessary to deliver our clients' target return levels for ultra-deepwater development projects. Though supported by these crude prices the market for ultra-deepwater rigs continues to be robust.

We have seen a succession of contracts for rigs in the U.S. Gulf of Mexico with rates in the $600,000 per day range and the industry backlog continues to increase as a percentage of contracted ultra-deepwater days grows and grows at a faster pace than the supply. Additionally, tendering activity remains very strong, 9 to 12 months out from contract start. We believe that (inaudible) five ultra-deepwater rigs actually remain available for 2013, and those are typically in advance discussions.

This market environment, obviously, continues to provide great opportunities for uncommitted rigs. Although we can't discuss details until the contract is finalized, we have signed a letter of intent for the Pacific Khamsin. As 2013 availability dwindles, we begin to see contracts of rigs with deliveries in 2014 and beyond and we see significant interest in the Pacific Meltem.

Before I turn the call over to William, I want to reiterate the company is exceeding our targets for operational performance with our more established rigs and we are now turning our attention to cost optimization. We continue to progress with contracting our uncommitted rigs and look forward to bringing two more rigs out of the shipyard in 2013 for drilling youngest and most capable fleet in the industry.

With that, I will ask William to review the financial results.

William Restrepo

Thank you, Chris. Good morning. Before I start going over our financial statement, I would like to point out that for the first time, our results reflect four rigs on revenue for the full quarter. However the rigs have different operational experience. The Boro and Scirocco are now beyond the shakedown phase. The Mistral approached the efficiency performance of our rigs in Nigeria, but incurred incremental maintenance expenses related to the rig's ramp up and acceptance. The Santa Ana, our newest rig experienced several shakedown issues that affected both its revenue efficiency and operational expenses.

For the third quarter of 2012, we had a net loss of $2 million or one cent per diluted share. This compares to a net loss of $11 million or $0.05 per share for the third quarter of 2011. As compared to the second quarter, net income decreased by $3 million. The reduction was driven by a two percentage point increase in fleet revenue efficiency as well as by $14,000 per day increases in rig operating expenses.

Contract drilling revenue for the third quarter of 2012 was $172 million as compared to revenue of $17 million during the third quarter of 2011. Revenue for the quarter included $26 million in recognition of deferred revenue for the mobilization and contract preparation of our rigs.

Revenue efficiency for the quarter was 83.1% with our three most experienced rigs delivering an average efficiency of 97.2%. The Santa Ana averaged 42.1%, primarily as a result of extended downtime related to its BOP.

Contract drilling expenses for the third quarter of 2012 were $96.2 million as compared to drilling expenses of $9.7 million in the third quarter of 2011. Contract drilling costs included $18.8 million in amortization of deferred mobilization costs.

Direct rig operating expenses accounted for $17.8 million of the total, while shore-based and other support costs were $6.6 million. Our direct rig expenses increased sequentially to an average for the fleet of approximately $192,000 per day. Expenses were impacted by unplanned equipment maintenance and repair for Santa Ana and Mistral.

From a review of our third quarter operating expenses, we have identified approximately $5 million of costs predominantly related to rig shakedown and acceptance, which we will not expect to be ongoing beyond the fourth quarter. I will discuss our updated guidance for the fourth quarter in a moment.

General and administrative expenses for the third quarter were $10.5 million as compared to $10.8 million in the second quarter of this year. The decrease was primarily due to lower legal and professional fees related for our existing project financing facility.

Income taxes for the third quarter were $4.2 million as compared to $4 million during the second quarter. As we have mentioned before, most of our revenues to date has come from Nigeria, which is a deemed profit tax regime. Therefore, our income taxes have been primarily related to our revenue in Nigeria. Although our effective tax rate is very volatile, quarter-to-quarter our revenue tax rate was 2.6% and 2.4% in the second and third quarters, respectively. In both cases below our full year guidance of 4% to 5% of total revenue.

I will now turn to our financing transactions and investment programs. We closed the third quarter with $457 million in cash and cash equivalents, of which $303 million were restricted by our project financing facility over collateral for our bonds and other lines of credit. In October, we continue to amortize our credit facility by $109 million, leaving our outstanding debt on the credit facility at $1.46 billion or $364 million per rig.

Total debt closed at $1.76 billion including the $300 million in senior unsecured bond. As disclosed earlier, we anticipate funding the remaining capital expenditures for our three newbuilds with a mix of a project financing facility and long-term secured bonds.

Given the current favorable state of the fixed-income markets, we expect to finance delivery payments for next rig, the Pacific Khamsin with long-term bonds. Nonetheless we still anticipate closing in the near future on a $1 billion financing facility, which is now expected to fund the Sharav and the Meltem. These two drillships' expected delivery dates are November 2013 and May 2014, respectively.

During the third quarter, we invested $140 million in the construction of (inaudible) including milestone payments on two of our three rigs under construction. We have approximately $970 million in remaining capital expenditures for the completion of Pacific Khamsin and Pacific Sharav, of which we expect to still pay approximately $100 million in 2012 and the remainder in 2013. In addition, the Meltem will require approximately $577 million in additional capital expenditures with $34 million remaining in 2012, $149 million in 2013 and the remaining $394 million in 2014.

Regarding operational guidance, we now expect direct rig operating expenses will range between $175,000 and $185,000 per day during the fourth quarter of 2012. As a result of the previously mentioned incremental costs which will continue, at least, in part during the quarter. We confirm the remaining fourth quarter guidance that we provided with our second quarter results.

In addition, due to the newbuild status of our fleets and the significance of certain financial measures to our result, we will continue to update our investor toolkit each quarter. In conjunction with a press release yesterday evening, we provided schedules of expected amortization of deferred revenue and of deferred mobilization expenses, depreciation of the four operating rigs, capital expenditures and interest expense for the existing debt. We have also updated our fleet status report as of October 31. These schedules are posted on our website, pacificdrilling.com in the investor relations section.

With that, I will turn the call back to Amy.

Amy Roddy

Thank you, William. Lea, we are now ready to begin the question-and-answer portion of the call.

Question-and-Answer Session

Operator

Our first question today comes from the Darren Hicks with Evercore Partners.

Darren Hicks - Evercore Partners

We have seen a lot of activity for long-term ultra-deepwater contracts and that’s been encouraging. But it seems that the rates have somewhat leveled off based on the last couple of contracts that have been announced. Is there something that you can point to or something you can foresee that might make rates move up or down in and one way or the other?

Christian Beckett

I would say that I think your observation is correct. The rates have appeared to have plateaued in the low $600,000 a day range on a U.S. Gulf of Mexico basis, but frankly that’s an extremely healthy dayrate from our viewpoint and we are very comfortable with that number. In terms of what could drive that number up or down, then obviously this is ultimately a supply, demand market and the rates the clients are willing to pay for rigs is almost entirely determined by them.

View of what the forward supplies will look like compared with their demand profile. So it’s a fairly simplistic statement, but what would drive rates higher is to continue seeing the available supply secured by clients quicker than expectations and by that, I would mean in advance of 12 months prior to delivery. That will tighten the market further and nay drive some higher rates.

I think the other thing that could drive higher rates is going to be opportunity specific based on the specific geography of the term of the contracts. In terms of what could weaken the market, obviously, if we don’t see the contracts that we expect to see coming to fruition over the course of the next three to six months then that could give the impression of a more supply and lead clients to be more aggressive at trying to talk prices down. But we think the market is in a pretty good balance from the drilling standpoint right now in terms of having a clearly tight supply and an attractive position to be in when negotiating with clients.

Darren Hicks - Evercore Partners

Okay, thanks and just follow-up on a different topic. You mentioned that the favorable debt market has made you compelled to finance the majority of the remaining CapEx with debt and you are not alone on that. A lot of your competitors have been taking advantage of the market as well, but can you remind us of your optimal capital structure given that you have significant coverage on the rigs you have on the water and you have LOIs in the works, apparently as well.

William Restrepo

Our optimal capital structure, I think we have referred to that before. We think there is wide range between our peers, more traditional peers, which have very, very low leverage, in the 10%, 20% range and then some of the newer companies that leverage around the 60% range and by that I mean debt to book cap. Our target is to be, once we are finished with the growth phase, to be around 30%.

That’s our preference, but obviously that is not a static number. We really view that as a range between 30% to 40% depending on that the state of the market, our backlog cost coverage and the financial markets. The open for those markets and the cost at which we can get that.

So, right now, obviously as we ramp up our (inaudible) phase and pay for the next three week rigs, we expect our leverage debt to book cap to go towards the 50% range and then as the rigs start delivering EBITDA and cash flow, we expect it to see that leverage fall in rather sharply.

Chris Beckett

I would add to that. The majority of the financing on our remaining three newbuilds is still going to come from a bank facility, is our expectation. But we always anticipated to put some non-amortizing debt into the capital structure and we believe now is an attractive time to do it.

Operator

(Operator Instructions) We will take our next question today from Mike Urban with Deutsche Bank.

Mike Urban - Deutsche Bank

Some of the cost that you have incurred are pretty clear and then you have explained those and a lot it is related to shakedown and startup cost, as you have talked about and you also, I guess, identified $5 million that should not recur. I would be interested in some of the longer-term or structural initiatives that you put in place in the terms of getting that efficiency up and some of the things that you talked about, from a cost perspective and what are some or the things you are targeting? Some specific initiatives and things like that.

Chris Beckett

I think that the first thing, as William said, we identified about $5 million worth of cost that we don’t consider will be ongoing. Those are primarily around the use of service hands from the various equipment manufacturers to get the rigs through the shakedown period to address the gremlins that we are always seeing in new vessels. Those are in fact higher in Brazil just because the cost of those individuals is higher in Brazil than elsewhere in the world but we expect that to be largely done with, by the end of the quarter.

The other areas that are directly related are the cost of freight and importation duties and related to materials required for those shakedown repairs or upgrades. Again that’s also part of what we expect to be completed by the end of the quarter.

On longer-term viewpoint of how we manage our costs going forwards, we have a couple of different initiatives that was released by Kongsberg about the information management system that we have piloted with them on the Pacific Santa Ana, which gives us visibility of the operating performance of al the various systems on board from shore. We can literally log into a web interface and see all the sensor results from the engines and from the drilling system that will give us a significant amount of information about our how systems are the running and allow us to optimize those in such a way that, for instance, we can optimize the use of the thrusters and therefore manage the required maintenance programs that will apply to them.

So that’s one area as looking at trying to use some of the newer technologies that are available to us and in that case it’s a cutting-edge technology that is unique to Pacific Drilling at this point to allow us to have an ability to better support the field operations and ensure that they optimize the use of the equipment offshore. The secondary, obviously, is going to be around personnel cost because that’s going to one of our largest costs going forward.

It's also, I think, the industry's largest challenge to ensure that we have highly qualified and capable people and in position on the rigs. We found that we have had a fantastic response in the industry's employees, in terms of wanting to work for Pacific drilling and having joined as wanting to favor Pacific Drilling. I think we continue to manage our personnel costs very carefully but ensuring that we get the best people. To be honest, Mike, our focus is primarily on making sure that we can deliver the maximum revenue we can rather that trying to minimize the cost but ensure that we spent wisely.

Mike Urban - Deutsche Bank

Right, that makes sense. Sticking with the personnel costs theme. One of your larger competitors have talked about, they haven’t seen anything yet but anticipating perhaps an acceleration on the labor costs side which makes sense given that it is a fairly unprecedented that how many rigs we are going to be adding to the fleet globally here while at the same time already operating at such high levels of utilization. Is that something that you would expect as well or should we think about cost inflations being in the range that it has been for the last few years?

Chris Beckett

I think, Mike, its somewhat market specific. By that, I mean, obviously most of the places that we now operate in have some level of nationalization requirements and therefore, that tends to put even more pressure on some countries than on others in terms of the available supply of qualified people and therefore the competition for those people. So I think some of the emerging areas, in our view, Brazil is going to continue to be challenged in terms of the cost base. I think that Angola is going to be another area that that has a massive increase in the number of operating rigs coming down the pipe and a relatively small supply base of qualified people.

So we are certainly going to see increased pressure in some of those areas. Across the board, this is an industry that has an aging experience that we are going to have to bring in the new stars of the future to the backfill those problems and all those people as they retire. That clearly will have some cost implications as well.

So the cost guidance we have given in the past is an across-the-board average of between personnel and materials with an expectation of the personnel side of the inflation equation is, it's higher than the materials. But we are looking to change our guidance at this point.

Operator

Our next question today comes from Andreas Stubsrud with Pareto.

Andreas Stubsrud - Pareto

My question is for you, William. I think you guided the last time on (inaudible) being to $17,000 in operation support costs per rig per day. Is that still the same but you just increased the per rig by $10,000 from last call?

William Restrepo

No, we haven’t. I mean the support and shore-base is still at about $16,500 per day. What we increased was the rig operational expenses.

Andreas Stubsrud - Pareto

Okay, so the support cost is still the same as last guidance?

William Restrepo

Quite correct.

Andreas Stubsrud - Pareto

Can you give us some flavor on the credit facility you are talking about the $1 billion credit facility?

William Restrepo

Sure, Andreas. We have been working since the summer in putting in place a credit facility, actually we intended to put it in place for the Hansen and Sharav. Obviously the capital structure is a mix of bank financing which, today, is in the mid-4% range and of course, the flexibility provided by bonds. So we try to find the right mix we felt that, given our stage of development as a company, we were going to put facility first and then bond for the Meltem.

So we are fairly advanced on that facility but the realities of the market provides us an opportunity to get long-term money at rates that are very compelling. So what we have done for the facility is continue to work on the facility as originally envisioned with all commercial terms and all the agreements we had already the commercial banks and the ECAs in place. But shifting the collateral package from the Hansen and Sharav to the Sharav and Meltem. So, basically, this is a secured facility. It allows for $500 million per rig and, again, we expect to close that in the very near future.

Andreas Stubsrud - Pareto

Okay, and very good. Then the last question. It's more to you, Chris. The LOI you announced today, can you tell us a little bit about the length, three or five years. My guess is three year and a little bit higher dayrate than the last one you announced but can you give us any flavor at all?

Chris Beckett

Andreas, I am going to have to let you continue to guess on that one, right. We have a very explicit agreement with the client in this case that won't release the details until the contract is finalized but unlike some of the earlier LOIs we have had, where there has been an extended period between LOI and contract, we expect this to be done very shortly. So I would expect to come out with full details of the contract before the end of the month, if not sooner.

Operator

Our next question today comes from Dave Wilson with Howard Weil.

Dave Wilson - Howard Weil

Chris, just one question. With regard to revenue efficiency, post the shakedown period for the rigs, it appears to be better than expectations, in most cases, it is in the high 90% range. Should we adjust those expectations going forward for this or should we keep those expectations in the little lower, maybe in the mid-90s?

Chris Beckett

Good question. Obviously, we were extremely pleased with the performance of the rigs that have passed the shakedown and all three of them an exceptional job. I don’t think we would guide you to change expectations from our normal, from what we have said before, which is mid-90s is a good number. As far as performance for any rig, we obviously hope to continue at the levels that we delivered for the last, it is almost three quarters now, on the most established rigs but I would hesitate to tell you that we can guarantee to deliver that every day.

So we wouldn’t change the guidance. We think mid-90s is consistent with industry expectations. We target to be better than that but we wouldn’t forecast that that facility would be better than that.

William Restrepo

I will make an additional comment to that. The Mistral is working with a contract that is not as favorable as the other rigs. It's in a tougher environment right now. So you would expect to see the Mistral to be several percentage points lower than the other rigs in the Nigeria, for instance.

Dave Wilson - Howard Weil

Got it, great. Then, just as a follow on. I guess the standard offshore question of the quarter is, your thoughts on MOP or something along those lines?

Chris Beckett

Dave, we expected that someone would ask the question. For us, at this point of our developments, it's probably not a viable approach in the near term. Obviously what Seadrill has been able to achieve is interesting to keep track of and we will see how it continues to perform. Any opportunity that becomes available to us to expand our sources of capital is obviously something we have to explore, but from a practical standpoint the financing structures that we have in place preclude that sort of a structure for a year or two here anyway. So we are watching it closely. We are exploring how it might be applicable to us but in the near term it's unlikely to be something that we would pursue.

Operator

Our next question today comes from Lukas Daul with SEB Investment Bank.

Lukas Daul - SEB Investment Bank

Quick question. When I was looking at your latest fleet update, I saw that the dayrate on Pacific Santa Ana was adjusted quite substantially, I would say. Is that a timing issue that is going to happen on other rigs as well or was that a case specific adjustment for the rig?

Chris Beckett

That was an adjustment for the inflation, post-installation adjustment that will happen on an annual basis. What you are seeing it's basically the first adjustment. Once the rig had started operating, there was a small delay in the period before we got the first adjustment. That would be an annual event on Santa Ana.

It was obviously intended to keep as whole in terms of cost increases. We don’t have the same agreement in place on the Bora or Scirocco. So won't see an adjustment in the same way on those two rigs until they either re-contract or have options exercised. On the Mistral, we have a similar structure. It's not quite as favorable to us. It's also, I believe on an annual basis.

The Mistral, you may the rate bounce around a little bit more in small amount just because of currency adjustments. Part of that contract is paid-in Real and when you see large changes in the currency exchange rate, you may see some of that impacting the rates on Mistral. So the simple answer is, it is really rig specific.

Lukas Daul - SEB Investment Bank

Okay, that’s fair. Then one more as sort of a housekeeping question for William. How should we think about the movement in the restricted cash facilities that you have both in current and non-current assets?

William Restrepo

We have several pieces, components to it. One is related, and that’s the smallest component, actually it is related to our temporary importation bonds in Nigeria. Because those bonds are actually Naira, there is a small amount of restricted cash, $22 million, that we keep for that facility. The remainder of those $303 million comes from the project financing facility, about $150 million of that is debt service reserve account. So that’s a permanent piece.

We also have a minimum liquidity that has permanent fees of about $50 million. The remainder fluctuates. We have to fund six of the semestral payment every month, until we build up to the semestral payment. So if it’s the March quarter, we are about to pay the next payment the next semestral payment, the restricted cash would be higher. If it’s the June quarter, we have paid earlier, so that amount falls.

So you will see a moving portion as well a fixed portion. Today that fixed portion, as I mentioned, is roughly $222 million and the rest is moving depending on which quarter it is. I don’t know if that was clearly, the answer to your question.

Lukas Daul - SEB Investment Bank

Well, at least a little bit. So thanks for that. Finally, on the new credit facilities you are putting in place. You are obviously getting higher leverage per rig than you were getting previously, $50 million.

William Restrepo

I think we are actually getting lower leverage because the EBITDA for those rigs is substantially higher than EBITDA for the prior rigs. So going from $450 million to $500 million when rates have gone up by the $100,000 per day or more and all of that has increased EBITDA basically. It means that the ability to support that debt is much higher for the new rigs than for the older rigs.

Lukas Daul - SEB Investment Bank

Okay, so it's vey much sort of a contract specific. I was, maybe also thinking if you are getting, let's say, a bigger amount because of your building track record and et cetera having more rates in place as well?

William Restrepo

No, that’s definitely a part of it. Of course the delivery of the drillships below budget and on-time influences the bank's thinking, and the track record and so forth. But actually the contract for the Sharav at five years for $550,000 per day is a big driver in being able to obtain the kind of amounts.

Chris Beckett

Frankly, I would add to that also. The market conditions and the expectations therefore from Meltem is also obviously very supportive.

Operator

Our next question comes from Anders Bergland with Platou Markets.

Anders Bergland - Platou Markets

I just got some couple of questions on the market on the BOP side. There seems to be a new trend that your client wants to have a second BOP. So what's your thought around that? Whether you need to invest more in the BOP side?

Secondly, where do you see Petrobras moving from this point? It is awfully quiet from that side at the moment.

William Restrepo

Okay. So let's take the BOP question first. We have two BOPs on the Pacific Bora. The second BOP is just about ready to go. We have two BOPs ordered with the Pacific Sharav and all of our vessels have the capability of carrying a second BOP. But we haven’t put one in place on the other rigs yet.

We have ordered a spare BOP as we consider it today. So BOP in the fleet that would be available if the client wants two BOPs and he is willing to contribute towards the cost, always available as a backup system for the fleet, should we need it.

Our view on the second BOP is, it depends somewhat on where in the world you are working and it depends somewhat on the approach that the individual client takes to BOP maintenance and repair time and the necessary testing. If you working short wells or relatively shorter wells then you can rotate BOPS effectively.

Therefore, you would be doing maintenance and work on one whilst you work with the second and finish the maintenance just as you get ready to switch them then I think it can be an effective way to improve revenue efficiency. From our standpoint and frankly, more importantly, cost efficiency from the clients because obviously every day that we take, non-productive day, in their view, by doing the necessary maintenance which we may well get paid for, but they don’t get incremental whole from it, is a negative for them, which is why the clients are certainly looking at whether the investment in the second BOP or contribution towards the cost of the second BOP can make economic sense for them by saving nonproductive time from the well.

I think it’s a trend you will continue to see. We are certainly ensuring that all of our vessels have the ability not just to store a second BOP but also to run the necessary testing and so on, going forwards because I do think it will become increasingly common. I don’t think it is going to be an absolute requirement. I think it's an incremental benefit. But when we have it we would certainly expect and hope to get paid for that incremental capability.

Anders Bergland - Platou Markets

Okay, and on Brazil?

William Restrepo

On Brazil, there is a lots of rumors floating around the market that as we discussed on the last call, Petrobras had made very clear that they were going to take a little bit of a hiatus and do some internal work to work out exactly what the capabilities of the fleet they had under contract is already and sort of spend some time refining their plans on what they felt they needed in the fleet so they could see whether the two matched as well as they should do.

We are obviously beginning to hear some feedback from that process now that they are less enthusiastic about keeping, maybe water all the rigs around. We are certainly not seeing any indication from them at this point that they are going to slow down their activity with the ultra-deepwater rigs but maybe they are running a little slower in terms of expanding that fleet and I think that along with everybody else we are beginning to get the impression that their preference, if they can meet their production targets is going to be to keep the existing fleet as is and not roll in the new rigs until they get delivered from their domestic construction program.

Now whether that’s a practical reality, I think, it may take some time to become clear how quickly those rigs can be delivered. So it does look like it's unlikely that Petrobras will be in the market again this year. But look, these things can change pretty quickly. The nice thing about that we have seen over the course of 2012, it is such a significant strengthening of activity everywhere else in the world but while Petrobras is clearly an important client and a very significant piece of the ultra-deepwater market that they are no longer really the only game in town as I think there was a perception last year.

So I think that they may have slowed down their pace of growth but we don’t see them shrinking. I think we have seen the rest of the world more than take up the slack in terms of filling that growth.

Operator

(Operator Instructions) We will hear next from Darren Gacicia with Guggenheim.

Darren Gacicia - Guggenheim Securities

First, just with regard to the shakedown with the BOP. Is that an issue that was existing with the BOP upon delivery and if so, do you get some sort of reimbursement or is there some kind of qualification you have with the OEM there?

Chris Beckett

There is the BOP issues that we have experienced is part of the shakedown and they are fairly, unfortunately common. Generally revolve around the individual valves that’s fickle or don’t seal as well as they are supposed to. They are covered by a warranty. The manufacturer typically provides a replacement valve but really the cost of repairing these things pales into insignificance compared to the lost revenue whilst you are doing it. There is no protection from the equipment manufacturers for revenue loss.

So the answer is, yes, we do get some protection in terms of repair of the equipment but we don’t get any protection in terms of the revenue impact of being down.

Darren Gacicia - Guggenheim Securities

Then second, probably a little bit on Dave's question. Honestly, I want to ask about MLP, I think that that’s kind of a special entity but as you get into it now thinking about lowering your (inaudible) and I think the target visibility is (inaudible) getting the 10 to 12, if you are looking to see those delivered over the next couple of years and then think further out in terms of you start it once you pick target, is it something where we try to get a variable payout model? Maybe not on the MLP structure but have the potential to being a variable payout model and the longer term after you reached your growth targets?

Chris Beckett

Look, we are still discussing with the board exactly what would be the company's strategy in four years time but the base model, as we said, is to growth the company to we think, 10 to 12 rigs being an optimal size, both in terms of our ability to provide service quality to the clients and mange operations effectively. If we were to stop growing at that point then clearly the model would become one of returning the cash generated to shareholders in the most efficient way and that may well involve some form of variable payout. It may involve a baseload fixed dividend with a variable top-up.

But those are discussions that are ongoing with the board as we get closer to that being a reality but obviously we are still a couple years away from it being something we can actually deliver on.

Darren Gacicia - Guggenheim Securities

It's good to hear you put some serious thought ahead. If I could sneak one more in. Just in terms of timing of deliveries and crew. Given that there is a pretty big queue for deliveries and you need the top people in the industry, the crew on the drillships. Is the order time and the lag between the deliveries going to start widening for you guys or how do we want to think about that?

Chris Beckett

I think what we have said is, we have a set of criteria that we look at in terms of the pace at which we want to add capacity to the fleet and obviously there are some contracting criteria in that we have we talked about in terms of only having two uncommitted rigs in the fleet, newbuilds in the fleet. We have also talked about the financing requirements at length. As I said, the criteria revolves around operational capabilities and on our ability to introduce another rig and make sure that, as you say, we have the sufficient qualified, trained people.

Some elements of that have become easier for us because now we have an installed based upon which we can train new incremental people and we can start newbuilds coming out of the yard. We have got that we already have had working with us for an extended period and therefore we can now see the new rigs from the existing rigs which was something we couldn’t do before.

But we also, at the same time, have to run the base business of the rig we have operating and do it as well as we can. So you put all that together when we look at comfort factor, introducing new rigs to the fleet at the pace of one every nine to 12 months, that kind of order of magnitude would be the way we would think about it, going forwards.

Operator

It appears there are no questions or comments at this time.

Amy Roddy

Okay, thank you everyone for participating in Pacific Drilling's third quarter 2012 results conference call. William and I are available following the call for any additional questions. Thank you.

Operator

Ladies and gentlemen, that will conclude today's presentation. You may now disconnect.

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