DIAMOND OFFSHORE DRILLING INC - 10-Q Quarterly Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
------------- -------------

Commission file number 1-13926

DIAMOND OFFSHORE DRILLING, INC.
(Exact name of registrant as specified in its charter)

Delaware 76-0321760
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)

15415 Katy Freeway
Houston, Texas
77094
(Address of principal executive offices)
(Zip Code)
(281) 492-5300
(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]

Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.

As of August 12, 2002 Common stock, $0.01 par value per share 131,483,155 shares

DIAMOND OFFSHORE DRILLING, INC.

TABLE OF CONTENTS FOR FORM 10-Q

QUARTER ENDED JUNE 30, 2002

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS.

DIAMOND OFFSHORE DRILLING, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED
FINANCIAL STATEMENTS.

3

DIAMOND OFFSHORE DRILLING, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(In thousands, except per share data)

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED
FINANCIAL STATEMENTS.

4

DIAMOND OFFSHORE DRILLING, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED
FINANCIAL STATEMENTS.

5

DIAMOND OFFSHORE DRILLING, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1. GENERAL

The consolidated financial statements of Diamond Offshore Drilling, Inc.
and subsidiaries (the "Company") should be read in conjunction with the Annual
Report on Form 10-K for the year ended December 31, 2001 (File No. 1-13926).

Interim Financial Information

The accompanying consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of
America for interim financial information and with the instructions to Form 10-Q
and Article 10 of Regulation S-X. Accordingly, they do not include all
disclosures required by generally accepted accounting principles for complete
financial statements. The consolidated financial information has not been
audited but, in the opinion of management, includes all adjustments (consisting
only of normal recurring accruals) necessary for a fair presentation of the
consolidated balance sheets, statements of income, and statements of cash flows
at the dates and for the periods indicated. Results of operations for interim
periods are not necessarily indicative of results of operations for the
respective full years.

Cash and Cash Equivalents and Marketable Securities

Short-term, highly liquid investments that have an original maturity of
three months or less and deposits in money market mutual funds that are readily
convertible into cash are considered cash equivalents. Cash equivalents at June
30, 2002 and December 31, 2001 included $252.2 million and $199.1 million,
respectively, of collateral received in connection with securities sold under
repurchase agreements. See "Securities Sold Under Agreements to Repurchase."

The Company's investments are classified as available for sale and stated
at fair value. Accordingly, any unrealized gains and losses, net of taxes, are
reported in the Consolidated Balance Sheets in "Accumulated other comprehensive
income" until realized. The cost of debt securities is adjusted for amortization
of premiums and accretion of discounts to maturity and such adjustments are
included in the Consolidated Statements of Income in "Interest income." The sale
and purchase of securities are recorded on the date of the trade. The cost of
debt securities sold is based on the specific identification method and the cost
of equity securities sold is based on the average cost method. Realized gains or
losses and declines in value, if any, judged to be other than temporary are
reported in the Consolidated Statements of Income in "Other income (expense)."

Securities Sold Under Agreements to Repurchase

The Company accounts for repurchase agreements in accordance with
Statement of Financial Accounting Standards ("SFAS") No. 140, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities."
From time to time the Company may lend securities to unrelated parties,
primarily major brokerage firms. Borrowers of these securities must deposit
collateral with the Company equal to 100% of the fair value of these securities,
if the collateral is cash, or 102% of the fair value of the securities, if the
collateral is securities. Cash deposits from these transactions are invested in
short-term investments and are included in the Consolidated Balance Sheets in
"Cash and cash equivalents." A liability of $252.2 million at June 30, 2002 and
$199.1 million at December 31, 2001 was recognized for the obligation to return
the collateral. The Company continues to receive interest income on the loaned
debt securities, as beneficial owner, and accordingly, the loaned debt
securities are included in the Consolidated Balance Sheets in "Marketable
securities." The fair value of collateral held and included with "Marketable
securities" at June 30, 2002 and December 31, 2001 was $252.9 million and $198.7
million, respectively. Interest expense associated with the related liability is
recorded as an offset to "Interest income" in the Consolidated Statements of
Income.

Derivative Financial Instruments

The Company accounts for derivative financial instruments in accordance
with SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities" and its corresponding amendments under SFAS No. 138.

6

Derivative financial instruments of the Company include forward exchange
contracts and a contingent interest provision that is embedded in the 1.5%
convertible senior debentures due 2031 (the "1.5% Debentures") issued on April
11, 2001. See Note 4.

Supplementary Cash Flow Information

Cash payments made for interest on long-term debt, including commitment
fees, totaled $3.4 million for the six months ended June 30, 2002 and $7.5
million for the six months ended June 30, 2001. Cash payments for foreign income
taxes, net of foreign tax refunds, were $6.6 million during the six months ended
June 30, 2002. A $14.5 million net cash refund of U.S. income tax was received
during the six months ended June 30, 2002. Cash payments for income taxes, net
of foreign tax refunds, made during the six months ended June 30, 2001 totaled
$2.2 million.

Capitalized Interest

Interest cost for construction and upgrade of qualifying assets is
capitalized. A reconciliation of the Company's total interest cost to "Interest
expense" as reported in the Consolidated Statements of Income is as follows:

Goodwill

Prior to January 1, 2002, goodwill from the merger with Arethusa
(Off-Shore) Limited ("Arethusa") had been amortized on a straight-line basis
over 20 years. The Company adopted SFAS No. 142, "Goodwill and Other Intangible
Assets" on January 1, 2002 and, accordingly, has suspended amortization of
goodwill. Goodwill and accumulated amortization on January 1, 2002 was $69.0
million and $30.7 million, respectively. Amortization charged to operating
expense during the quarter and six months ended June 30, 2001 totaled $0.8
million and $1.7 million, respectively. Goodwill is reduced for adjustments
representing tax benefits not previously recognized for the excess of tax
deductible goodwill over book goodwill. See Note 6.

Debt Issuance Costs

Debt issuance costs are included in the Consolidated Balance Sheets in
"Other assets" and are amortized over the terms of the related debt.

Treasury Stock and Common Equity Put Options

Depending on market conditions, the Company may, from time to time,
purchase shares of its common stock or issue put options in the open market or
otherwise. The purchase of treasury stock is accounted for using the cost method
which reports the cost of the shares acquired in "Treasury stock" as a deduction
from stockholders' equity in the Consolidated Balance Sheets.

During the six months ended June 30, 2002 the Company purchased 500,000
shares of its common stock at an aggregate cost of $20.0 million, or $40.00 per
share, upon the exercise of put options sold in February 2001. The Company
reduced "Additional paid-in-capital" in the Consolidated Balance Sheet by $3.1
million, the amount of the premium received for the sale of these put options,
and reported the net cost of the shares, $16.9 million, in "Treasury stock."
During the six months ended June 30, 2001, the Company purchased 100,000 shares
of its common stock, which settled on July 3, 2001, at an aggregate cost of $3.3
million, or at an average cost of $33.00 per share. In August 2002 the Company
purchased 70,000 shares of its common stock at an aggregate cost of $1.4
million, or at an average cost of $20.59 per share.

7

The Company settled put options which covered 1,000,000 shares of its
common stock during the first six months of 2002 with cash payments totaling
$1.2 million and reduced "Additional paid-in-capital" in the Consolidated
Balance Sheet for amounts paid to settle these put options. The Company's
remaining put options sold in 2001, which covered 187,321 shares of the
Company's common stock, expired during the first half of 2002.

Comprehensive Income

Comprehensive income is the change in equity of a business enterprise
during a period from transactions and other events and circumstances except
those transactions resulting from investments by owners and distributions to
owners. For the quarter and six months ended June 30, 2002, comprehensive income
totaled $18.8 million and $34.7 million, respectively. For the quarter and six
months ended June 30, 2001, comprehensive income totaled $39.7 million and $81.4
million, respectively. Comprehensive income includes net income, foreign
currency translation gains and losses, minimum pension liability adjustments and
unrealized holding gains and losses on marketable securities.

Currency Translation

The Company's primary functional currency is the U.S. dollar. Certain of
the Company's subsidiaries use the local currency in the country where they
conduct operations as their functional currency. These subsidiaries translate
assets and liabilities at period-end exchange rates while income and expense
accounts are translated at average exchange rates. Translation adjustments are
reflected in the Consolidated Balance Sheets in "Accumulated other comprehensive
gains/ (losses)." Currency transaction gains and losses are included in the
Consolidated Statements of Income in "Other income (expense)." Additionally,
translation gains and losses of subsidiaries operating in hyperinflationary
economies are included in operating results.

Revenue Recognition

Income from dayrate drilling contracts is recognized currently. In
connection with such drilling contracts, the Company may receive lump-sum fees
for the mobilization of equipment and personnel. The excess of mobilization fees
received over costs incurred to mobilize an offshore rig from one market to
another is recognized over the term of the related drilling contract. Absent a
contract, mobilization costs are recognized currently. Lump-sum payments
received from customers relating to specific contracts are deferred and
amortized to income over the term of the drilling contract.

Income from offshore turnkey drilling contracts is recognized on the
completed contract method, with revenues accrued to the extent of costs until
the specified turnkey depth and other contract requirements are met. Provisions
for future losses on turnkey drilling contracts are recognized when it becomes
apparent that expenses to be incurred on a specific contract will exceed the
revenue from that contract.

Use of Estimates in the Preparation of Financial Statements

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amount of revenues and
expenses during the reporting period. Actual results could differ from those
estimated.

Reclassifications

Certain amounts applicable to prior periods have been reclassified to
conform to the classifications currently followed. Such reclassifications do not
affect earnings.

8

Recent Accounting Pronouncements

In July 2002 the Financial Accounting Standards Board ("FASB") issued SFAS
No. 146, "Accounting for Costs Associated with Exit or Disposal Activities."
SFAS No. 146 requires companies to recognize costs associated with exit or
disposal activities when they are incurred rather than at the date of a
commitment to an exit or disposal plan. SFAS No. 146 is to be applied
prospectively to exit or disposal activities initiated after December 31, 2002.
The Company does not expect the adoption of SFAS No. 146 to have a material
impact on the Company's consolidated results of operations, financial position
or cash flows.

In April 2002 the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment to FASB Statement No. 13, and Technical
Corrections." The rescission of SFAS No. 4 and 64 by SFAS No. 145 streamlines
the reporting of debt extinguishments and requires that only gains and losses
from extinguishments meeting the criteria in Opinion 30 would be classified as
extraordinary. Thus, gains or losses arising from extinguishments that are part
of a company's recurring operations would not be reported as an extraordinary
item. SFAS No. 145 is effective for fiscal years beginning after May 15, 2002
with earlier adoption encouraged. The Company adopted SFAS No. 145 in April 2002
and, accordingly, reclassified its April 2001 extraordinary loss of $7.7
million, from early extinguishment of debt, as a result of the Company's
redemption of its outstanding 3.75% Convertible Subordinated Notes due 2007. The
pre-tax loss from early extinguishment of debt of $11.9 million was reclassified
to "Interest expense." The related tax benefit was reclassified to "Income tax
expense."

In October 2001 the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS No. 144 replaces SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of" and provides updated guidance concerning the
recognition and measurement of an impairment loss for certain types of
long-lived assets. SFAS No. 144 is effective for fiscal years beginning after
December 15, 2001 with earlier application encouraged. The Company's adoption of
SFAS No. 144 in January 2002 has not had, nor is it expected to have, a material
impact on the Company's consolidated results of operations, financial position
or cash flow.

In August 2001 the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." SFAS No. 143 addresses financial accounting and
reporting obligations associated with the retirement of tangible, long-lived
assets and their associated asset retirement costs. SFAS No. 143 is effective
for fiscal years beginning after June 15, 2002 with early adoption encouraged.
Adoption of SFAS No. 143 in 2003 is not expected to have a material impact on
the Company's consolidated results of operations, financial position or cash
flows.

In June 2001 the FASB issued two new pronouncements, SFAS No. 141,
"Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible
Assets." SFAS No. 141 requires that all business combinations be accounted for
by the purchase method and applies to all business combinations initiated after
June 30, 2001 and also applies to all business combinations accounted for using
the purchase method for which the date of acquisition is July 1, 2001 or later.
There are also transition provisions that apply to business combinations
completed before July 1, 2001, that were accounted for by the purchase method.
SFAS No. 142 is effective for fiscal years beginning after December 15, 2001 for
all goodwill and other intangible assets recognized in an entity's statement of
financial position at that date, regardless of when those assets were initially
recognized. The Company adopted SFAS No. 142 on January 1, 2002 and has
suspended amortization of goodwill. The adoption of SFAS No. 142 has not had,
nor is it expected to have, a material impact on the Company's consolidated
results of operations, financial position or cash flows. See Note 6.

9

2. EARNINGS PER SHARE

A reconciliation of the numerators and the denominators of the basic and
diluted per-share computations follows:

The computation of diluted earnings per share ("EPS") for the quarter
ended June 30, 2002 excludes approximately 9.4 million potentially dilutive
shares issuable upon conversion of the Company's 1.5% Debentures, issued in
April 2001. Diluted EPS for the quarter and six months ended June 30, 2002 and
2001 also excludes approximately 6.9 million potentially dilutive shares
issuable upon conversion of the Company's zero coupon convertible debentures due
2020 ("Zero Coupon Debentures"), issued in June 2000. The inclusion of such
shares would be antidilutive.

Put options covering 1,687,321 shares of common stock at various stated
exercise prices per share were outstanding during part of the first half of 2002
prior to their expiration or settlement. The computation of diluted EPS for the
quarter and six months ended June 30, 2002 excluded put options covering
1,687,321 shares and 1,187,321 shares of common stock, respectively, because the
options' exercise prices were less than the average market price of the common
stock.

The incremental shares calculated from non-qualified stock options that
were included in the computation of diluted EPS for the quarter and six months
ended June 30, 2002 did not include stock options representing 182,700 shares of
common stock. The incremental shares calculated from non-qualified stock options
included in the computation of diluted EPS for the quarter and six months ended
June 30, 2001 were immaterial for presentation purposes and did not include
stock options representing 112,000 shares of common stock. Certain stock options
were excluded because the options' exercise prices were more than the average
market price per share of the common stock.

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3. MARKETABLE SECURITIES

Investments classified as available for sale are summarized as follows:

All of the Company's investments are included as current assets in the
Consolidated Balance Sheets in "Marketable securities," representing the
investment of cash available for current operations.

Proceeds from sales of marketable securities and gross realized gains and
losses are summarized as follows:

4. DERIVATIVE FINANCIAL INSTRUMENTS

Forward Exchange Contracts

The Company operates internationally, resulting in exposure to foreign
exchange risk. This risk is primarily associated with costs payable in foreign
currencies for employee compensation and for purchases from foreign suppliers.
The Company's primary technique for minimizing its foreign exchange risk
involves structuring customer contracts to provide for payment in both the U. S.
dollar and the foreign currency whenever possible. The payment portion
denominated in the foreign currency is based on anticipated foreign currency
requirements over the contract term. In some instances, a foreign exchange
forward contract is used to minimize the forward exchange risk. A forward
exchange contract obligates the Company to exchange predetermined amounts of
specified foreign currencies at specified foreign exchange rates on specified
dates.

11

In June 2002 the Company entered into forward exchange contracts to
purchase approximately 50.0 million Australian dollars; 4.2 million Australian
dollars to be purchased monthly from August 29, 2002 through June 26, 2003 and
3.8 million to be purchased on July 31, 2003. In July 2001 the Company entered
into twelve forward contracts to purchase 3.5 million Australian dollars each
month from August 31, 2001 through July 31, 2002. These forward contracts are
derivatives as defined by SFAS No. 133. SFAS No. 133 requires that each
derivative be stated in the balance sheet at its fair value with gains and
losses reflected in the income statement except that, to the extent the
derivative qualifies for hedge accounting, the gains and losses are reflected in
income in the same period as offsetting losses and gains on the qualifying
hedged positions. SFAS No. 133 further provides specific criteria necessary for
a derivative to qualify for hedge accounting. The forward exchange contracts
purchased by the Company in 2002 and 2001 do not qualify for hedge accounting.
At June 30, 2002, an asset of $0.2 million, reflecting the fair value of the
forward exchange contracts, was included with "Prepaid expenses and other" in
the Consolidated Balance Sheet. A pre-tax gain of $0.5 million (comprised of a
$0.6 million realized gain and a $0.1 million unrealized loss) was recorded in
the Consolidated Statements of Income for the quarter ended June 30, 2002 in
"Other income (expense)." A pre-tax gain of $1.2 million (comprised of a $0.9
million realized gain and a $0.3 million unrealized gain) was recorded in the
Consolidated Statements of Income for the six months ended June 30, 2002 in
"Other income (expense)." The Company had no forward exchange contracts during
the first six months of 2001.

Contingent Interest

On April 11, 2001, the Company issued $460.0 million principal amount of
the 1.5% Debentures, which are due April 15, 2031 and contain a contingent
interest provision (see Note 8). The contingent interest component is an
embedded derivative as defined by SFAS No. 133 and accordingly must be split
from the host instrument and recorded at fair value on the balance sheet. The
contingent interest component had no value at issuance or at June 30, 2002.

5. DRILLING AND OTHER PROPERTY AND EQUIPMENT

Cost and accumulated depreciation of drilling and other property and
equipment are summarized as follows:

Construction work-in-progress at June 30, 2002, included $59.1 million for
the significant upgrade of the Ocean Rover to high specification capabilities.

In March 2002, $157.4 million was reclassified from construction
work-in-progress to drilling rigs and equipment upon completion of the
significant upgrade of the Ocean Baroness to high specification capabilities.
The Company took delivery of the Ocean Baroness in January 2002 and it was
accepted by the customer on March 17, 2002 at which time it began its current
contract offshore Malaysia. See "Ocean Baroness Update" in Item 2 of Part I of
this report.

6. GOODWILL

Goodwill from the merger with Arethusa in 1996 was generated from an
excess of the purchase price over the net assets acquired. Prior to January 1,
2002 the Company was amortizing goodwill on a straight-line basis over 20 years.
The Company adopted SFAS No. 142 on January 1, 2002 and, accordingly, has
suspended amortization of goodwill in 2002.

12

The Company's net income and earnings per share, adjusted to exclude
amortization expense (net of its related tax benefit) for the quarter and six
months ended June 30, 2002 and 2001, are as follows:

For purposes of applying SFAS No. 142, the Company determined that it has
one reporting unit to which to assign goodwill. As of January 1, 2002, the
Company performed the transitional goodwill impairment test and determined that
the fair value of the reporting unit exceeded its carrying value, and
accordingly, no further testing for goodwill impairment was required.

There were no recognized intangible assets other than goodwill associated
with the Arethusa merger.

During each of the six months ended June 30, 2002 and 2001, an adjustment
of $6.8 million was recorded to reduce goodwill. The adjustments represent the
tax benefits not previously recognized for the excess of tax deductible goodwill
over book goodwill. The Company will continue to reduce goodwill in future
periods as the tax benefits of excess tax goodwill over book goodwill is
recognized. Goodwill is expected to be reduced to zero during the year 2004.

7. ACCRUED LIABILITIES

Accrued liabilities consist of the following:

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8. LONG-TERM DEBT

Long-term debt consists of the following:

9. COMMITMENTS AND CONTINGENCIES

Raymond Verdin, on behalf of himself and those similarly situated v. Pride
Offshore, Inc., et al; C.A. No. G-01-168 in the United States District Court for
the Southern District of Texas, Houston Division; formerly styled Raymond Verdin
v. R&B Falcon Drilling USA, Inc., et al; No. G-00-488 in the United States
District Court for the Southern District of Texas, Galveston Division, filed
October 10, 2000. The Company was named as a defendant in a proposed class
action suit filed on behalf of offshore workers against all of the major
offshore drilling companies. The proposed class included persons hired in the
United States by the companies to work in the Gulf of Mexico and around the
world. The allegation was that the companies, through trade groups, shared
information in violation of the Sherman Antitrust Act and various state laws.
Plaintiff Thomas Bryant replaced the named plaintiff as the proposed class
representative. The lawsuit was seeking money damages and injunctive relief as
well as attorneys' fees and costs. During the first quarter of 2001, the Company
recorded a $10.0 million reserve for this pending litigation in the Company's
Consolidated Statements of Income. In July 2001 the Company filed a stipulation
of settlement with the District Court in which it agreed to settle the
plaintiffs' outstanding claims for certain injunctive relief and a cash payment
within the limits of the reserve. In April 2002 the United States District Judge
for the Southern District of Texas, Houston Division, entered an order finally
approving the proposed class action settlement and finally certifying the
settlement class, and entered a final judgment and order of dismissal of this
lawsuit. In June 2002 the Company made the final settlement payment of $9.4
million from its reserve for this litigation.

Various other claims have been filed against the Company in the ordinary
course of business, particularly claims alleging personal injuries. Management
believes that the Company has established adequate reserves for any liabilities
that may reasonably be expected to result from these claims. In the opinion of
management, no pending or threatened claims, actions or proceedings against the
Company are expected to have a material adverse effect on the Company's
consolidated financial position, results of operations, or cash flows.

10. SEGMENTS AND GEOGRAPHIC AREA ANALYSIS

The Company reports its operations as one reportable segment, contract
drilling of offshore oil and gas wells. Although the Company provides contract
drilling services from different types of offshore drilling rigs and provides
such services in many geographic locations, these operations have been
aggregated into one reportable segment based on the similarity of economic
characteristics among all divisions and locations, including the nature of
services provided and the type of customers of such services.

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Similar Services

Revenues from external customers for contract drilling and similar
services by equipment-type are listed below (eliminations offset dayrate
revenues earned when the Company's rigs are utilized in its integrated
services):

Geographic Areas

At June 30, 2002, the Company had drilling rigs located offshore nine
countries other than the United States. As a result, the Company is exposed to
the risk of changes in social, political, economic and other conditions inherent
in foreign operations and the Company's results of operations and the value of
its foreign assets are affected by fluctuations in foreign currency exchange
rates. Revenues by geographic area are presented by attributing revenues to the
individual country or areas where the services were performed.

11. OTHER INCOME AND EXPENSE (OTHER, NET)

Other, net consists of the following:

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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.

The following discussion should be read in conjunction with the Company's
Consolidated Financial Statements (including the Notes thereto) included
elsewhere herein. References to the "Company" mean Diamond Offshore Drilling,
Inc., a Delaware corporation, and its subsidiaries.

The Company is a leader in deep water drilling with a fleet of 45 offshore
drilling rigs. The fleet consists of 30 semisubmersibles, 14 jack-ups and one
drillship.

RESULTS OF OPERATIONS

Recent Developments

On August 9, 2002, the Company's jack-up drilling unit the Ocean King,
while conducting routine operations offshore Louisiana, experienced a well
control event and fire. The rig's standing emergency action plan was initiated
and all personnel on board the rig were safely evacuated. There were no reported
injuries and no apparent pollution. The fire burned a short time and the rig was
reboarded later that day by a limited crew. Early assessments reveal that damage
was localized; primarily affecting electrical systems on the aft end of the
cantilever structure. At this time, primary rig systems do not appear to be
affected.

Ocean Baroness Update

On April 22, 2002 the Ocean Baroness experienced a parting of its marine
riser during operations offshore Malaysia in 5,700 feet of water. No injuries
were sustained and the well was secured without incident and successfully
plugged. The drilling unit was undamaged and known damage was limited to
subsurface elements of the riser. The rig resumed normal operations on May 19,
2002 after retrieving its marine riser. On May 30, 2002, the Company filed a
lawsuit against the manufacturer of the marine riser seeking to recover damages
the Company incurred as a result of the incident.

General

Revenues. The Company's revenues vary based upon demand, which affects the
number of days the fleet is utilized and dayrates earned. When a rig is idle,
generally no dayrate is earned and revenues will decrease as a result. Revenues
can also increase or decrease as a result of the acquisition or disposal of
rigs. In order to improve utilization or realize higher dayrates, the Company
may mobilize its rigs from one market to another. During periods of
mobilization, however, revenues may be adversely affected. As a response to
changes in demand, the Company may withdraw a rig from the market by stacking it
or may reactivate a rig stacked previously, which may decrease or increase
revenues, respectively.

Revenues from dayrate drilling contracts are recognized currently. The
Company may receive lump-sum payments in connection with specific drilling
contracts. Such payments are recognized as revenues over the term of the related
drilling contract. Mobilization revenues, less costs incurred to mobilize an
offshore rig from one market to another, are recognized over the term of the
related drilling contract.

Revenues from offshore turnkey contracts are accrued to the extent of
costs until the specified turnkey depth and other contract requirements are met.
Income is recognized on the completed contract method. Provisions for future
losses on turnkey contracts are recognized when it becomes apparent that
expenses to be incurred on a specific contract will exceed the revenue from that
contract.

Operating Income. Operating income is primarily affected by revenue
factors, but is also a function of varying levels of operating expenses.
Operating expenses generally are not affected by changes in dayrates and may not
be significantly affected by fluctuations in utilization. For instance, if a rig
is to be idle for a short period of time, the Company may realize few decreases
in operating expenses since the rig is typically maintained in a prepared state
with a full crew. In addition, when a rig is idle, the Company is responsible
for certain operating expenses such as rig fuel and supply boat costs, which are
typically charged to the operator under drilling contracts. However, if the rig
is to be idle for an extended period of time, the Company may reduce the size of
a rig's crew and take steps to "cold stack" the rig, which lowers expenses and
partially offsets the impact on operating income. The Company recognizes as
operating expenses activities such as inspections, painting projects and routine
overhauls, which meet certain criteria, that maintain rather than upgrade its
rigs. These expenses vary from period to period. Costs of rig enhancements are
capitalized and depreciated over the expected useful lives of the enhancements.
Increased depreciation expense decreases operating income in periods subsequent
to capital upgrades.

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THREE MONTHS ENDED JUNE 30, 2002 AND 2001

Comparative data relating to the Company's revenues and operating expenses
by equipment type are listed below (eliminations offset (i) dayrate revenues
earned when the Company's rigs are utilized in its integrated services and (ii)
intercompany expenses charged to rig operations). Certain amounts applicable to
the prior periods have been reclassified to conform to the classifications
currently followed. Such reclassifications do not affect earnings.

High Specification Floaters.

Revenues. Revenues from high specification floaters decreased $6.8 million
during the quarter ended June 30, 2002 compared to the same quarter of 2001.
Lower utilization in 2002 accounted for $11.3 million of the decrease (excluding
the Ocean Baroness). Utilization for this class of rig dropped from 96% during
the second quarter of 2001 to 82% during the second quarter of 2002 (excluding
the Ocean Baroness). The Ocean America was idle for a majority of the second
quarter of 2002 and was responsible for $9.0 million of the decline. Lower
utilization of the Ocean Star, which spent approximately one month in a shipyard
for inspection and repairs in 2002, resulted in reduced revenues of $3.2
million.

A decline in average operating dayrates, which fell from $117,700 per day
for the second quarter of 2001 to $108,100 per day for the second quarter of
2002 (excluding the Ocean Baroness), caused $7.0 million of the overall revenue
reduction. The most significant decreases in dayrates were experienced by the
Ocean Valiant ($41,200), the Ocean Star ($32,300) and the Ocean Victory
($27,100).

Partially offsetting the overall decrease in revenues was $11.5 million
generated by the Ocean Baroness, which began operations in mid-March 2002 upon
completion of its upgrade to high specification capabilities.

Contract Drilling Expense. Contract drilling expense for high
specification floaters during the quarter ended June 30, 2002 increased $7.8
million from the same period in 2001 primarily due to $6.7 million of expenses
from the Ocean Baroness. Contract drilling expense for the Ocean Baroness
included costs incurred in connection with the recovery of its marine riser, net
of costs charged to an associated insurance claim, as well as its normal
operating

17

costs. See "-- Ocean Baroness Update." Contract drilling expense for the Ocean
America increased $1.3 million over the second quarter of 2001 due to various
maintenance projects performed while the rig was idle and mobilization costs
incurred when the rig returned to work at the end of the second quarter of 2002.
Contract drilling expense for the Ocean Star was $0.9 million higher in the
second quarter of 2002 as a result of its inspection and repairs while in a
shipyard. Lower spending for maintenance and repairs in the second quarter of
2002 by several other high specification floaters partially mitigated these
unfavorable variances.

Other Semisubmersibles.

Revenues. Revenues from other semisubmersibles for the quarter ended June
30, 2002 decreased $23.1 million from the same period in 2001. A decline in
utilization accounted for $21.1 million of this decrease as utilization fell to
54% in the second quarter of 2002 from 75% in the same period of 2001. The Ocean
Voyager and the Ocean Endeavor were both cold stacked the entire second quarter
of 2002 but worked most of the second quarter of 2001. The Ocean New Era, Ocean
Ambassador, Ocean Lexington and the Ocean Saratoga were each idle more days in
the second quarter of 2002 than in the same period of 2001. The Ocean General
was in a shipyard for approximately one month during the second quarter of 2002
for an inspection and preparation for its mobilization to Vietnam but worked the
entire second quarter of 2001. Partially offsetting these revenue decreases were
utilization improvements for the Ocean Princess, Ocean Whittington, and Ocean
Guardian, all of which worked more days in the second quarter of 2002 than in
the same period of 2001.

Of the $23.1 million revenue decline in the second quarter of 2002, $2.0
million resulted from lower overall dayrates earned by the other semisubmersible
rig fleet. However, the average operating dayrate for this fleet increased from
$65,000 during the second quarter of 2001 to $71,500 during the second quarter
of 2002. This occurred because several of the rigs that were contracted at lower
dayrates in the second quarter of 2001 were stacked throughout the second
quarter of 2002. Consequently, the average operating dayrate rose in 2002 for
the working rigs in this category. Significant changes in operating dayrates
included the Ocean Worker which decreased approximately $83,100, and the Ocean
Guardian and Ocean Princess which increased approximately $33,300 and $35,300,
respectively.

Contract Drilling Expense. Contract drilling expense for other
semisubmersibles decreased $2.9 million during the quarter ended June 30, 2002
compared to the same quarter of 2001. Contract drilling expense was $4.6 million
lower than the same period in 2001 as a result of cold stacking the Ocean
Voyager and Ocean Endeavor in 2002. Cost savings of $1.2 million were achieved
by reducing crews on the Ocean New Era and the Ocean Ambassador, both of which
were stacked during the second quarter of 2002. Partially offsetting the expense
reductions were increased expenses of $1.3 million for inspection and repair and
the mobilization of the Ocean General to Vietnam and $0.7 million for equipment
maintenance and repairs on the Ocean Liberator.

Jack-Ups.

Revenues. Revenues from jack-ups decreased $20.7 million in the second
quarter of 2002 compared to the same period in 2001. Average operating dayrates
of $28,700 during the second quarter of 2002, down from $43,700 during the first
quarter of 2001, resulted in $12.3 million of the decrease. All of the Company's
jack-up rigs, except one, experienced lower average dayrates in the second
quarter of 2002. The average dayrate of the exception, the Ocean Heritage,
increased $47,300 from the second quarter of 2001 to the second quarter of 2002
and contributed $3.9 million to revenues. In addition, the Ocean Heritage
received a $2.4 million demobilization fee upon completion of its contract in
Australia in the second quarter of 2002.

Revenues decreased $8.4 million as a result of a decline in utilization
for the Company's jack-up fleet to 74% for the quarter ended June 30, 2002 from
85% for the same period in 2001. Utilization for the Ocean Spartan and the Ocean
Spur was down for the second quarter of 2002 as both rigs were undergoing leg
extension upgrades during the period. Utilization also declined for the Ocean
Champion which was cold stacked during the second quarter of 2002 but worked the
entire second quarter of 2001. Utilization improved for the Ocean Sovereign,
which worked throughout the second quarter of 2002 but spent the entire second
quarter of 2001 in a shipyard for repairs, partially offsetting the revenue
decline.

Contract Drilling Expense. Contract drilling expense for jack-ups during
the second quarter of 2002 decreased $3.6 million compared to the same period in
2001. Contract drilling expense for the Ocean Spartan and the Ocean Spur was
lower by $2.4 million for the second quarter of 2002 as a result of capitalizing
costs while these rigs were in a shipyard for leg extension upgrades. Contract
drilling expense for the Ocean Champion, cold stacked during

18

the second quarter of 2002, decreased $1.8 million from the same quarter in
2001. Partially offsetting this decrease, the Ocean Heritage experienced an
increase in contract drilling expenses of $0.6 million from higher labor costs
while working in Australia during the second quarter of 2002 compared to the
labor costs incurred while working in Indonesia during the second quarter of
2001.

Integrated Services.

Operating income for integrated services decreased in the second quarter
of 2002 compared to the second quarter of 2001 as a result of the difference in
type and magnitude of projects during those periods. During the second quarter
of 2002, an integrated services' operating loss of $0.3 million resulted from
two turnkey wells in the Gulf of Mexico. During the same period in 2001,
operating income of $0.2 million was primarily due the completion of one
international turnkey project.

Depreciation and Amortization Expense.

Depreciation and amortization expense for the second quarter of 2002
increased $2.4 million over the second quarter of 2001. Higher 2002 depreciation
resulted primarily from an increase in capital additions and additional
depreciation for the Ocean Baroness, which completed its deepwater upgrade and
began operations in March 2002. The suspension of goodwill amortization on
January 1, 2002 partially offset this increase. See Note 1 "--Goodwill" and Note
6 of the Company's Consolidated Financial Statements in Item 1 of Part I of this
report.

General and Administrative Expense.

General and administrative expense for the second quarter of 2002 of $7.4
million increased $1.3 million over $6.1 million for the second quarter of 2001.
This increase was primarily due to higher personnel costs and professional
expenses in the current quarter.

Interest Income.

Interest income of $7.7 million for the quarter ended June 30, 2002
decreased $3.9 million from $11.6 million for the same period in 2001 primarily
due to lower interest rates earned on invested cash and marketable securities in
2002. Interest expense of $0.4 million incurred in connection with the Company's
repurchase agreements also contributed to the decrease in the quarter ended June
30, 2002. See Note 1 "--Securities Sold Under Agreements to Repurchase" in Item
I of Part I of this report.

Interest Expense.

Interest expense of $6.3 million for the quarter ended June 30, 2002
decreased $11.7 million from $18.0 million for the same period in 2001 primarily
due to the $ 11.9 million pre-tax loss from the April 2001 redemption of the
Company's 3.75% Convertible Subordinated Notes Due 2007 ("3.75% Notes"). In
addition, the Company's interest rate in 2002 was lower than in 2001 resulting
from the redemption of the 3.75% Notes in 2001 and the issuance of the 1.5%
Convertible Senior Debentures due 2031 (the "1.5% Debentures") on April 11,
2001. Interest capitalized to rig upgrades in the second quarter of 2002
decreased compared to the same period in 2001 and partially offset the decrease
in interest expense.

Income Tax Expense.

Income tax expense of $6.6 million for the quarter ended June 30, 2002
decreased $14.8 million from $21.4 million for the same period in 2001 primarily
as a result of the $46.6 million decrease in "Income before income tax expense"
in the second quarter of 2002.

The 35.6% effective income tax rate for the second quarter of 2002
resulted from a revision of the estimated annual effective tax rate from 30.6%
anticipated in the first quarter of 2002 to 32.4% in the second quarter of 2002.
The Company indefinitely reinvests the earnings of its U.K. subsidiaries and,
accordingly, provides no deferred U.S. income taxes on these earnings. The tax
rate in the U.K. is lower than the U.S. statutory rate. During the second
quarter of 2002, the full year projected earnings of the Company's U.K.
subsidiaries changed relative to the Company's projected worldwide earnings.
Second quarter 2002 tax expense includes an adjustment to bring the effective
tax rate for the full year to 32.4%.

19

SIX MONTHS ENDED JUNE 30, 2002 AND 2001

Comparative data relating to the Company's revenues and operating expenses
by equipment type are listed below (eliminations offset (i) dayrate revenues
earned when the Company's rigs are utilized in its integrated services and (ii)
intercompany expenses charged to rig operations). Certain amounts applicable to
the prior periods have been reclassified to conform to the classifications
currently followed. Such reclassifications do not affect earnings.

High Specification Floaters.

Revenues. Revenues from high specification floaters during the six months
ended June 30, 2002 decreased $8.8 million from the same period in 2001. A
decline in utilization accounted for $14.5 million of the decrease as
utilization declined from 96% during the first six months of 2001 to 85%
(excluding the Ocean Baroness) during the same period in 2002. Utilization for
the Ocean America declined as the rig was idle for most of the first half of
2002. In addition, the Ocean Star spent three months in 2002 in a shipyard for
inspection and repairs but worked all of the first six months of 2001.

Lower average operating dayrates accounted for $8.2 million of the
decrease in revenue for this classification of rig. Average dayrates fell from
$115,000 during the six months ended June 30, 2001 to $111,500 (excluding the
Ocean Baroness) during the same period in 2002. The most significant dayrate
decreases were experienced by the Ocean Valiant ($36,700) and the Ocean Victory
($20,700). These decreases were partially offset by an increase in the average
operating dayrate for the Ocean America from $98,800 to $118,000 per day.

The Ocean Baroness, which began operations in mid-March 2002 after
completing an upgrade to high specification capabilities, contributed $13.9
million to revenue during the first half of 2002.

Contract Drilling Expense. Contract drilling expense for high
specification floaters during the six months ended June 30, 2002 increased $15.1
million from the same period in 2001. Operating expenses for the Ocean Baroness
added $7.5 million to contract drilling expense in the first six months of 2002
and included costs incurred in connection with the recovery of its marine riser,
net of costs charged to an associated insurance claim, as well as

20

its normal operating costs. See "-- Ocean Baroness Update." Mobilization to and
from the shipyard for inspection and repairs of the Ocean Star in 2002 resulted
in increased expenses of $2.0 million. Higher Brazilian customs fees in 2002 for
the importation of spare parts and supplies for the Ocean Alliance and the Ocean
Clipper were responsible for increased costs of $1.5 million. The 2001
recognition of a $1.8 million revision to an estimated insurance deductible for
the Ocean Clipper also contributed to the cost increase in 2002.

Other Semisubmersibles.

Revenues. Revenues from other semisubmersibles for the six months ended
June 30, 2002 decreased $16.0 million from the same period in 2001. A decline in
utilization accounted for $15.7 million of the decrease as utilization dropped
from 69% for the first half of 2001 to 61% for the first half of 2002. During
part of the first half of 2002 the Ocean Worker was in a shipyard for inspection
and repairs and the Ocean Saratoga was in a shipyard for repairs, while both
rigs worked most of the first half of 2001. The Ocean Ambassador and the Ocean
General were stacked for more days in the first half of 2002 than in the same
period in 2001 and the Ocean Voyager and the Ocean Endeavor were cold stacked in
March 2002. An improvement in utilization for the Ocean Nomad, which worked most
of the first half of 2002 but spent most of the first half of 2001 in a shipyard
undergoing stability enhancements and other upgrades, was partially offsetting.

Revenues in the first half of 2002 were not significantly affected by the
overall change in dayrates from the same period in 2001. However, the average
operating dayrate increased from $64,900 for the first half of 2001 to $69,400
during the first half of 2002. Several of the rigs that were contracted at lower
dayrates worked in 2001 but were stacked throughout the first half of 2002.
Consequently, the average operating dayrate has increased in 2002 for the
working rigs in this category. Significant changes in average operating dayrates
included the Ocean Worker and the Ocean Whittington, which decreased $63,600 and
$30,400, respectively, and the Ocean Guardian and the Ocean Princess, which
increased $36,700 and $33,200, respectively.

Contract Drilling Expense. Contract drilling expense for other
semisubmersibles was $3.1 million higher in the first half of 2002 than in the
same period in 2001. The mobilization of the Ocean Worker to a shipyard for
inspection and repairs added $2.5 million to contract drilling expense in 2002.
Contract drilling expense for the Ocean Nomad was $2.1 million higher in the
first half of 2002 primarily due to a reduction in costs in the first half of
2001 resulting from capitalizing costs while the rig was in a shipyard for an
upgrade. An increase in Brazilian customs fees for the importation of spare
parts and supplies for the Ocean Yatzy, Ocean Yorktown and the Ocean Winner
resulted in a $1.5 million increase to contract drilling expense. The
inspection, repair and mobilization of the Ocean General to Vietnam and repairs
to the Ocean Liberator added $1.2 million and $0.7 million, respectively, to
contract drilling expense during the first half of 2002. Partially offsetting
these increases were cost reductions of $5.6 million resulting from cold
stacking the Ocean Endeavor and the Ocean Voyager in the first half of 2002.

Jack-Ups.

Revenues. Revenues from jack-ups decreased $34.6 million in the first half
of 2002 compared to the same period in 2001. Average operating dayrates of
$29,300 during the first half of 2002, down from $41,800 during the first half
of 2001, resulted in a $23.6 million decline in revenue. For this rig
classification, only the Ocean Heritage experienced a substantial increase in
average dayrate of $31,400 from the first half of 2001 to the first half of
2002. In addition, the Ocean Heritage received a $4.7 million mobilization fee
in connection with its contract in Australia during 2002.

Revenues decreased $11.0 million as a result of a decline in utilization
to 82% in the first six months of 2002 from 86% for the same period in 2001.
Utilization was down for the Ocean Champion, which was idle and/or cold stacked
the entire first half of 2002, and for the Ocean Spartan and the Ocean Spur,
which began their leg extension upgrades during 2002. All three of these
jack-ups were working in the first half of 2001. Higher utilization in 2002 for
the Ocean Sovereign, which worked the entire first half of 2002 but spent most
of the first half of 2001 in a shipyard for repairs, was partially offsetting.

Contract Drilling Expense. Contract drilling expense for jack-ups
decreased $3.4 million in the first six months of 2002 compared to the same
period in 2001. Contract drilling expense was lower in 2002 for the Ocean
Spartan and the Ocean Spur as a result of capitalizing costs while these rigs
were being upgraded and for the Ocean Champion which was idle and/or cold
stacked during the first half of 2002. Increased contract drilling expense
during the first half of 2001 from repairs to the Ocean Nugget, the Ocean
Crusader, and the Ocean Summit also

21

contributed to this decrease. Higher expenses for the Ocean Heritage in 2002,
primarily due to the mobilization of the rig from Indonesia to Australia and
higher labor costs in Australia, were partially offsetting.

Integrated Services.

Operating income for integrated services decreased in the first half of
2002 compared to the first half of 2001 as a result of the difference in type
and magnitude of projects during those periods. During the first six months of
2002, an integrated services' operating loss of $1.3 million resulted from two
turnkey wells in the Gulf of Mexico. During the same period in 2001, operating
income of $0.5 million was primarily due the completion of one international
turnkey project.

Depreciation and Amortization Expense.

Depreciation and amortization expense for the six months ended June 30,
2002 increased $3.6 million over the first half of 2001. Higher depreciation in
2002 resulted primarily from an increase in capital additions and additional
depreciation for the Ocean Baroness, which completed its deepwater upgrade and
began operations in March 2002. The suspension of goodwill amortization on
January 1, 2002 partially offset this increase. See Note 1 "--Goodwill" and Note
6 to the Company's Consolidated Financial Statements in Item 1 of Part I of this
report.

General and Administrative Expense.

General and administrative expense for the six months ended June 30, 2002
of $14.1 million increased $1.1 million over $13.0 million for the same period
in 2001. This increase was primarily due to higher personnel costs and
professional expenses in the first half of 2002.

Interest Income.

Interest income of $17.2 million for the six months ended June 30, 2002
decreased $6.1 million from $23.3 million for the same period in 2001 primarily
due to lower interest rates earned on invested cash and marketable securities in
2002. Interest expense of $0.7 million incurred in connection with the Company's
repurchase agreements also contributed to the decrease. See "--Securities Sold
Under Agreements to Repurchase" in Item I of Part I of this report.

Interest Expense.

Interest expense of $11.8 million for the six months ended June 30, 2002
decreased $14.5 million from $26.3 million for the same period in 2001 primarily
due to the $ 11.9 million pre-tax loss from the April 2001 redemption of the
Company's 3.75% Notes. In addition, the Company's interest rate in 2002 was
lower than in 2001 resulting from the redemption of the 3.75% Notes in 2001 and
the issuance of the 1.5% Convertible Senior Debentures due 2031 (the "1.5%
Debentures") on April 11, 2001. Higher interest capitalized to the Ocean
Baroness and Ocean Rover upgrades also contributed to reduced interest expense
during the first half of 2002 compared to the same period in 2001. See
"--Liquidity."

Other Income and Expense (Other, net).

Other income of $1.4 million for the six months ended June 30, 2002
increased $4.1 million from other expense of $2.7 million for the same period in
2001. Other income in the first half of 2002 resulted primarily from a $1.2
million pre-tax gain on forward exchange contracts. Other expense in the first
half of 2001 included a $10.0 million expense associated with a reserve for
class action litigation partially offset by a $7.3 million receipt for settled
litigation.

Income Tax Expense.

Income tax expense of $16.6 million for the six months ended June 30, 2002
decreased $22.6 million from $39.2 million for the same period in 2001 primarily
as a result of the $68.7 million decrease in "Income before income tax expense"
in the first half of 2002 compared to the same period in 2001.

22

OUTLOOK

Oil and natural gas prices have stabilized considerably from early 2002
and late 2001 and, historically, there has been a strong correlation between
these product prices and the demand for the Company's services. However, the
Company believes that its customers continue to lack confidence in the
sustainability of the current prices and therefore expects the market to remain
relatively fragile in the near term. If product prices continue to exhibit signs
of stability, then the Company anticipates a slow, modest growth in drilling
activity through year-end.

Given the current market environment, the Company anticipates reasonable
utilization among its deepwater rigs and other active floaters in the Gulf of
Mexico. However, work will be almost exclusively short term and therefore
periodic idle time is likely.

The Company expects its jack-up business to remain stable with modest
upward pressure on rates throughout the rest of the year. Furthermore, the
Company anticipates that the rigs currently undergoing shipyard upgrades will
emerge to a market that has improved since these rigs entered shipyards in the
first and second quarters of this year.

Internationally, the Company expects its business to remain relatively
stable in most regions, with the exception of the North Sea, where downward
pressure is expected.

LIQUIDITY

Operating Activities.

At June 30, 2002, the Company's cash and marketable securities totaled $1.2
billion, up from $1.1 billion at December 31, 2001. Cash of $252.2 million and
$199.1 million generated by repurchase agreements is included at June 30, 2002
and December 31, 2001, respectively. Cash provided by operating activities for
the six months ended June 30, 2002 increased by $26.8 million to $165.6 million,
compared to $138.8 million for the same period in 2001. This increase in cash
was primarily attributable to a $98.1 million increase in cash provided by
changes in net working capital components in the first half of 2002. Net income,
after adjustment for non-cash items, resulted in a decrease in cash of $71.3
million.

Investing Activities.

Investing activities used $61.7 million of cash during the first six
months of 2002, compared to $149.8 million of cash used during the same period
in 2001. The $88.1 million decrease in cash usage was primarily due to $53.1
million provided by securities sold under repurchase agreements in 2002. In
addition, $0.7 million was provided by the net sales of certain of the Company's
investments in marketable securities in the first half of 2002 compared to the
same period in 2001 when $54.5 million was used for net purchases of
investments. Also, cash provided by investing activities included $1.3 million
in proceeds from the sale of assets (an increase of $0.2 million over 2001) and
$0.9 million from the settlement of forward contracts entered into in July 2001.
Other sources of cash usage for the first half of 2002 included $117.8 million
used for capital expenditures primarily for the Ocean Baroness and Ocean Rover
upgrades, an increase of $21.4 million over the same period in 2001.

Financing Activities.

Financing activities used $54.1 million of cash during the six months
ended June 30, 2002 compared to $23.5 million of cash provided in the same
period of 2001. Depending on market conditions, the Company may, from time to
time, purchase shares of its common stock or issue put options in the open
market or otherwise. During the first half of 2002, the Company purchased
500,000 shares of its common stock at an aggregate cost of $20.0 million, or
$40.00 per share, upon the exercise of put options sold in February 2001. See
"--Treasury Stock and Common Equity Put Options" in Note 1 to the Company's
Consolidated Financial Statements in Item 1 of Part I of this report. During the
six months ended June 30, 2001, the Company purchased 100,000 shares of its
common stock, which settled on July 3, 2001, at an aggregate cost of $3.3
million or at an average cost of $33.00 per share. In August 2002 the Company
purchased 70,000 shares of its common stock at an aggregate cost of $1.4
million, or at an average cost of $20.59 per share.

Cash used in financing activities in the first half of 2002 also included
payments totaling $1.2 million for the settlement of put options which covered
1,000,000 shares of the Company's common stock. Financing activities in the
first half of 2001 provided cash from premiums of $3.1 million received from the
sale of put options covering

23

500,000 shares of the Company's common stock. The options gave the holders the
right to require the Company to repurchase up to the contracted number of shares
of its common stock at the stated exercise price per share at any time prior to
their expiration. The Company had the option to settle in cash or shares of its
common stock. Put options sold in 2001 which covered 187,321 shares of the
Company's common stock, expired during the first half of 2002. See "--Treasury
Stock and Common Equity Put Options" in Note 1 to the Company's Consolidated
Financial Statements in Item 1 of Part I of this report.

Financing activities in the first six months of 2002 also used $33.0
million for dividends paid to stockholders compared to $33.3 million in 2001.

Cash provided by financing activities for the first six months of 2001
consisted primarily of net proceeds of $449.4 million from the issuance of
$460.0 million principal amount of the 1.5% Debentures on April 11, 2001.

The primary source of cash usage for financing activities in 2001 resulted
from the Company's redemption of all of its outstanding 3.75% Notes in
accordance with the indenture under which they were issued. The Company redeemed
the outstanding 3.75% Notes at 102.8% of the principal amount thereof plus
accrued interest for a total cash payment of $397.7 million, resulting in an
$11.9 million loss which is reported in "Interest expense" in the Consolidated
Statements of Income.

Other.

The Company has the ability to issue an aggregate of approximately $117.5
million in debt, equity and other securities under a shelf registration
statement. In addition, the Company may issue, from time to time, up to eight
million shares of common stock, which shares are registered under an acquisition
shelf registration statement (upon effectiveness of an amendment thereto
reflecting the effect of the two-for-one stock split declared in July 1997), in
connection with one or more acquisitions by the Company of securities or assets
of other businesses.

The Company believes it has the financial resources needed to meet its
business requirements in the foreseeable future, including capital expenditures
for rig upgrades and continuing rig enhancements, and working capital
requirements.

CAPITAL RESOURCES

Cash required to meet the Company's capital commitments is determined by
evaluating the need to upgrade rigs to meet specific customer requirements and
by evaluating the Company's ongoing rig equipment replacement and enhancement
programs, including water depth and drilling capability upgrades. It is
management's opinion that operating cash flows and the Company's cash reserves
will be sufficient to meet these capital commitments; however, the Company will
continue to make periodic assessments based on industry conditions. In addition,
the Company may, from time to time, issue debt or equity securities, or a
combination thereof, to finance capital expenditures, the acquisition of assets
and businesses or for general corporate purposes. The Company's ability to
affect any such issuance will be dependent on the Company's results of
operations, its current financial condition, current market conditions and other
factors beyond its control.

During the first half of 2002, the Company spent $93.1 million, including
capitalized interest expense, for rig upgrades, of which $38.3 million was for
the conversion of the Ocean Rover and $30.1 million was for the completion of
the conversion of the Ocean Baroness. The Company spent $22.5 million in the
first six months of 2002 to upgrade six of the Company's jack-up rigs. The
Company expects to spend approximately $275 million for rig upgrade capital
expenditures during 2002 primarily for upgrades of the Ocean Rover and six
jack-up rigs.

The Ocean Rover, one of the Company's Victory-class semisubmersibles,
arrived at a shipyard in Singapore for a major upgrade in mid-January 2002. The
completed upgrade will include the following enhancements: capability for
operation in 7,000-foot water depths on a stand alone basis; approximately 5,590
metric tons variable deckload; a 15,000 psi blow-out prevention system;
3,600-kips riser tensioning and riser with a multiplex control system.
Additional features, including a high capacity deck crane, significantly
enlarged cellar deck area and a 25-by 91- foot moon pool, will provide enhanced
subsea completion and development capabilities. Water depths in excess of 7,000
feet should be achievable utilizing preset taut-leg mooring systems on a case by
case basis. The upgrade is estimated to cost approximately $200 million with
approximately $135 million to be spent in 2002. The upgrade is expected to take
approximately 19 months to complete with delivery estimated in the third quarter
of 2003.

24

The significant upgrade of the Company's semisubmersible rig, the Ocean
Baroness, to high specification capabilities has resulted in an enhanced version
of the Company's previous Victory-class upgrades. The upgrade was similar to the
upgrade currently being performed on the Ocean Rover. The Company took delivery
of the Ocean Baroness in January 2002 and it was accepted by the customer on
March 17, 2002, at which time it began its current contract offshore Malaysia.
The approximate cost of the upgrade was $170 million. See "--Ocean Baroness
Update."

The Company also expects to spend approximately $100 million to
significantly upgrade six of its 14 jack-up rigs over the next two years to
expand the shallow water fleet's capabilities. The Ocean Titan and Ocean Tower,
both 350- foot water depth capability independent-leg slot rigs, are scheduled
to have cantilever packages installed. The cantilever systems enable a rig to
cantilever or extend its drilling package over the aft end of the rig. This is
particularly important when attempting to drill over existing platforms.
Cantilever rigs have historically enjoyed higher dayrates and greater
utilization compared to slot rigs. The Ocean Spartan, Ocean Spur, Ocean
Sovereign and the Ocean Heritage, all 250-foot water depth capability
independent-leg cantilever rigs, are scheduled to have leg extensions installed
enabling these rigs to work in water depths up to 300 feet. The Ocean Spartan,
Ocean Spur and Ocean Heritage are currently in shipyards with their leg
extension upgrades at various stages of completion. Upgrades planned for the
Ocean Titan and Ocean Tower are expected to commence later in 2002. The upgrade
of the Ocean Sovereign will commence in late 2002 or early 2003 once its current
commitments have been met. The Company expects to finance these upgrades through
the use of existing cash balances or internally generated funds.

During the six months ended June 30, 2002, the Company spent $24.7 million
in association with its continuing rig enhancement program and to meet other
corporate capital expenditure requirements. These expenditures included
purchases of drill pipe, anchor chain, riser, cranes, and other drilling
equipment. The Company has budgeted $100.0 million for 2002 capital expenditures
associated with its continuing rig enhancement program (other than rig upgrades)
and other corporate requirements.

The Company continues to consider opportunities, which include, but are
not limited to, the purchase of existing rigs, construction of new rigs and the
acquisition of other companies engaged in contract drilling or related
businesses. Certain of these potential transactions reviewed by the Company
would, if completed, result in its entering new lines of business. In general,
however, these opportunities have been related in some manner to the Company's
existing operations. Although the Company does not, as of the date hereof, have
any commitment with respect to a material acquisition, it could enter into such
an agreement in the future and such acquisition could result in a material
expansion of its existing operations or result in its entering a new line of
business. Some of the potential acquisitions considered by the Company could, if
completed, result in the expenditure of a material amount of funds or the
issuance of a material amount of debt or equity securities.

INTEGRATED SERVICES

The Company's wholly owned subsidiary, Diamond Offshore Team Solutions,
Inc. ("DOTS"), from time to time, selectively engages in drilling services
pursuant to turnkey or modified-turnkey contracts under which DOTS agrees to
drill a well to a specified depth for a fixed price. In such cases, DOTS
generally is not entitled to payment unless the well is drilled to the specified
depth and other contract requirements are met. Profitability of the contract is
dependent upon its ability to keep expenses within the estimates used in
determining the contract price. Drilling a well under a turnkey contract
therefore typically requires a greater cash commitment by the Company and
exposes the Company to risks of potential financial losses that generally are
substantially greater than those that would ordinarily exist when drilling under
a conventional dayrate contract. DOTS also offers a portfolio of drilling
services including overall project management, extended well tests, and
completion operations. During the six months ended June 30, 2002, DOTS had an
operating loss of $1.3 million, primarily from two domestic turnkey projects.
During the same period in 2001, DOTS provided turnkey and integrated services
resulting in operating income of $0.5 million, primarily from the completion of
one international turnkey project.

25

ACCOUNTING STANDARDS

In July 2002 the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 146, "Accounting for
Costs Associated with Exit or Disposal Activities." SFAS No. 146 requires
companies to recognize costs associated with exit or disposal activities when
they are incurred rather than at the date of a commitment to an exit or disposal
plan. SFAS No. 146 is to be applied prospectively to exit or disposal activities
initiated after December 31, 2002. The Company does not expect the adoption of
SFAS No. 146 to have a material impact on the Company's consolidated results of
operations, financial position or cash flows.

In April 2002 the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment to FASB Statement No. 13, and Technical
Corrections." The rescission of SFAS No. 4 and 64 by SFAS No. 145 streamlines
the reporting of debt extinguishments and requires that only gains and losses
from extinguishments meeting the criteria in Opinion 30 would be classified as
extraordinary. Thus, gains or losses arising from extinguishments that are part
of a company's recurring operations would not be reported as an extraordinary
item. SFAS No. 145 is effective for fiscal years beginning after May 15, 2002
with earlier adoption encouraged. The Company adopted SFAS No. 145 in April 2002
and, accordingly, reclassified its April 2001 loss of $7.7 million, net-of-tax,
from early extinguishment of debt, as a result of the Company's redemption of
the outstanding 3.75% Notes, out of extraordinary items. The pre-tax loss from
early extinguishment of debt of $11.9 million was reclassified to "Interest
expense." The related tax benefit was reclassified to "Income tax expense."

In October 2001 the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS No. 144 replaces SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of" and provides updated guidance concerning the
recognition and measurement of an impairment loss for certain types of
long-lived assets. SFAS No. 144 is effective for fiscal years beginning after
December 15, 2001 with earlier application encouraged. The Company's adoption of
SFAS No. 144 in January 2002 has not had, nor is it expected to have, a material
impact on the Company's consolidated results of operations, financial position
or cash flow.

In August 2001 the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." SFAS No. 143 addresses financial accounting and
reporting obligations associated with the retirement of tangible, long-lived
assets and their associated asset retirement costs. SFAS No. 143 is effective
for fiscal years beginning after June 15, 2002 with early adoption encouraged.
Adoption of SFAS No. 143 in 2003 is not expected to have a material impact on
the Company's consolidated results of operations, financial position or cash
flow.

In June 2001 the FASB issued two new pronouncements, SFAS No. 141,
"Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible
Assets." SFAS No. 141 requires that all business combinations be accounted for
by the purchase method and applies to all business combinations initiated after
June 30, 2001 and also applies to all business combinations accounted for using
the purchase method for which the date of acquisition is July 1, 2001 or later.
There are also transition provisions that apply to business combinations
completed before July 1, 2001, that were accounted for by the purchase method.
SFAS No. 142 is effective for fiscal years beginning after December 15, 2001 for
all goodwill and other intangible assets recognized in an entity's statement of
financial position at that date, regardless of when those assets were initially
recognized. The Company adopted SFAS No. 142 on January 1, 2002 and has
suspended amortization of goodwill. The adoption of SFAS No. 142 has not had,
nor is it expected to have, a material impact on the Company's consolidated
results of operations, financial position or cash flow. See Note 6 to the
Company's Consolidated Financial Statements in Item 1 of Part I of this report.

FORWARD-LOOKING STATEMENTS

Certain written and oral statements made or incorporated by reference from
time to time by the Company or its representatives are "forward-looking
statements" within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended.
Forward-looking statements include, without limitation, any statement that may
project, indicate or imply future results, events, performance or achievements,
and may contain the words "expect," "intend," "plan," "anticipate," "estimate,"
"believe," "will be," "will continue," "will likely result," "project," and
similar expressions. Statements by the Company in this report that contain
forward-looking statements include, but are not limited to, discussions
regarding future market conditions and the effect of such conditions on the
Company's future results of operations (see "-- Outlook"), future uses of and
requirements for financial resources, including, but not limited to,
expenditures related to the deepwater upgrade of the Ocean Rover and six of the
Company's jack-up rigs (see "-- Liquidity" and "-- Capital Resources")

26

and interest rate and foreign exchange risk (see "Quantitative and Qualitative
Disclosures About Market Risk"). Such statements inherently are subject to a
variety of risks and uncertainties that could cause actual results to differ
materially from those projected. Such risks and uncertainties include, among
others, general economic and business conditions, casualty losses, industry
fleet capacity, changes in foreign and domestic oil and gas exploration and
production activity, competition, changes in foreign, political, social and
economic conditions, war risk, regulatory initiatives and compliance with
governmental regulations, customer preferences and various other matters, many
of which are beyond the Company's control. The risks included here are not
exhaustive. Other sections of this report and the Company's other filings with
the Securities and Exchange Commission include and describe additional factors
that could adversely affect the Company's business and financial performance.
Given these risks and uncertainties, investors should not place undue reliance
on forward-looking statements. Each forward-looking statement speaks only as of
the date of this report, and the Company expressly disclaims any obligation or
undertaking to release publicly any updates or revisions to any forward-looking
statement to reflect any change in the Company's expectations with regard
thereto or any change in events, conditions or circumstances on which any
forward-looking statement is based.

27

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

The information included in this Item is considered to constitute
"forward-looking statements" for purposes of the statutory safe harbor provided
in Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Forward-Looking
Statements" in Item 2 of Part I of this report.

INTEREST RATE RISK

The Company's financial instruments subject to interest rate risk include
the Zero Coupon Convertible Debentures Due 2020 (the "Zero Coupon Debentures"),
the 1.5% Debentures, the Ocean Alliance lease-leaseback agreement, and
investments in debt securities, including U.S. Treasury and other U.S.
government agency securities and collateralized mortgage obligations ("CMO's").

At June 30, 2002, the fair value of the Company's Zero Coupon Debentures,
based on quoted market prices, was approximately $426.5 million, compared to a
carrying amount of $432.1 million.

At June 30, 2002, the fair value of the Company's 1.5% Debentures, based on
quoted market prices, was approximately $421.8 million, compared to a carrying
amount of $460.0 million. At June 30, 2002, the contingent interest component of
the Company's 1.5% Debentures was carried at its fair value of zero.

At June 30, 2002, the fair value of the Company's Ocean Alliance
lease-leaseback agreement, based on the present value of estimated future cash
flows using a discount rate of 7.27%, was approximately $46.2 million, compared
to a carrying amount of $46.4 million.

At June 30, 2002, the fair market value of the Company's investment in debt
securities issued by the U.S. Treasury and other U.S. government corporations
and agencies, excluding CMO's, was approximately $627.5 million, which includes
an unrealized holding gain of $4.8 million. The Company's investment in Treasury
bills bear no interest and had an effective yield of 1.7% at June 30, 2002. The
Company's investment in Treasury notes bear interest of 4.4%. These securities
are U.S. government-backed, generally short-term and readily marketable.

The fair market value of the Company's investment in CMO's at June 30, 2002
was approximately $135.4 million, which includes an unrealized holding gain of
$0.4 million. The CMO's bear interest at rates ranging from 5.3% to 5.5%. The
CMO's are also short-term and readily marketable with an implied AAA rating
backed by U.S. government guaranteed mortgages.

FOREIGN EXCHANGE RISK

In June 2002 the Company entered into foreign exchange forward contracts to
purchase approximately 50.0 million Australian dollars; 4.2 million Australian
dollars to be purchased monthly from August 29, 2002 through June 26, 2003 and
3.8 million to be purchased on July 31, 2003. In July 2001 the Company had
contracted to purchase 3.5 million Australian dollars each month from August 31,
2001 through July 31, 2002. These foreign exchange forward contracts are
recorded at their fair value determined by discounting future cash flows at
current forward exchange rates. At June 30, 2002, an asset of $0.2 million
reflecting the fair value of the forward contracts, was included with "Prepaid
expenses and other" in the Consolidated Balance Sheet. The associated unrealized
net pre-tax gain of $0.2 million was included in "Other income (expense)" in the
Consolidated Statement of Income for the quarter ended June 30, 2002.

28

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS.

Raymond Verdin, on behalf of himself and those similarly situated v. Pride
Offshore, Inc., et al; C.A. No. G-01-168 in the United States District Court for
the Southern District of Texas, Houston Division; formerly styled Raymond Verdin
v. R&B Falcon Drilling USA, Inc., et al; No. G-00-488 in the United States
District Court for the Southern District of Texas, Galveston Division, filed
October 10, 2000. The Company was named as a defendant in a proposed class
action suit filed on behalf of offshore workers against all of the major
offshore drilling companies. The proposed class included persons hired in the
United States by the companies to work in the Gulf of Mexico and around the
world. The allegation was that the companies, through trade groups, shared
information in violation of the Sherman Antitrust Act and various state laws.
Plaintiff Thomas Bryant replaced the named plaintiff as the proposed class
representative. The lawsuit was seeking money damages and injunctive relief as
well as attorneys' fees and costs. During the first quarter of 2001, the Company
recorded a $10.0 million reserve for this pending litigation in the Company's
Consolidated Statements of Income. In July 2001 the Company filed a stipulation
of settlement with the District Court in which it agreed to settle the
plaintiffs' outstanding claims for certain injunctive relief and a cash payment
within the limits of the reserve. In April 2002 the United States District Judge
for the Southern District of Texas, Houston Division, entered an order finally
approving the proposed class action settlement and finally certifying the
settlement class, and entered a final judgment and order of dismissal of this
lawsuit. In June 2002 the Company made the final settlement payment of $9.4
million from its reserve for this litigation.

The Company and its subsidiaries are named defendants in various lawsuits
and are involved from time to time as parties to governmental proceedings, all
arising in the ordinary course of business. Although the outcome of lawsuits or
other proceedings involving the Company and its subsidiaries cannot be predicted
with certainty and the amount of any liability that could arise with respect to
such lawsuits or other proceedings cannot be predicted accurately, management
does not expect these matters to have a material adverse effect on the financial
position, results of operations, or cash flows of the Company.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.

None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

None.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

The Annual Meeting of Stockholders (the "Annual Meeting") of Diamond
Offshore Drilling, Inc. was held on May 21, 2002 in New York, New York. At the
Annual Meeting, the holders of 128,559,930 shares of common stock out of
131,553,155 shares entitled to vote as of the record date were represented in
person or by proxy, constituting a quorum. The following matters were voted on
and adopted by the margins indicated:

a. To elect eight directors, each to serve until the next annual
meeting of stockholders and until their respective successors
are elected and qualified or until their earlier resignation
or removal.

29

b. To ratify the appointment of Deloitte & Touche LLP as
independent certified public accountants for the Company and
its subsidiaries for fiscal year 2002.

For 127,534,456
Against 992,123
Abstain 33,351
Broker Non-Vote 0

ITEM 5. OTHER INFORMATION.

On June 4, 2002 William B. Richardson became the Democratic nominee for
Governor of New Mexico and effective June 30, 2002 resigned his position as a
member of the Company's Board of Directors.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.

(a) Exhibits

See the Exhibit Index for a list of those exhibits filed herewith.

(b) The Company filed the following reports on Form 8-K during the second
quarter of 2002:

30

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

DIAMOND OFFSHORE DRILLING, INC.
(Registrant)

Date 13-August-2002 By: /s/ Gary T. Krenek
------------------------------------------
Gary T. Krenek
Vice President and Chief Financial Officer

Date 13-August-2002 /s/ Beth G. Gordon
-----------------------------------------
Beth G. Gordon
Controller (Chief Accounting Officer)

31

EXHIBIT INDEX