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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 September 30, 2003
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 (I.R.S. Employer
incorporation 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 by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act).
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 October 29, 2003 Common stock, $0.01 par 130,336,455 shares
value per share
DIAMOND OFFSHORE DRILLING, INC.
TABLE OF CONTENTS FOR FORM 10-Q
QUARTER ENDED SEPTEMBER 30, 2003
PAGE NO.
COVER PAGE.................................................................................. 1
TABLE OF CONTENTS........................................................................... 2
PART I. FINANCIAL INFORMATION.............................................................. 3
ITEM 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets............................................... 3
Consolidated Statements of Operations..................................... 4
Consolidated Statements of Cash Flows..................................... 5
Notes to Unaudited Consolidated Financial Statements...................... 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS................................................. 18
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ............... 36
ITEM 4. CONTROLS AND PROCEDURES .................................................. 38
PART II. OTHER INFORMATION................................................................. 39
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.......................................... 39
SIGNATURES.................................................................................. 40
EXHIBIT INDEX............................................................................... 41
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
DIAMOND OFFSHORE DRILLING, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
SEPTEMBER 30, DECEMBER 31,
-------------------------------
2003 2002
-------------------------------
(UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents ......................................... $ 175,674 $ 184,910
Marketable securities ............................................. 405,447 627,614
Accounts receivable ............................................... 168,499 146,957
Rig inventory and supplies ........................................ 48,295 45,405
Prepaid expenses and other ........................................ 22,304 28,870
------------- -------------
Total current assets ........................................ 820,219 1,033,756
DRILLING AND OTHER PROPERTY AND EQUIPMENT, NET OF
ACCUMULATED DEPRECIATION ........................................ 2,270,377 2,164,627
GOODWILL ............................................................. 14,503 24,714
OTHER ASSETS ......................................................... 32,194 35,668
------------- -------------
Total assets ................................................ $ 3,137,293 $ 3,258,765
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt ................................. $ 11,155 $ 11,155
Accounts payable .................................................. 20,868 39,721
Accrued liabilities ............................................... 68,850 63,113
Taxes payable ..................................................... 2,265 4,413
------------- -------------
Total current liabilities ................................... 103,138 118,402
LONG-TERM DEBT ....................................................... 936,075 924,475
DEFERRED TAX LIABILITY ............................................... 351,501 375,309
OTHER LIABILITIES .................................................... 41,024 33,065
------------- -------------
Total liabilities ........................................... 1,431,738 1,451,251
------------- -------------
COMMITMENTS AND CONTINGENCIES (NOTE 9) ............................... - -
STOCKHOLDERS' EQUITY:
Preferred stock (par value $0.01, 25,000,000 shares
authorized, none issued or outstanding) ........................ - -
Common stock (par value $0.01, 500,000,000 shares
authorized, 133,457,055 issued, 130,336,455 outstanding at
September 30, 2003 and December 31, 2002) ...................... 1,335 1,335
Additional paid-in capital ........................................ 1,263,692 1,263,692
Retained earnings ................................................. 522,750 621,342
Accumulated other comprehensive loss .............................. (4,097) (730)
Treasury stock, at net cost (3,120,600 shares at
September 30, 2003 and December 31, 2002) ..................... (78,125) (78,125)
------------- -------------
Total stockholders' equity .................................. 1,705,555 1,807,514
------------- -------------
Total liabilities and stockholders' equity .................. $ 3,137,293 $ 3,258,765
============= =============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED
FINANCIAL STATEMENTS.
3
DIAMOND OFFSHORE DRILLING, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except per share data)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------- -----------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
REVENUES:
Contract drilling ................................ $ 174,923 $ 174,146 $ 471,820 $ 547,488
Revenues related to reimbursable expenses ........ 8,984 6,037 21,436 22,032
------------ ------------ ------------ ------------
Total revenues ................................ 183,907 180,183 493,256 569,520
------------ ------------ ------------ ------------
OPERATING EXPENSES:
Contract drilling ................................ 126,934 112,963 365,210 354,163
Reimbursable expenses ............................ 8,208 5,457 19,471 20,012
Depreciation ..................................... 43,256 45,187 132,086 132,469
General and administrative ....................... 7,181 7,026 22,595 21,114
Loss (gain) on sale and disposition of assets .... 1,509 23 1,451 (42)
------------ ------------ ------------ ------------
Total operating expenses ...................... 187,088 170,656 540,813 527,716
------------ ------------ ------------ ------------
OPERATING INCOME (LOSS) ............................... (3,181) 9,527 (47,557) 41,804
OTHER INCOME (EXPENSE):
Interest income .................................. 2,742 6,660 10,235 23,892
Interest expense ................................. (6,432) (5,998) (17,385) (17,758)
Gain (loss) on sale of marketable securities ..... (6,179) 21,858 (7,310) 34,021
Other, net ....................................... (140) (534) 2,891 627
------------ ------------ ------------ ------------
INCOME (LOSS) BEFORE INCOME TAX EXPENSE ............... (13,190) 31,513 (59,126) 82,586
INCOME TAX BENEFIT (EXPENSE) .......................... 1,727 (9,809) 9,410 (26,362)
------------ ------------ ------------ ------------
NET INCOME (LOSS) ..................................... $ (11,463) $ 21,704 $ (49,716) $ 56,224
============ ============ ============ ============
EARNINGS (LOSS) PER SHARE:
BASIC ......................................... $ (0.09) $ 0.17 $ (0.38) $ 0.43
============ ============ ============ ============
DILUTED ....................................... $ (0.09) $ 0.16 $ (0.38) $ 0.42
============ ============ ============ ============
WEIGHTED AVERAGE SHARES OF COMMON STOCK:
Shares of common stock ........................... 130,336 131,450 130,336 131,595
Dilutive potential shares of common stock ........ - 9,383 - 9,425
------------ ------------ ------------ ------------
Total weighted average shares outstanding
assuming dilution ........................ 130,336 140,833 130,336 141,020
============ ============ ============ ============
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)
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------------------
2003 2002
-------------------------------
OPERATING ACTIVITIES:
Net income (loss) ............................................ $ (49,716) $ 56,224
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation ............................................... 132,086 132,469
(Gain) loss on sale and disposition of assets .............. 1,451 (42)
(Gain) loss on sale of marketable securities ............... 7,310 (34,021)
Deferred tax provision (benefit) ........................... (11,785) 16,450
Accretion of discounts on marketable securities ............ (2,000) (3,602)
Amortization of debt issuance costs ........................ 891 981
Accretion of discount on zero coupon convertible debentures 11,600 11,204
Changes in operating assets and liabilities:
Accounts receivable ........................................ (21,542) 57,036
Rig inventory and supplies and other current assets ........ 4,426 15,041
Other assets, non-current .................................. 2,583 438
Accounts payable and accrued liabilities ................... (13,116) 873
Taxes payable .............................................. (2,148) (429)
Other liabilities, non-current ............................. 7,959 (3,873)
Other items, net ........................................... (2,972) (1,893)
------------- -------------
Net cash provided by operating activities ...... 65,027 246,856
------------- -------------
INVESTING ACTIVITIES:
Capital expenditures (excluding rig acquisitions) ............ (177,416) (206,055)
Rig acquisitions ............................................. (63,500) -
Proceeds from sale of assets ................................. 879 1,483
Proceeds from sale and maturities of marketable securities ... 2,571,618 3,396,577
Purchase of marketable securities ............................ (2,359,460) (3,289,671)
Securities repurchased under repurchase agreements, net ...... - (199,062)
Proceeds from settlement of forward contracts ................ 2,492 986
------------- -------------
Net cash used in investing activities .......... (25,387) (295,742)
------------- -------------
FINANCING ACTIVITIES:
Payment of dividends ......................................... (48,876) (49,395)
Acquisition of treasury stock ................................ - (30,567)
Settlement of put options .................................... - (1,193)
------------- -------------
Net cash used in financing activities .......... (48,876) (81,155)
------------- -------------
NET CHANGE IN CASH AND CASH EQUIVALENTS .............................. (9,236) (130,041)
Cash and cash equivalents, beginning of period ............... 184,910 398,990
------------- -------------
Cash and cash equivalents, end of period ..................... $ 175,674 $ 268,949
============= =============
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 INFORMATION
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, 2002 (File No.
1-13926).
As of October 29, 2003, Loews Corporation ("Loews") owned 53.8% of the
outstanding shares of common stock of Diamond Offshore Drilling, Inc., which was
a wholly owned subsidiary of Loews prior to its initial public offering in
October 1995.
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 operations, 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.
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 loss" 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 Operations 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. Realized gains or losses and declines in value, if any,
judged to be other than temporary are reported in the Consolidated Statements of
Operations in "Other income (expense)."
Securities Sold Under Agreements to Repurchase
From time to time the Company may lend securities to unrelated parties,
primarily major brokerage firms. Borrowers of these securities must transfer to
the Company cash collateral equal to the securities transferred. 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
is recognized for the obligation to return the cash 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." Interest expense
associated with the related liability is recorded as an offset to "Interest
income" in the Consolidated Statements of Operations. During the nine months
ended September 30, 2002, loaned debt securities that were outstanding at
December 31, 2001, were returned to the Company. The Company did not have any
loaned debt securities outstanding at September 30, 2003 or December 31, 2002.
Derivative Financial Instruments
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.
6
Supplementary Cash Flow Information
Cash payments made for interest on long-term debt totaled $3.4 million
for each of the nine-month periods ended September 30, 2003 and 2002.
Cash payments made for foreign income taxes, net of foreign tax
refunds, were $7.1 million and $10.1 million during the nine months ended
September 30, 2003 and 2002, respectively. There were no payments of U.S. income
taxes during the nine months ended September 30, 2003. A $14.5 million net cash
refund of U.S. income tax was received during the nine months ended September
30, 2002.
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 Operations is as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------------------------------
2003 2002 2003 2002
-------------------------------------------------------
(IN THOUSANDS)
Total interest cost including amortization of
debt issuance costs ............................. $ 6,567 $ 6,650 $ 19,584 $ 19,836
Capitalized interest ............................... (135) (652) (2,199) (2,078)
-------------------------------------------------------
Total interest expense as reported ............. $ 6,432 $ 5,998 $ 17,385 $ 17,758
=======================================================
Interest on the Ocean Rover was capitalized through July 10, 2003 when
its upgrade was complete. Currently, there are no capital projects for which
interest is being capitalized.
Debt Issuance Costs
Debt issuance costs are included in the Consolidated Balance Sheets in
"Other assets" and are amortized over the respective 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.
The Company did not purchase any of its common stock during the nine
months ended September 30, 2003. During the nine months ended September 30, 2002
the Company purchased 1,035,800 shares of its common stock at an aggregate cost
of $30.6 million, or at an average cost of $29.51 per share. This includes the
Company's purchase of 500,000 shares of its common stock at an aggregate cost of
$20.0 million, or at an average cost of $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."
The Company settled put options which covered 1,000,000 shares of its
common stock during the nine months ended September 30, 2002 with cash payments
totaling $1.2 million. The Company 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 nine months ended September 30,
2002.
There were no common equity put options issued or outstanding at
December 31, 2002, September 30, 2003 or during the nine months ended September
30, 2003.
7
Comprehensive Income (Loss)
A reconciliation of net income (loss) to comprehensive income (loss) is
as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------------------------------
2003 2002 2003 2002
-------------------------------------------------------
(IN THOUSANDS)
Net income (loss) .................................. $ (11,463) $ 21,704 $ (49,716) $ 56,224
Other comprehensive gains (losses), net of tax:
Foreign currency translation loss ............... (164) (35) (313) (559)
Unrealized holding gain (loss) on investments ... (49) 1,633 (4,263) 1,008
Reclassification adjustment for realized
gain (loss) on sale of available-for-sale
securities included in net income (loss) ...... 1,218 (3,120) 1,209 (1,775)
-------------------------------------------------------
Comprehensive income (loss) ........................ $ (10,458) $ 20,182 $ (53,083) $ 54,898
=======================================================
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
loss." Currency transaction gains and losses are included in the Consolidated
Statements of Operations in "Other income (expense)." Re-measurement translation
gains and losses of subsidiaries operating in hyperinflationary economies, when
applicable, are included in operating results.
Stock-Based Compensation
The Company accounts for its 2000 Stock Option Plan in accordance with
Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued
to Employees." Accordingly, no compensation expense has been recognized for the
options granted to employees under the plan. Had compensation expense for the
Company's stock options been recognized based on the fair value of the options
at the grant dates, using the methodology prescribed by Statement of Financial
Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation," the Company's net income (loss) and earnings (loss) per share
would have been as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------------------------------
2003 2002 2003 2002
-------------------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net income (loss) as reported ........................ $ (11,463) $ 21,704 $ (49,716) $ 56,224
Deduct: Total stock-based employee compensation
expense determined under fair value based method,
net of related tax effects ........................ (288) (243) (825) (675)
-------------------------------------------------------
Pro forma net income (loss) .......................... $ (11,751) $ 21,461 $ (50,541) $ 55,549
=======================================================
Earnings (loss) per share of common stock:
As reported ....................................... $ (0.09) $ 0.17 $ (0.38) $ 0.43
=======================================================
Pro forma ......................................... $ (0.09) $ 0.16 $ (0.39) $ 0.42
=======================================================
Earnings (loss) per share of common stock - assuming
dilution:
As reported ....................................... $ (0.09) $ 0.16 $ (0.38) $ 0.42
=======================================================
Pro forma ......................................... $ (0.09) $ 0.16 $ (0.39) $ 0.42
=======================================================
8
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. Any excess in these lump-sum
mobilization fees received over the related costs incurred to mobilize an
offshore rig from one market to another is recognized in income over the primary
term of the related drilling contract. Absent a contract, mobilization costs are
recognized currently. Other lump-sum payments received from customers relating
to specific contracts are deferred and amortized to income over the primary term
of the related 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. It is the Company's intent not to pursue contracts
for integrated services, which includes turnkey contracts, except in very
limited circumstances.
Income from reimbursements received for the purchase of supplies,
equipment, personnel services and other services provided at the request of the
Company's customers in accordance with a contract or agreement is recorded, for
the gross amount billed to the customer, as "Revenues related to reimbursable
expenses" in the Consolidated Statements of Operations.
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.
Changes in Accounting Estimates
In April 2003 the Company commissioned a study from an independent
appraiser to evaluate the economic lives of its drilling rigs. As a result of
this independent study, effective April 1, 2003, the Company recorded changes in
accounting estimates by increasing the estimated service lives and salvage
values of most of the Company's drilling rigs to better reflect their remaining
economic lives and salvage values. The effect of this change in accounting
estimates resulted in an increase to net income (after-tax) for the quarter and
nine months ended September 30, 2003 of $6.9 million, or $0.05 per share and
$12.7 million, or $0.10 per share, respectively.
Reclassifications
Certain amounts applicable to prior periods have been reclassified to
conform to the classifications currently followed. Such reclassifications do not
affect earnings.
Recent Accounting Pronouncements
In May 2003 the Financial Accounting Standards Board ("FASB") issued
SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics
of both Liabilities and Equity." This statement requires that an issuer classify
a financial instrument that is within its scope as a liability (or an asset in
some circumstances). SFAS No. 150 is effective for financial instruments entered
into or modified after May 31, 2003, and otherwise is effective at the beginning
of the first interim period beginning after June 15, 2003. It is to be
implemented by reporting the cumulative effect of a change in an accounting
principle for financial instruments created before the issuance date of SFAS No.
150 and still existing at the beginning of the interim period of adoption.
Restatement is not permitted. The Company's adoption of SFAS No. 150 has not had
a material impact on the Company's consolidated results of operations, financial
position or cash flows.
In April 2003 the FASB issued SFAS No. 149, "Amendment of Statement 133
on Derivative Instruments and Hedging Activities." This statement amends and
clarifies financial accounting and reporting for derivative instruments embedded
in other contracts (collectively referred to as derivatives) and for hedging
activities under SFAS No. 133. SFAS No. 149 is to be applied prospectively for
contracts entered into or modified after June 30,
9
2003. For contracts involving hedging relationships, SFAS No. 149 should be
applied to both existing contracts and new contracts entered into after June 30,
2003. The Company's adoption of SFAS No. 149 has not had a material impact on
the Company's consolidated results of operations, financial position or cash
flows.
In January 2003 the FASB issued Interpretation No. 46, "Consolidation
of Variable Interest Entities, an interpretation of Accounting Research Bulletin
No. 51" ("FIN 46"). This interpretation provides guidance on the identification
of, and financial reporting for, entities over which control is achieved through
means other than voting rights, or variable-interest entities ("VIEs"). FIN 46
is effective as of the beginning of the first interim or annual period ending
after December 15, 2003 for existing interests and effective immediately for new
interests. The Company believes that, currently, it does not have any VIEs
within the scope of FIN 46.
In December 2002 the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation-Transition and Disclosure." SFAS No. 148 amends SFAS
No. 123, "Accounting for Stock-Based Compensation," to provide alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. In addition, SFAS No. 148
amends the disclosure requirements of SFAS No. 123 to require prominent
disclosures in both annual and interim financial statements regarding the method
of accounting for stock-based employee compensation and the effect of the method
used on reported results. SFAS No. 148 is effective for financial statements for
fiscal years ending after December 15, 2002. The Company accounts for
stock-based employee compensation in accordance with APB Opinion No. 25,
"Accounting for Stock Issued to Employees." The Company has adopted the
provisions of SFAS No. 148 which require prominent disclosure regarding the
method of accounting for stock-based employee compensation in its annual and
interim financial statements. See "-Stock-Based Compensation."
In July 2002 the 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's adoption of SFAS No. 146 has
not had a material impact on the Company's consolidated results of operations,
financial position or cash flows.
2. EARNINGS (LOSS) PER SHARE
A reconciliation of the numerators and the denominators of the basic
and diluted per-share computations follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------------------------------
2003 2002 2003 2002
-------------------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net income (loss) - basic (numerator): ............. $ (11,463) $ 21,704 $ (49,716) $ 56,224
Effect of dilutive potential shares
1.5% Debentures ........................... -- 1,053 -- 3,137
-------------------------------------------------------
Net income (loss) including conversions -
diluted (numerator) ................................ $ (11,463) $ 22,757 $ (49,716) $ 59,361
=======================================================
Weighted average shares - basic (denominator): ..... 130,336 131,450 130,336 131,595
Effect of dilutive potential shares
1.5% Debentures ........................... -- 9,383 -- 9,383
Stock options ............................. -- -- -- 4
Put options ............................... -- -- -- 38
-------------------------------------------------------
Weighted average shares including conversions -
diluted (denominator) 130,336 140,833 130,336 141,020
=======================================================
Earnings (loss) per share:
Basic ....................................... $ (0.09) $ 0.17 $ (0.38) $ 0.43
=======================================================
Diluted ..................................... $ (0.09) $ 0.16 $ (0.38) $ 0.42
=======================================================
10
The computation of diluted earnings per share ("EPS") for both the
quarter and nine-month periods ended September 30, 2003 and 2002 excludes
approximately 6.9 million potentially dilutive shares issuable upon conversion
of the Company's zero coupon convertible debentures due 2020 ("Zero Coupon
Debentures") because the inclusion of such shares would be antidilutive. The
computation of diluted EPS for the quarter and nine months ended September 30,
2003 excludes approximately 9.4 million potentially dilutive shares issuable
upon conversion of the Company's 1.5% Debentures because 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 nine months ended
September 30, 2002 prior to their expiration or settlement. The computation of
diluted EPS for the quarter and nine months ended September 30, 2002 excluded
put options covering 1,687,321 shares and 187,321 shares of common stock,
respectively, because the options' exercise prices were less than the average
market price per share of the common stock. There were no put options
outstanding during the quarter or nine months ended September 30, 2003.
Certain stock options were excluded from the computation of diluted EPS
because the options' exercise prices were more than the average market price per
share of the common stock. Stock options representing 506,150 shares and 423,400
shares of common stock were excluded from the computation of diluted EPS for the
quarter and nine months ended September 30, 2003, respectively. Stock options
representing 338,150 shares and 224,575 shares of common stock were excluded
from the computation of diluted EPS for the quarter and nine months ended
September 30, 2002, respectively.
Other stock options with average market prices that exceeded their
exercise prices during the period (in-the-money options) were excluded from the
computation of diluted EPS because potential shares of common stock are not
included when a loss from continuing operations exists. Stock options
representing 2,500 shares and 85,250 shares of common stock were excluded from
the computation of diluted EPS for the quarter and nine months ended September
30, 2003, respectively.
3. MARKETABLE SECURITIES
Investments classified as available for sale are summarized as follows:
SEPTEMBER 30, 2003
----------------------------------------
UNREALIZED MARKET
COST GAIN (LOSS) VALUE
----------------------------------------
(IN THOUSANDS)
Debt securities issued by the U.S. Treasury
and other U.S. government agencies:
Due within one year ......................... $ 399,708 $ 21 $ 399,729
Collateralized mortgage obligations .............. 6,272 (554) 5,718
----------------------------------------
Total ....................................... $ 405,980 $ (533) $ 405,447
========================================
DECEMBER 31, 2002
----------------------------------------
UNREALIZED MARKET
COST GAIN VALUE
----------------------------------------
(IN THOUSANDS)
Debt securities issued by the U.S. Treasury
and other U.S. government agencies:
Due within one year ......................... $ 449,445 $ 20 $ 449,465
Collateralized mortgage obligations .............. 174,003 4,146 178,149
----------------------------------------
Total ....................................... $ 623,448 $ 4,166 $ 627,614
========================================
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.
11
Proceeds from sales and maturities of marketable securities and gross
realized gains and losses are summarized as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------------------------------
2003 2002 2003 2002
-------------------------------------------------------
(IN THOUSANDS)
Proceeds from sales ................................ $ 518,612 $ 927,899 $ 746,618 $2,896,577
Proceeds from maturities ........................... 450,000 250,000 1,825,000 500,000
Gross realized gains ............................... 2,259 21,953 2,367 36,888
Gross realized losses .............................. (8,438) (95) (9,677) (2,867)
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, when customer contracts
cannot be structured to generate a sufficient amount of foreign currency for
operating purposes, a foreign exchange forward contract may be 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.
In June 2002 the Company entered into 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 entered into twelve
forward contracts to purchase 3.5 million Australian dollars each month through
July 31, 2002. These forward contracts were 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
contracts purchased by the Company in 2002 and 2001 did not qualify for hedge
accounting. A pre-tax gain of $0.5 million and $2.5 million was recorded in the
Consolidated Statements of Operations for the quarter and nine months ended
September 30, 2003, respectively, in "Other income (expense)." For the quarter
and nine months ended September 30, 2002 a pre-tax loss of $0.8 million and a
pre-tax gain of $0.2 million, respectively, was recorded in the Consolidated
Statements of Operations in "Other income (expense)." As of September 30, 2003
the Company had satisfied all obligations under these contracts and no new
forward exchange contracts had been entered into at that time.
Contingent Interest
The Company's $460.0 million principal amount of 1.5% Debentures, which
were issued on April 11, 2001 and are due on April 15, 2031, contain a
contingent interest provision. 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, at December 31, 2002 or at
September 30, 2003.
12
5. DRILLING AND OTHER PROPERTY AND EQUIPMENT
Cost and accumulated depreciation of drilling and other property and
equipment are summarized as follows:
SEPTEMBER 30, DECEMBER 31,
-------------------------------
2003 2002
-------------------------------
(IN THOUSANDS)
Drilling rigs and equipment .......................................... $ 3,429,858 $ 3,091,892
Construction work-in-progress ........................................ 14,008 141,247
Land and buildings ................................................... 15,036 15,035
Office equipment and other ........................................... 21,901 21,076
-------------------------------
Cost ........................................................... 3,480,803 3,269,250
Less: accumulated depreciation ....................................... (1,210,426) (1,104,623)
-------------------------------
Drilling and other property and equipment, net ................ $ 2,270,377 $ 2,164,627
===============================
Effective September 30, 2003 the Company retired two of its second
generation semisubmersible drilling rigs, the Ocean Century and Ocean
Prospector. These rigs, which have been cold stacked in the Gulf of Mexico since
July 1998 and October 1998, respectively, are being offered for sale and as a
result of this decision, were written-down $1.6 million to their fair market
values of $375,000 each. These rigs have been reclassified from "Drilling and
other property and equipment" to current assets held-for-sale in "Prepaid
expenses and other" on the Consolidated Balance Sheet as of September 30, 2003.
In April 2003 the Company commissioned a study from an independent
appraiser to evaluate the economic lives of its drilling rigs. As a result of
this independent study, effective April 1, 2003, the Company recorded changes in
accounting estimates by increasing the estimated service lives and salvage
values of most of the Company's drilling rigs to better reflect their remaining
economic lives and salvage values. The effect of this change in accounting
estimates resulted in an increase to net income (after-tax) for the third
quarter and nine months ended September 30, 2003 of $6.9 million, or $0.05 per
share, and $12.7 million, or $0.10 per share, respectively.
Construction work-in-progress at September 30, 2003 consisted of $14.0
million for the cantilever conversion of the Ocean Titan. During the third
quarter of 2003, approximately $175.7 million was reclassified from construction
work-in-progress to drilling rigs and equipment for the upgrade of the Ocean
Rover to high specification capabilities. The upgrade was completed on time and
under budget in July 2003 for an estimated total cost of $189 million. The rig
is currently operating under a three well drilling program for Murphy Sabah Oil
Co., Ltd. offshore Malaysia.
In March 2003, Diamond Offshore Drilling Limited, a subsidiary of the
Company, completed the acquisition of the third-generation semisubmersible
drilling rig, Omega, renamed Ocean Patriot, for $65.0 million. The Company
capitalized $63.5 million to drilling rigs and equipment and recorded $1.5
million to rig inventory.
In December 2002, the acquisition of the third-generation
semisubmersible drilling rig, West Vanguard, renamed Ocean Vanguard, was
completed for $68.5 million. The Company capitalized $67.0 million to drilling
rigs and equipment and recorded $1.5 million to rig inventory.
6. GOODWILL
Goodwill from the merger with Arethusa (Off-Shore) Limited ("Arethusa")
in 1996 was generated from an excess of the purchase price over the net assets
acquired. Prior to January 1, 2002 the Company amortized goodwill on a
straight-line basis over 20 years. The Company adopted SFAS No. 142 on January
1, 2002 and, accordingly, suspended amortization of goodwill at that time.
For purposes of applying SFAS No. 142, the Company determined that it
has one reporting unit to which to assign goodwill. The Company performed the
annual goodwill impairment test on December 31, 2002 and determined that the
fair value of the reporting unit exceeded its carrying value, and accordingly,
no further steps were required for testing goodwill impairment at that time.
Annual goodwill impairment testing will be performed at each year-end.
There were no recognized intangible assets other than goodwill
associated with the Arethusa merger.
13
During each of the nine-month periods ended September 30, 2003 and
2002, an adjustment of $10.2 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 are recognized. Goodwill is expected to be reduced to zero
during the year 2004.
7. ACCRUED LIABILITIES
Accrued liabilities consist of the following:
SEPTEMBER 30, DECEMBER 31,
-------------------------------
2003 2002
-------------------------------
(IN THOUSANDS)
Payroll and benefits ....................................... $ 32,440 $ 29,337
Personal injury and other claims ........................... 6,815 6,815
Interest payable ........................................... 5,235 1,588
Deferred revenue ........................................... 3,405 3,539
Other ...................................................... 20,955 21,834
-------------------------------
Total ............................................ $ 68,850 $ 63,113
===============================
8. LONG-TERM DEBT
Long-term debt consists of the following:
SEPTEMBER 30, DECEMBER 31,
-------------------------------
2003 2002
-------------------------------
(IN THOUSANDS)
Zero Coupon Debentures ..................................... $ 451,288 $ 439,688
1.5% Debentures ............................................ 460,000 460,000
Ocean Alliance Lease-leaseback Agreement ................... 35,942 35,942
-------------------------------
947,230 935,630
Less: Current maturities (11,155) (11,155)
-------------------------------
Total ............................................ $ 936,075 $ 924,475
===============================
The aggregate maturities of long-term debt for each of the five years
subsequent to December 31, 2002, are as follows (see discussions following table
for description of the rights that holders of the debentures have to put the
securities to the Company):
(IN THOUSANDS)
- -------------------------------------------------------------------------------
2003 ............................................................ $ 11,155
2004 ............................................................ 11,969
2005 ............................................................ 12,818
2006............................................................. --
2007............................................................. --
Thereafter ...................................................... 911,288
- -------------------------------------------------------------------------------
947,230
Less: Current maturities......................................... (11,155)
- -------------------------------------------------------------------------------
Total ........................................................ $ 936,075
===============================================================================
1.5% Debentures
The Company's $460.0 million principal amount of 1.5% Debentures that
it issued on April 11, 2001 are due April 15, 2031. The 1.5% Debentures are
convertible into shares of the Company's common stock at an initial conversion
rate of 20.3978 shares per $1,000 principal amount of the 1.5% Debentures,
subject to adjustment in
14
certain circumstances. Upon conversion, the Company has the right to deliver
cash in lieu of shares of the Company's common stock.
Interest of 1.5% per year on the outstanding principal amount is
payable semiannually in arrears on each April 15 and October 15. The 1.5%
Debentures are unsecured obligations of the Company and rank equally with all of
the Company's other unsecured senior indebtedness.
Holders may require the Company to purchase all or a portion of their
1.5% Debentures on April 15, 2008, at a price equal to 100% of the principal
amount of the 1.5% Debentures to be purchased plus accrued and unpaid interest.
The Company may choose to pay the purchase price in cash or shares of the
Company's common stock or a combination of cash and common stock. In addition,
holders may require the Company to purchase, for cash, all or a portion of their
1.5% Debentures upon a change in control (as defined).
The Company may redeem all or a portion of the 1.5% Debentures at any
time on or after April 15, 2008, at a price equal to 100% of the principal
amount plus accrued and unpaid interest.
Zero Coupon Debentures
The Company's Zero Coupon Debentures issued on June 6, 2000 at a price
of $499.60 per $1,000 debenture, which represents a yield to maturity of 3.50%
per year, are due June 6, 2020. The Company will not pay interest prior to
maturity unless it elects to convert the Zero Coupon Debentures to
interest-bearing debentures upon the occurrence of certain tax events. The Zero
Coupon Debentures are convertible at the option of the holder at any time prior
to maturity, unless previously redeemed, into the Company's common stock at a
fixed conversion rate of 8.6075 shares of common stock per $1,000 principal
amount of the Zero Coupon Debentures, subject to adjustment in certain
circumstances. The Zero Coupon Debentures are senior unsecured obligations of
the Company.
The Company has the right to redeem the Zero Coupon Debentures, in
whole or in part, after June 6, 2005, for a price equal to the issuance price
plus accrued original issue discount through the date of redemption. Holders
have the right to require the Company to repurchase the Zero Coupon Debentures
on the fifth, tenth and fifteenth anniversaries of issuance at the accreted
value through the date of repurchase. The Company may pay such repurchase price
with either cash or shares of the Company's common stock or a combination of
cash and shares of common stock.
Ocean Alliance Lease-leaseback Agreement
The Company entered into a lease-leaseback agreement with a European
bank in December 2000. The lease-leaseback agreement provides for the Company to
lease the Ocean Alliance, one of the Company's high specification
semisubmersible drilling rigs, to the bank for a lump-sum payment of $55.0
million plus an origination fee of $1.1 million and for the bank to then
sub-lease the rig back to the Company. Under the agreement, which has a
five-year term, the Company is to make five annual payments of $13.7 million.
The Company has made two of the five annual payments as of September 30, 2003.
This financing arrangement has an effective interest rate of 7.13% and is an
unsecured subordinated obligation of the Company.
9. COMMITMENTS AND CONTINGENCIES
Various claims have been filed against the Company in the ordinary
course of business, including claims by offshore workers 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.
15
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):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------------------------------
2003 2002 2003 2002
-------------------------------------------------------
(IN THOUSANDS)
High Specification Floaters ........................ $ 79,688 $ 72,376 $ 215,982 $ 222,771
Other Semisubmersibles ............................. 72,588 80,745 185,556 242,802
Jack-ups ........................................... 23,006 18,703 69,688 75,042
Integrated Services ................................ -- 3,017 1,189 9,246
Other .............................................. (359) -- (362) (436)
Eliminations ....................................... -- (695) (233) (1,937)
-------------------------------------------------------
Total Contract Drilling Revenues ................ 174,923 174,146 471,820 547,488
Revenues Related to Reimbursable
Expenses ..................................... 8,984 6,037 21,436 22,032
-------------------------------------------------------
Total revenues ............................. $ 183,907 $ 180,183 $ 493,256 $ 569,520
=======================================================
Geographic Areas
At September 30, 2003, 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.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------------------------------
2003 2002 2003 2002
-------------------------------------------------------
(IN THOUSANDS)
Revenues from unaffiliated customers:
United States .................................... $ 84,441 $ 74,576 $ 248,115 $ 246,100
Foreign:
South America ................................. 37,909 43,916 119,188 130,834
Europe/Africa ................................. 13,377 22,486 34,248 80,424
Australia/Southeast Asia ...................... 32,901 39,205 75,524 112,162
Mexico ........................................ 15,279 -- 16,181 --
-------------------------------------------------------
Total revenues ........................... $ 183,907 $ 180,183 $ 493,256 $ 569,520
=======================================================
11. INCOME TAXES
In 2002 the Company formed a Cayman Islands corporation, Diamond
Offshore International Limited, which is a wholly-owned subsidiary of Diamond
Offshore Drilling, Inc. Certain of the Company's rigs that operate
internationally are now owned and operated, directly or indirectly, by the
Cayman Islands subsidiary. Effective January 1, 2003 the Company began to
postpone remittance of the earnings from this subsidiary to the U.S. and
indefinitely reinvest these earnings internationally. Consequently, no U.S.
taxes were provided on these earnings and no U.S. tax benefits were recognized
on losses during the first nine months of 2003. The 13.1% effective tax rate for
the three months ended September 30, 2003 resulted from a revision of the
estimated annual effective tax rate from 16.7% in the second quarter of 2003 to
15.9% in the third quarter of 2003 .
In 2002 a portion of the earnings from the Company's U.K. subsidiaries
was considered to be indefinitely reinvested. No U.S. taxes were provided on
these earnings in the three-month or nine-month periods ended September 30, 2002
and the estimated annual effective tax rate as of September 30, 2002 was 31.9%.
The effective rate of 31.1%
16
for the three months ended September 30, 2002 resulted from a revision of the
estimated annual effective tax rate from 32.4% in the second quarter of 2002 to
31.9% in the third quarter of 2002. These U.K. subsidiaries are now owned,
directly or indirectly, by Diamond Offshore International Limited. Consequently,
earnings and losses from the U.K. subsidiaries for the quarter and nine-month
period ended September 30, 2003 are part of the earnings and losses of the
Cayman Islands subsidiary on which no U.S. taxes are provided.
17
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. Effective September 30,
2003, the Company retired two of its second generation semisubmersible drilling
rigs, the Ocean Century and the Ocean Prospector. These rigs, which have been
cold stacked in the Gulf of Mexico since July 1998 and October 1998,
respectively, are being offered for sale, have been written down to their fair
market values and will not be returned to service as offshore drilling units. As
a result of the retirement of these two drilling units and the March 2003
acquisition of the third-generation semisubmersible drilling rig, Omega, renamed
Ocean Patriot, the Company now has a fleet of 45 offshore drilling rigs. The
fleet consists of 30 semisubmersibles, 14 jack-ups and one drillship.
GENERAL
Revenues. The Company's revenues vary based upon demand, which affects
the number of days the fleet is utilized and the dayrates earned. When a rig is
idle, 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. However, during periods of
mobilization, 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 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 primary term of the related
drilling contract.
Revenues from offshore turnkey drilling 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. It is the Company's intent not to pursue contracts
for integrated services, which includes turnkey contracts, except in very
limited circumstances.
Revenues from reimbursements received for the purchase of supplies,
equipment, personnel services and other services provided at the request of the
Company's customers in accordance with a contract or agreement are recorded for
the gross amount billed to the customer, as "Revenues related to reimbursable
expenses" in the Consolidated Statements of Operations.
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 a cost of the operator under a drilling contract. 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, meeting certain criteria, which 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.
Higher depreciation expense decreases operating income in periods subsequent to
capital upgrades.
18
CRITICAL ACCOUNTING ESTIMATES
The Company's significant accounting policies are included in Note 1 of
its Notes to Consolidated Financial Statements in Part I, Item 1 of this report.
Management's judgments, assumptions and estimates are inherent in the
preparation of the Company's financial statements and the application of its
significant accounting policies. The Company believes that its most critical
accounting estimates are as follows:
Property, Plant and Equipment. Drilling and other property and
equipment is carried at cost. Maintenance and routine repairs are charged to
income currently while replacements and betterments, which meet certain
criteria, are capitalized. Depreciation is amortized up to applicable salvage
values by applying the straight-line method over the remaining estimated useful
lives.
In April 2003 the Company commissioned a study from an independent
appraiser to evaluate the economic lives of its drilling rigs. As a result of
this independent study, effective April 1, 2003, the Company recorded changes in
accounting estimates by increasing the estimated service lives and salvage
values for most of the Company's drilling rigs to better reflect their remaining
economic lives and salvage values. The effect of this change in accounting
estimate resulted in an increase to net income (after-tax) for the quarter and
nine months ended September 30, 2003 of $6.9 million, or $0.05 per share, and
$12.7 million, or $0.10 per share, respectively. Management makes judgments,
assumptions and estimates regarding capitalization, useful lives and salvage
values. Changes in these assumptions could produce results that differ from
those reported.
The Company evaluates its property and equipment for impairment
whenever changes in circumstances indicate that the carrying amount of an asset
may not be recoverable. Effective September 30, 2003, the Company wrote down two
of its second generation semisubmersible drilling rigs, the Ocean Century and
the Ocean Prospector, by $1.6 million to their fair market values of $375,000
each, subsequent to a decision to offer the rigs for sale. Management's
assumptions are an inherent part of an asset impairment evaluation and the use
of different assumptions could produce results that differ from those reported.
Personal Injury Claims. The Company's retention of liability for
personal injury claims, which primarily results from Jones Act liability in the
Gulf of Mexico, is $0.5 million per claim with an aggregate annual deductible
of $1.5 million. The Company estimates its liability for personal injury claims
based on the existing facts and circumstances in conjunction with historical
experience regarding past personal injury claims. Eventual settlement or
adjudication of these claims could differ significantly from the estimated
amounts.
19
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
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.
THREE MONTHS ENDED
SEPTEMBER 30,
------------------------- FAVORABLE/
2003 2002 (UNFAVORABLE)
-------------------------------------------
(in thousands)
CONTRACT DRILLING REVENUE
High Specification Floaters .................... $ 79,688 $ 72,376 $ 7,312
Other Semisubmersibles ......................... 72,588 80,745 (8,157)
Jack-ups ....................................... 23,006 18,703 4,303
Integrated Services ............................ -- 3,017 (3,017)
Other .......................................... (359) -- (359)
Eliminations ................................... -- (695) 695
-------------------------------------------
TOTAL CONTRACT DRILLING REVENUE ................ $ 174,923 $ 174,146 $ 777
===========================================
REVENUES RELATED TO REIMBURSABLE EXPENSES ...... $ 8,984 $ 6,037 $ 2,947
CONTRACT DRILLING EXPENSE
High Specification Floaters .................... $ 39,974 $ 38,301 $ (1,673)
Other Semisubmersibles ......................... 62,494 51,363 (11,131)
Jack-ups ....................................... 23,677 20,714 (2,963)
Integrated Services ............................ (6) 3,038 3,044
Other .......................................... 795 242 (553)
Eliminations ................................... -- (695) (695)
-------------------------------------------
TOTAL CONTRACT DRILLING EXPENSE ................ $ 126,934 $ 112,963 $ (13,971)
===========================================
REIMBURSABLE EXPENSES .......................... $ 8,208 $ 5,457 $ (2,751)
OPERATING INCOME (LOSS)
High Specification Floaters .................... $ 39,714 $ 34,075 $ 5,639
Other Semisubmersibles ......................... 10,094 29,382 (19,288)
Jack-ups ....................................... (671) (2,011) 1,340
Integrated Services ............................ 6 (21) 27
Other .......................................... (1,154) (242) (912)
Reimbursable expenses, net ..................... 776 580 196
Depreciation ................................... (43,256) (45,187) 1,931
General and administrative expense ............. (7,181) (7,026) (155)
Loss on sale and disposition of assets ......... (1,509) (23) (1,486)
-------------------------------------------
TOTAL OPERATING INCOME (LOSS) .................. $ (3,181) $ 9,527 $ (12,708)
===========================================
High Specification Floaters.
Revenues. Revenues from high specification floaters increased $7.3
million during the quarter ended September 30, 2003 compared to the same quarter
in 2002.
The Ocean Rover contributed $8.7 million to the overall increase in
revenues due to the completion of its upgrade to high specification capabilities
in July 2003.
20
Utilization for the third quarter of 2003 (excluding the Ocean Rover)
improved to 89% from 80% in the third quarter of 2002 resulting in an additional
$4.9 million in revenue. Significant improvements in utilization were from:
- the Ocean America, which worked all of the third quarter of
2003 but was stacked one-half of the third quarter of 2002;
and
- the Ocean Star, which worked all of the third quarter of 2003
but was stacked one month of the third quarter of 2002.
The average operating dayrate for the third quarter of 2003 (excluding
the Ocean Rover) decreased from $108,700 to $96,300, resulting in a $6.3 million
decline which partially offset the overall revenue increase. Significant
declines to average operating dayrates were:
- the Ocean Baroness ($144,600 to $115,300);
- the Ocean Valiant ($79,500 to $54,900); and
- the Ocean Victory ($94,900 to $66,000).
Contract Drilling Expense. Contract drilling expense for high
specification floaters was higher by $1.7 million for the quarter ended
September 30, 2003 compared to the same period in 2002. Increased contract
drilling expenses were primarily attributable to:
- operating costs for the Ocean Rover, which began working upon
completion of its upgrade to high specification capabilities
in early July 2003 compared to the third quarter of 2002 when
most of the rig's costs were capitalized in connection with
its upgrade; and
- mobilization and demobilization costs for the Ocean Victory
to and from its operating location during the third quarter
of 2003.
Partially offsetting the overall higher contract drilling expenses in
the third quarter of 2003 were lower expenses resulting from:
- the Company's efforts to reduce operating costs, which
resulted in lower overall contract drilling expense (with the
most significant savings in labor costs); and
- normal operating costs for the Ocean Victory and the Ocean
Quest in the third quarter of 2003 compared to the third
quarter of 2002, which included $1.1 million for inspection
and repairs.
Other Semisubmersibles.
Revenues. Revenues from other semisubmersibles for the quarter ended
September 30, 2003 decreased $8.2 million from the same period in 2002.
Average operating dayrates (excluding the Ocean Vanguard and the Ocean
Patriot) fell to $59,200 from $69,100 in the quarter ended September 30, 2003
compared to the same quarter in 2002 and resulted in a reduction in revenue of
approximately $11.4 million. Most of the rigs in this classification that
operate internationally experienced lower average operating dayrates during the
third quarter of 2003 while all of the domestic rigs experienced higher average
operating dayrates, compared to the same period in 2002.
Higher utilization during the third quarter of 2003 resulted in a
revenue improvement of $1.6 million as utilization (excluding the Ocean Vanguard
and Ocean Patriot) increased to 62% from 61% compared to the third quarter of
2002. Improvements in utilization were experienced by:
- the Ocean Whittington, which mobilized to the Mexican sector
of the Gulf of Mexico from offshore Africa and began working
under a long term contract during the third quarter of 2003
but operated offshore Ghana for only part of the third
quarter of 2002;
- the Ocean Ambassador, which mobilized to the Mexican sector
of the Gulf of Mexico and began operating under a long term
contract in the third quarter of 2003 after being stacked in
a Galveston shipyard. During the third quarter of 2002 the
rig operated for approximately 43 days in the U. S. Gulf of
Mexico, about 32 days less than it operated in the third
quarter of 2003;
21
- the Ocean Worker, which mobilized to the Mexican sector of
the Gulf of Mexico and began working offshore Mexico under a
long term contract in the third quarter of 2003 immediately
upon completion of its contract in the U.S. Gulf of Mexico.
During the third quarter of 2002 the rig operated for
approximately 63 days, about 29 days less than it operated in
the third quarter of 2003; and
- the Ocean Nomad, which operated 81 days in the third quarter
of 2003 compared to 42 days in the third quarter of 2002.
Partially offsetting the increase in utilization during the third
quarter of 2003 was lower utilization for:
- the Ocean Epoch, which was stacked for approximately two
months in 2003; and
- the Ocean Yorktown, which mobilized to a Gulf of Mexico
shipyard in 2003 to prepare for an upcoming contract in
Mexico, but operated offshore Brazil during all of the third
quarter of 2002.
The Ocean Patriot, which the Company acquired in March 2003,
contributed $1.7 million to revenues during the third quarter of 2003.
Contract Drilling Expense. Contract drilling expense for other
semisubmersibles increased $11.1 million during the third quarter of 2003
compared to the same period in 2002, primarily due to:
- operating expenses for the Ocean Vanguard (acquired in
December 2002);
- operating expenses for the Ocean Patriot (acquired in March
2003);
- mobilization costs to relocate the Ocean Worker, Ocean
Ambassador and the Ocean Whittington to Mexico during the
third quarter of 2003; and
- mobilization costs associated with the Ocean Yorktown's move
to the Gulf of Mexico from Brazil during the third quarter of
2003.
Partially offsetting the higher contract drilling expenses during the
third quarter of 2003 were lower expenses from:
- the Ocean Liberator and the Ocean New Era, which were both
cold stacked the entire third quarter of 2003 but were warm
stacked during the same period in 2002; and
- the Company's efforts to reduce operating costs, which
resulted in lower overall contract drilling expenses.
Jack-Ups.
Revenues. Revenues from jack-ups increased $4.3 million during the
third quarter of 2003 compared to the same quarter in 2002.
Higher average operating dayrates for all of the rigs in this
classification contributed to the higher revenue as average dayrates rose to
$27,800 during the third quarter of 2003 from $22,400 during the third quarter
of 2002.
Utilization dropped to 64% during the third quarter of 2003 compared to
65% during the third quarter of 2002, primarily due to:
- the Ocean Sovereign, which was stacked all of the third
quarter of 2003 but operated throughout the same period of
2002; and
- the Ocean Titan, which continued its upgrade to install a
cantilever package for all of the third quarter of 2003 but
operated during most of the third quarter of 2002.
Partially offsetting were improvements in utilization from:
- the Ocean Spartan and Ocean Spur, which worked most of the
third quarter of 2003 compared to the same period in 2002
when these rigs were undergoing leg extension upgrades; and
- the Ocean Heritage, which worked one month in the third
quarter of 2003 but was in a shipyard for a leg extension
upgrade during the same period of 2002.
22
Contract Drilling Expense. Contract drilling expense for jack-ups
during the third quarter of 2003 rose $3.0 million from the same period in 2002
primarily from:
- higher operating costs for the Ocean Spartan and Ocean Spur,
as these rigs worked most of the third quarter of 2003
compared to the same period in 2002 when these rigs were
undergoing leg extension upgrades; and
- higher operating costs for the Ocean Tower, as the rig worked
all of the third quarter of 2003 compared to the same period
in 2002 when the rig began its cantilever upgrade in
mid-August 2002.
Partially offsetting were lower expenses during the third quarter of
2003 for the Ocean Titan due to the capitalization of most of its costs
associated with its cantilever upgrade, which began in the second quarter of
2003.
Reimbursable expenses, net.
Reimbursable expenses include items that the Company purchases, and/or
services it performs, at the request of its customers. Revenues related to
reimbursable items, offset by the related expenditures for these items, were
$0.8 million and $0.6 million for the quarters ended September 30, 2003 and
2002, respectively.
Depreciation.
Depreciation expense decreased $1.9 million to $43.3 million in the
third quarter of 2003 compared to $45.2 million in the third quarter of 2002. An
$8.2 million reduction in depreciation expense for the third quarter of 2003
resulted from increasing the estimated service lives and salvage values for most
of the Company's drilling rigs, effective April 1, 2003, to better reflect their
remaining economic lives and salvage values. This reduction was partially offset
by depreciation of the Ocean Vanguard and the Ocean Patriot, which the Company
acquired in December 2002 and March 2003, respectively, additional depreciation
for five of the Company's recently upgraded jack-up rigs and additional
depreciation for the Ocean Rover, which completed its upgrade in July 2003.
General and Administrative Expense.
General and administrative expense for the quarter ended September 30,
2003 of $7.2 million increased $0.2 million over $7.0 million for the same
period in 2002. This increase was primarily due to higher professional expenses
for legal fees, tax planning for foreign operations and higher net operating
costs from the corporate office building due to a reduction in rental income to
offset expenses. Partially offsetting was a reduction in personnel costs.
Loss on Sale and Disposition of Assets.
A loss on the sale and disposition of assets of $1.5 million occurred
during the quarter ended September 30, 2003 primarily from the retirement of two
of the Company's second generation semisubmersible drilling rigs, the Ocean
Century and Ocean Prospector. These rigs have been cold stacked since July 1998
and October 1998, respectively, are being offered for sale and, as a result of
this decision, were written down to their fair market values. A loss on the sale
of assets of approximately $23,000 occurred during the quarter ended September
30, 2002.
Interest Income.
Interest income of $2.7 million earned during the quarter ended
September 30, 2003 declined $4.0 million, from $6.7 million earned during the
same period in 2002. Interest income was lower primarily due to the lower
interest rates earned on cash and marketable securities compared to the same
period in 2002. In addition, the Company had less cash investment in the third
quarter of 2003 than in the same period of 2002.
Gain (Loss) on Sale of Marketable Securities.
A loss on the sale of marketable securities of $6.2 million occurred in
the quarter ended September 30, 2003 compared to a $21.9 million gain on the
sale of marketable securities during the same period in 2002.
23
Income Tax Benefit (Expense).
An income tax benefit of $1.7 million was recognized on a pre-tax loss
of $13.2 million in the third quarter of 2003 compared to tax expense of $9.8
million which was recognized on pre-tax income of $31.5 million in the third
quarter of 2002.
In 2002 the Company formed a Cayman Islands corporation, Diamond
Offshore International Limited, which is a wholly-owned subsidiary of Diamond
Offshore Drilling, Inc. Certain of the Company's rigs that operate
internationally are now owned and operated, directly or indirectly, by the
Cayman Islands subsidiary. Effective January 1, 2003 the Company began to
postpone remittance of the earnings from this subsidiary to the U.S. and
indefinitely reinvest these earnings internationally. Consequently, no U.S.
taxes were provided on these earnings and no U.S. tax benefits were recognized
on losses during the third quarter of 2003. The 13.1% effective tax rate for the
three months ended September 30, 2003 resulted from a revision of the estimated
annual effective tax rate from 16.7% in the second quarter of 2003 to 15.9% in
the third quarter of 2003.
In 2002 a portion of the earnings from the Company's U.K. subsidiaries
was considered to be indefinitely reinvested. No U.S. taxes were provided on
these earnings in the third quarter of 2002 and the estimated annual effective
tax rate as of September 30, 2002 was 31.9%. The effective rate of 31.1% for the
three months ended September 30, 2002 resulted from a revision of the estimated
annual effective tax rate from 32.4% in the second quarter of 2002 to 31.9% in
the third quarter of 2002. These U.K. subsidiaries are now owned, directly or
indirectly, by Diamond Offshore International Limited. Consequently, earnings
and losses from the U.K. subsidiaries for the third quarter ended September 30,
2003 are part of the earnings and losses of the Cayman Islands subsidiary on
which no U.S. taxes are provided.
24
RESULTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
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.
NINE MONTHS ENDED
SEPTEMBER 30,
------------------------- FAVORABLE/
2003 2002 (UNFAVORABLE)
-------------------------------------------
(in thousands)
CONTRACT DRILLING REVENUE
High Specification Floaters .................... $ 215,982 $ 222,771 $ (6,789)
Other Semisubmersibles ......................... 185,556 242,802 (57,246)
Jack-ups ....................................... 69,688 75,042 (5,354)
Integrated Services ............................ 1,189 9,246 (8,057)
Other .......................................... (362) (436) 74
Eliminations ................................... (233) (1,937) 1,704
-------------------------------------------
TOTAL CONTRACT DRILLING REVENUE ................ $ 471,820 $ 547,488 $ (75,668)
===========================================
REVENUES RELATED TO REIMBURSABLE EXPENSES $ 21,436 $ 22,032 $ (596)
CONTRACT DRILLING EXPENSE
High Specification Floaters .................... $ 116,805 $ 113,374 $ (3,431)
Other Semisubmersibles ......................... 170,021 161,680 (8,341)
Jack-ups ....................................... 74,940 69,131 (5,809)
Integrated Services ............................ 2,084 10,568 8,484
Other .......................................... 1,593 1,347 (246)
Eliminations ................................... (233) (1,937) (1,704)
-------------------------------------------
TOTAL CONTRACT DRILLING EXPENSE ................ $ 365,210 $ 354,163 $ (11,047)
===========================================
REIMBURSABLE EXPENSES .......................... $ 19,471 $ 20,012 $ 541
OPERATING INCOME (LOSS)
High Specification Floaters .................... $ 99,177 $ 109,397 $ (10,220)
Other Semisubmersibles ......................... 15,535 81,122 (65,587)
Jack-ups ....................................... (5,252) 5,911 (11,163)
Integrated Services ............................ (895) (1,322) 427
Other .......................................... (1,955) (1,783) (172)
Reimbursable expenses, net ..................... 1,965 2,020 (55)
Depreciation ................................... (132,086) (132,469) 383
General and administrative expense ............. (22,595) (21,114) (1,481)
Gain (loss) on sale and disposition of assets .. (1,451) 42 (1,493)
-------------------------------------------
TOTAL OPERATING INCOME (LOSS) .................. $ (47,557) $ 41,804 $ (89,361)
===========================================
High Specification Floaters.
Revenues. Revenues from high specification floaters decreased $6.8
million for the nine months ended September 30, 2003 compared to the same period
in 2002.
25
Lower average operating dayrates for most of the rigs in this
classification resulted in a $35.2 million reduction in revenue. Average
operating dayrates fell to $95,700 (excluding the Ocean Rover) in the first nine
months of 2003 from $113,100 during the same period of 2002. Significant
reductions in the average operating dayrates were:
- the Ocean Baroness ($158,900 to $99,000);
- the Ocean Victory ($107,500 to $69,300); and
- the Ocean Valiant ($82,300 to $51,100).
An overall improvement in utilization during the nine months ended
September 30, 2003 contributed $19.7 million to revenues and partially offset
the negative effect of lower average operating dayrates. Utilization (excluding
the Ocean Rover) rose to 88% in the first nine months of 2003 from 83% during
the same period in 2002. Utilization improved for:
- the Ocean America, which worked all of the nine months ended
September 30, 2003 but was stacked five months during the
same period in 2002;
- the Ocean Star, which worked most of the nine months ended
September 30, 2003 but was stacked four months during the
same period in 2002, including three months for inspection
and repairs; and
- the Ocean Baroness, which worked more days during the first
nine months of 2003 than in the same period in 2002 when the
rig spent most of the first quarter of 2002 completing its
upgrade to high specification capabilities.
Partially offsetting the overall improvement in utilization was a
decline in utilization for the Ocean Valiant, which was stacked approximately
three more months during the nine months ended September 30, 2003 than in the
same period of 2002.
Also offsetting the decrease in revenue due to lower average operating
dayrates noted above was the Ocean Rover, which contributed an additional $8.7
million to revenues when it began its drilling program offshore Malaysia in July
2003 upon completion of its upgrade to high specification capabilities. The rig
spent all of the first nine months of 2002 undergoing its upgrade.
Contract Drilling Expense. Contract drilling expense for high
specification floaters for the nine months ended September 30, 2003 increased
$3.4 million compared to the same period in 2002. Higher contract drilling
expenses were primarily due to:
- operating costs for the Ocean Baroness, which worked most of
the current year period compared to the same period in 2002
when the rig began operations late in the first quarter upon
completion of its upgrade;
- operating costs associated with the Ocean Rover, which began
operating in July 2003 compared to the first nine months of
2002, when most of the rig's costs were capitalized in
connection with its upgrade; and
- mobilization, inspection and repair costs incurred by the
Ocean Valiant during the nine months ended September 30,
2003.
These higher contract drilling expenses were partially offset by lower
expenses for the nine months ended September 30, 2003 when compared to the same
period in 2002. The declines resulted from:
- higher costs incurred during the first nine months of 2002
for the recovery of the Ocean Baroness's marine riser, net of
costs charged to an associated insurance claim; and
- inspection and repair costs to the Ocean Victory and the
Ocean Star incurred during the first nine months of 2002.
Other Semisubmersibles.
Revenues. Revenues from other semisubmersibles for the nine months
ended September 30, 2003 decreased $57.2 million from the same period in 2002.
26
A decline in the average operating dayrate (excluding the Ocean Patriot
and the Ocean Vanguard), from $69,300 during the first nine months of 2002 to
$58,500 during the same period of 2003, resulted in lower revenues of $34.2
million. The most significant decreases in average operating dayrates were to:
- the Ocean Guardian ($89,600 to $55,500);
- the Ocean Princess ($72,500 to $40,200); and
- the Ocean Nomad ($74,800 to $42,700).
Lower utilization of 53% (excluding the Ocean Patriot and the Ocean
Vanguard) during the first nine months of 2003 compared to 61% for the same
period of 2002 resulted in a $31.0 million revenue decrease. Utilization
declined primarily due to:
- the Ocean Epoch, which has been stacked the majority of 2003
but worked most of 2002;
- the Ocean Whittington, which was stacked until early June
2003 when it began mobilizing to the Gulf of Mexico for its
long-term contract offshore Mexico, which it began on July
30, 2003. The rig operated during most of the same period in
2002 offshore Africa; and
- the Ocean Guardian and Ocean Princess, both of which have
been stacked approximately three months during the first nine
months of 2003 compared to 2002 when both rigs worked most of
the period.
Partially offsetting the lower revenue was $8.0 million contributed by
the Ocean Vanguard and the Ocean Patriot, which the Company acquired in December
2002 and March 2003, respectively.
Contract Drilling Expense. Contract drilling expense for other
semisubmersibles during the nine months ended September 30, 2003 was higher by
$8.3 million compared to the same period in 2002 primarily due to additional
costs in the first nine months of 2003 associated with:
- the Ocean Vanguard and the Ocean Patriot, which the Company
acquired in December 2002 and March 2003, respectively;
- the mobilization of the Ocean Worker, Ocean Ambassador and
the Ocean Whittington to Mexico in 2003; and
- the inspections of the Ocean Ambassador, Ocean Guardian,
Ocean Nomad and the Ocean Bounty during 2003.
Partially offsetting the higher contract drilling expenses during the
first nine months of 2003 were lower expenses resulting from the Ocean
Liberator, Ocean New Era, Ocean Voyager and the Ocean Endeavor which have been
cold stacked for all of 2003 but were warm stacked during most or part of the
same period in 2002.
Jack-Ups.
Revenues. Revenues from jack-ups decreased $5.4 million during the nine
months ended September 30, 2003 compared to the same period in 2002.
Utilization fell to 67% during the nine months ended September 30, 2003
from 72% during the same period in 2002, resulting in a $4.8 million reduction
in revenue. The decline in utilization was primarily from:
- the Ocean Sovereign, which spent most of the 2003 period in a
shipyard completing its leg extension upgrade but operated
offshore Indonesia throughout the same period in 2002; and
- the Ocean Titan, which began its cantilever conversion
upgrade in May 2003 but worked almost all of the same period
in 2002.
Partially offsetting the reduction in revenue were improvements in
utilization for:
- the Ocean Spartan, Ocean Spur and the Ocean Heritage, which
were undergoing leg extension upgrades during 2002 but
operated during most of the same period in 2003; and
- the Ocean Crusader, which was stacked for approximately three
months in 2002 but operated throughout the 2003 period.
27
Average operating dayrates remained relatively constant between the
nine months ended 2002 and the same period in 2003 ranging from $27,200 in the
2002 period to $27,400 in the 2003 period.
Contract Drilling Expense. Contract drilling expense for jack-ups
during the nine months ended September 30, 2003 increased $5.8 million from the
same period in 2002 primarily due to:
- a majority of costs incurred in 2002 for the Ocean Spartan,
Ocean Spur and the Ocean Heritage capitalized in connection
with their leg extension upgrades; and
- costs associated with the 2003 inspections of the Ocean Drake
and Ocean Warwick.
Partially offsetting the higher contract drilling expenses were:
- reduced costs for the Ocean Champion, which was cold stacked
during all of 2003 but only part of 2002; and
- reduced costs for the Ocean Titan due to the capitalization
of most costs during its cantilever upgrade, which began in
the second quarter of 2003.
Integrated Services.
During the first nine months of 2003 integrated services had a loss of
$0.9 million. The loss was comprised of project income of $0.4 million from the
completion of one turnkey plug and abandonment project in the Gulf of Mexico
during the first quarter of 2003 which was more than offset by operating
overhead costs and insurance premiums. During the first nine months of 2002, an
operating loss of $1.3 million resulted from an unprofitable turnkey project in
the Gulf of Mexico.
Reimbursable expenses, net.
Reimbursable expenses include items that the Company purchases, and/or
services it performs, at the request of its customers. Revenues related to
reimbursable items, offset by the related expenditures for these items, were
$2.0 million for each of the nine month periods ended September 30, 2003 and
2002.
Depreciation.
Depreciation expense decreased $0.4 million to $132.1 million during
the nine months ended September 30, 2003 compared to $132.5 million in the same
period of 2002. A $15.1 million reduction in depreciation expense resulted from
increasing the estimated service lives and salvage values of most of the
Company's drilling rigs, effective April 1, 2003, to better reflect their
remaining economic lives and salvage values. This decrease was almost completely
offset by additional depreciation from the Ocean Vanguard and the Ocean Patriot,
which the Company acquired in December 2002 and March 2003, respectively.
Depreciation also rose from additional depreciation for five of the Company's
recently upgraded jack-up rigs, additional depreciation for the Ocean Baroness,
which completed its upgrade in March 2002, and additional depreciation for the
Ocean Rover, which completed its upgrade in July 2003.
General and Administrative Expense.
General and administrative expense of $22.6 million was $1.5 million
higher during the nine months ended September 30, 2003 than the $21.1 million
incurred during the same period in 2002. This increase was primarily due to
severance pay associated with the elimination of certain positions in the
Company as part of a cost reduction program and higher professional expenses for
legal fees. Partially offsetting was a reduction in other personnel costs.
Gain (Loss) on Sale and Disposition of Assets.
A loss on the sale and disposition of assets of $1.5 million occurred
during the nine months ended September 30, 2003 primarily due to the retirement
of two of the Company's second generation semisubmersible drilling rigs, the
Ocean Century and Ocean Prospector. These rigs have been cold stacked since July
1998 and October 1998, respectively, are being offered for sale and as a result
of this decision, were written down to their fair market values. A gain on the
sale of assets of approximately $42,000 occurred during the nine months ended
September 30, 2002.
28
Interest Income.
Interest income of $10.2 million earned during the nine months ended
September 30, 2003 declined $13.7 million, from $23.9 million earned during the
same period in 2002. Interest income was lower primarily due to the lower
interest rates earned on cash and marketable securities compared to the same
period in 2002. In addition, the Company had less cash investment during the
nine months ended September 30, 2003 than the same period of 2002.
Gain (Loss) on Sale of Marketable Securities.
A loss on the sale of marketable securities of $7.3 million occurred
during the nine months ended September 30, 2003 compared to a $34.0 million gain
on the sale of marketable securities for the same period in 2002.
Income Tax Benefit (Expense).
An income tax benefit of $9.4 million was recognized on a pre-tax loss
of $59.1 million during the nine months ended September 30, 2003 compared to tax
expense of $26.4 million which was recognized on pre-tax income of $82.6 million
in the same period of 2002.
The Company's estimated aggregate annual effective income tax rate for
the nine months ended September 30, 2003 was 15.9%. In 2002 the Company formed a
Cayman Islands corporation, Diamond Offshore International Limited, which is a
wholly owned subsidiary of Diamond Offshore Drilling, Inc. Certain of the
Company's rigs that operate internationally are now owned and operated, directly
or indirectly, by the Cayman Islands subsidiary. Effective January 1, 2003 the
Company began to postpone remittance of the earnings from this subsidiary to the
U.S. and to indefinitely reinvest these earnings internationally. Consequently,
no U.S. taxes were provided on these earnings and no U.S. tax benefits were
recognized on losses during the nine months ended September 30, 2003.
The Company's estimated effective income tax rate for the nine months
ended September 30, 2002 was 31.9%. In the first quarter of 2002, a portion of
the earnings from the Company's U.K. subsidiaries was considered to be
indefinitely reinvested and no U.S. taxes were provided on those earnings. These
U.K. subsidiaries are now owned, directly or indirectly, by Diamond Offshore
International Limited. Consequently, earnings and losses from the U.K.
subsidiaries for the nine months ended September 30, 2003 are part of the
earnings and losses of the Cayman Islands subsidiary on which no U.S. taxes are
provided.
INDUSTRY CONDITIONS
The offshore contract drilling industry continues to be extremely
competitive and demand for the Company's drilling services improved only
slightly during the third quarter of 2003 compared to the previous quarter. Soft
market conditions persisted for deepwater semisubmersibles in the U.S. Gulf of
Mexico ("U.S. GOM") where an oversupply of rigs held dayrates at levels below
expectations during the quarter. The Company has endeavored to maintain
utilization of its deepwater semisubmersible fleet by operating these rigs in
the mid-water depth market at lower dayrates when necessary. Utilization of the
Company's mid-water depth semisubmersible fleet in the U.S. GOM has been stable
with firm dayrates but limited backlog. In contrast, jack-up supply in the U.S.
GOM is at its lowest level in 10 years, and dayrates for the jack-up fleet in
this sector have improved 20% - 30% during the past three months, with
utilization high in all but the low-end jack-up market.
As noted, Pemex-Exploracion Y Produccion ("Pemex"), Mexico's
state-owned oil company, has continued to increase its activity offshore by
attracting rigs from the U.S waters as well as from abroad. During the third
quarter of 2003, the Company began operating three of its semisubmersible rigs
under long-term contracts for Pemex. In October 2003, the Company entered into
another long term contract with Pemex to operate the Ocean Yorktown, a
semisubmersible rig that recently mobilized from Brazil. Additional tenders from
Pemex have been announced for jack-up rigs for work beginning in 2004, and
further tenders for both semisubmersibles and jack-up rigs may be possible in
2004. There is no assurance that the Company will bid on these initial tenders
or possible future jobs, or if it does bid that it will be successful in the
bidding process.
In other international markets, the North Sea floater market is weak,
with an oversupply of rigs coupled with the normal winter downturn in drilling
activity. This market is not expected to begin to recover until the first or
second quarter of 2004, and consequently the Company is marketing its two idle
North Sea semisubmersibles in other operating theaters. Elsewhere, while the
international markets are expected to remain relatively flat into at least early
2004, the Company believes that there is good potential for increased activity
particularly offshore West
29
Africa and India next year and extending into 2005, although there is no
assurance that the Company would elect to participate in any such future
contract tenders or that it would be successful in the bidding process if it did
participate. Additionally, the Company has recently obtained letters of intent
for two of its jack-up rigs, the Ocean Sovereign and the Ocean Heritage, to
operate into mid-2004. The units are currently stacked.
OPERATIONS OUTSIDE THE UNITED STATES
The Company's non-U.S. operations are subject to certain political,
economic and other uncertainties not normally encountered in U.S. operations,
including risks of war and civil disturbances (or other risks that may limit
or disrupt markets), expropriation and the general hazards associated with the
assertion of national sovereignty over certain areas in which operations are
conducted. No prediction can be made as to what governmental regulations may be
enacted in the future that could adversely affect the Company's non-U.S.
operations or the international offshore contract drilling industry. The
Company's operations outside the United States may also face the additional risk
of fluctuating currency values, hard currency shortages, controls of currency
exchange and repatriation of income or capital.
During the nine months ended September 30, 2003, the Company entered
into contracts to operate three of its semisubmersible rigs offshore Mexico for
Pemex, the national oil company of Mexico, and in October 2003 entered into a
contract for a fourth semisubmersible to work offshore Mexico for this same
customer. The terms of these contracts expose the Company to greater risks than
it normally assumes, such as exposure to greater environmental liability. While
the Company believes that the financial terms of the contracts and the Company's
operating safeguards in place mitigate these risks, there can be no assurance
that the Company's increased risk exposure will not have a negative impact on
the Company's future operations or financial results.
LIQUIDITY
At September 30, 2003, the Company's cash and marketable securities
totaled $581.1 million, down from $812.5 million at December 31, 2002. A
discussion of the sources and uses of cash for the nine months ended September
30, 2003 compared to the same period in 2002 follows.
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------------
2003 2002 CHANGE
----------------------------------------
(IN THOUSANDS)
NET CASH PROVIDED BY OPERATING ACTIVITIES
Net income (loss) ................................ $ (49,716) $ 56,224 $ (105,940)
Depreciation ..................................... 132,086 132,469 (383)
Deferred tax provision ........................... (11,785) 16,450 (28,235)
Other non-cash items, net ........................ 19,252 (25,480) 44,732
Net changes in operating assets and liabilities .. (24,810) 67,193 (92,003)
----------------------------------------
$ 65,027 $ 246,856 $ (181,829)
========================================
Cash generated by a net loss adjusted for non-cash items, including
depreciation, for the nine months ended September 30, 2003 decreased $181.8
million compared to the same period in 2002 primarily due to a decline in the
results of operations in the first nine months of 2003.
30
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------------
2003 2002 CHANGE
----------------------------------------
(IN THOUSANDS)
NET CASH USED IN INVESTING ACTIVITIES
Capital expenditures (excluding rig acquisition) $ (177,416) $ (206,055) $ 28,639
Rig acquisition ................................ (63,500) -- (63,500)
Proceeds from sale of assets ................... 879 1,483 (604)
Proceeds from sale and maturities of
marketable securities ........................ 2,571,618 3,396,577 (824,958)
Purchase of marketable securities .............. (2,359,460) (3,289,671) 930,210
Securities repurchased under repurchase
agreements, net ............................. -- (199,062) 199,062
Proceeds from settlement of forward contracts .. 2,492 986 1,506
----------------------------------------
$ (25,387) $ (295,742) $ 270,355
========================================
Net cash used in investing activities decreased $270.4 million during
the nine months ended September 30, 2003 compared to the same period in 2002.
During the nine-month periods ended September 30, 2003 and 2002 cash was
provided by the net sale and maturity of certain of the Company's investments in
marketable securities, the settlement of forward contracts at favorable exchange
rates and the sale of miscellaneous equipment. Cash used during the first nine
months of 2003 was for the purchase of the semisubmersible rig, Omega, renamed
the Ocean Patriot, and capital expenditures, primarily for the completion of the
Ocean Rover upgrade and the upgrades of three of the Company's jack-up rigs.
During the nine months ended September 30, 2002, $199.1 million was used for the
repurchase of securities sold under repurchase agreements in 2001 and $206.1
million was used for capital expenditures (primarily the Ocean Baroness and
Ocean Rover upgrades). There were no outstanding loaned debt securities at
September 30, 2003.
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------------
2003 2002 CHANGE
----------------------------------------
(IN THOUSANDS)
NET CASH USED IN FINANCING ACTIVITIES
Payment of dividends ........................... $ (48,876) $ (49,395) $ 519
Acquisition of treasury stock .................. -- (30,567) 30,567
Settlement of put options ...................... -- (1,193) 1,193
----------------------------------------
$ (48,876) $ (81,155) $ 32,279
========================================
The Company paid cash dividends of $48.9 million to stockholders during
the nine months ended September 30, 2003 compared to $49.4 million in the same
period of 2002. The dividends were lower for the nine months ended September 30,
2003 as a result of the Company's purchase of shares of its common stock during
2002.
During the nine months ended September 30, 2002, the Company purchased
1,035,800 shares of its common stock at an aggregate cost of $30.6 million, or
$29.51 per share. This includes the Company's purchase of 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. 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.
Cash was also used during the nine months ended September 30, 2002 for
payments totaling $1.2 million for the settlement of put options which covered
1,000,000 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 nine months ended September 30, 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.
31
Contractual Cash Obligations.
The Company's long-term debt and operating leases have not changed
materially from those discussed and reported in the Company's Annual Report on
Form 10-K for the year ended December 31, 2002.
The Company is contingently liable as of September 30, 2003 in the
amount of $64.2 million under certain performance, bid, customs and export
bonds. Banks have issued letters of credit securing certain of these bonds. All
of these obligations expire in less than one year.
Dividend Reduction.
On October 16, 2003 the Company announced that its quarterly cash
dividend effective December 1, 2003, for stockholders of record on November 3,
2003 will be $0.0625 per share of common stock. The dividend rate for previous
quarters this year was $0.125 per share of common stock. The Company elected to
reduce the dividend rate in order to help maintain the Company's strong
liquidity position in light of recent earnings declines.
Other.
The Company has an effective shelf registration statement under which
it has the ability to issue an aggregate of approximately $117.5 million in
debt, equity and other securities. 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.
At September 30, 2003 and December 31, 2002, the Company had no
off-balance sheet debt.
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 effect 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.
In March 2003, Diamond Offshore Drilling Limited, a subsidiary of the
Company, completed the acquisition of the third-generation semisubmersible
drilling rig, Omega, renamed the Ocean Patriot for $65.0 million. The Company
capitalized $63.5 million to rig equipment and recorded $1.5 million to rig
inventory.
The Company expects to spend a total of approximately $110 million for
rig upgrade capital expenditures during 2003 (approximately $68 million for the
Ocean Rover upgrade and approximately $42 million to complete the upgrades of
three of the Company's jack-up rigs). During the nine months ended September 30,
2003, the Company spent $96.1 million, including capitalized interest expense,
for rig upgrades, of which $67.5 million was for the deepwater upgrade of the
Ocean Rover and $28.6 million was for the Company's jack-up rig upgrade program
discussed below.
The upgrade of the Ocean Rover, which began in January 2002, was
completed early in July 2003 on time and under budget. The project, originally
budgeted to cost $200 million, was completed for approximately $189 million. The
rig commenced its contract with Murphy Sabah Oil Co., Ltd. on July 10, 2003 for
a minimum three well drilling program offshore Malaysia.
32
The Company's two year program to expand the capabilities of its
jack-up fleet by significantly upgrading six of its 14 jack-up rigs is now more
than 95% complete. Three of these upgrades were completed in 2002 and two have
been completed in 2003. The Ocean Sovereign, a 250-foot water depth
independent-leg cantilever rig prior to the upgrade, completed leg extension
installations in May 2003 allowing the rig to work in water depths up to 300
feet. The cost of this upgrade was approximately $11 million. The Ocean Tower, a
350-foot water depth capability independent-leg slot rig prior to its upgrade,
completed its cantilever upgrade in March 2003 for approximately $27 million.
The installation of a cantilever package on the Ocean Titan began in May 2003
and is scheduled for completion late in the fourth quarter of 2003.
The Company expects to spend approximately $100 million to $110 million
in 2003 for capital expenditures associated with its continuing rig enhancement
program (other than rig upgrades) and other corporate requirements. During the
nine months ended September 30, 2003, the Company spent $81.3 million on its
continuing rig enhancement program and to meet other corporate capital
expenditure requirements.
The Company expects to finance its capital expenditures through the use
of existing cash balances or internally generated funds.
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. During the nine months ended September 30, 2003
integrated services had project income of $0.4 million from one turnkey plug and
abandonment project in the Gulf of Mexico completed in the first quarter of 2003
which was more than offset by operating overhead costs and insurance premiums.
During the nine months ended September 30, 2002 an operating loss of $1.3
million resulted primarily from an unprofitable turnkey project in the Gulf of
Mexico. It is the Company's intent not to pursue contracts for integrated
services, which includes turnkey contracts, except in very limited
circumstances.
RECENT ACCOUNTING PRONOUNCEMENTS
In May 2003 the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 150, "Accounting for
Certain Financial Instruments with Characteristics of both Liabilities and
Equity." This statement requires that an issuer classify a financial instrument
that is within its scope as a liability (or an asset in some circumstances).
SFAS No. 150 is effective for financial instruments entered into or modified
after May 31, 2003, and otherwise is effective at the beginning of the first
interim period beginning after June 15, 2003. It is to be implemented by
reporting the cumulative effect of a change in an accounting principle for
financial instruments created before the issuance date of SFAS No. 150 and still
existing at the beginning of the interim period of adoption. Restatement is not
permitted. The Company's adoption of SFAS No. 150 has not had a material impact
on the Company's consolidated results of operations, financial position or cash
flows.
In April 2003 the FASB issued SFAS No. 149, "Amendment of Statement 133
on Derivative Instruments and Hedging Activities." This statement amends and
clarifies financial accounting and reporting for derivative instruments embedded
in other contracts (collectively referred to as derivatives) and for hedging
activities under SFAS No. 133. SFAS No. 149 is to be applied prospectively for
contracts entered into or modified after June 30, 2003. For contracts involving
hedging relationships, SFAS No. 149 should be applied to both existing contracts
and new contracts entered into after June 30, 2003. The Company's adoption of
SFAS No. 149 has not had a material impact on the Company's consolidated
results of operations, financial position or cash flows.
In January 2003 the FASB issued Interpretation No. 46, "Consolidation
of Variable Interest Entities, an interpretation of Accounting Research Bulletin
No. 51" ("FIN 46"). This interpretation provides guidance on the identification
of, and financial reporting for, entities over which control is achieved through
means other than voting rights, or variable-interest entities ("VIEs"). FIN 46
is effective as of the beginning of the first interim or annual period ending
after December 15, 2003 for existing interests and effective immediately for new
interests. The Company believes that, currently, it does not have any VIEs
within the scope of FIN 46.
33
In December 2002 the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation-Transition and Disclosure." SFAS No. 148 amends SFAS
No. 123, "Accounting for Stock-Based Compensation," to provide alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. In addition, SFAS No. 148
amends the disclosure requirements of SFAS No. 123 to require prominent
disclosures in both annual and interim financial statements regarding the method
of accounting for stock-based employee compensation and the effect of the method
used on reported results. SFAS No. 148 is effective for financial statements for
fiscal years ending after December 15, 2002. The Company accounts for
stock-based employee compensation in accordance with Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees." The Company has
adopted the provisions of SFAS No. 148 which require prominent disclosure
regarding the method of accounting for stock-based employee compensation in its
annual and interim financial statements. See "--Stock-Based Compensation" In
Note 1 to the Company's Consolidated Financial Statements in Item 1 of Part 1 of
this report.
In July 2002 the 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's adoption of SFAS No. 146 has
not had a material impact on the Company's consolidated results of operations,
financial position or cash flows.
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 (the "Securities Act"), and Section 21E of the Securities Exchange Act
of 1934, as amended (the "Exchange Act"). All statements other than statements
of historical fact are, or may be deemed to be, forward-looking statements.
Forward-looking statements include, without limitation, any statement that may
project, indicate or imply future results, events, performance or achievements,
and may contain or be identified by the words "expect," "intend," "plan,"
"predict," "anticipate," "estimate," "believe," "should," "could," "may,"
"might," "will be," "will continue," "will likely result," "project,"
"forecast," "budget" and similar expressions. Statements by the Company in this
report that contain forward-looking statements include, but are not limited to,
information concerning possible or assumed future results of operations of the
Company and statements about the following subjects:
- future market conditions and the effect of such conditions on
the Company's future results of operations (see "- Industry
Conditions");
- future uses of and requirements for financial resources,
including, but not limited to, expenditures related to the
upgrade of the Ocean Titan, one of the Company's jack-up rigs
(see "- Liquidity" and "- Capital Resources");
- interest rate and foreign exchange risk (see "Quantitative and
Qualitative Disclosures About Market Risk");
- future contractual obligations (see "--Industry Conditions,"
"--Operations Outside the United States" and "- Liquidity -
Contractual Cash Obligations");
- future operations outside the United States including, without
limitation, the Company's operations in Mexico (see
"--Industry Conditions" and "--Operations Outside the United
States");
- business strategy;
- growth opportunities;
- competitive position;
- expected financial position;
- future cash flows;
- future dividends;
- financing plans;
- tax planning;
- budgets for capital and other expenditures (see "--Capital
Resources");
- timing and cost of completion of rig upgrades and other
capital projects (see "--Capital Resources");
- delivery dates and drilling contracts related to rig
conversion and upgrade projects (see "--Industry Conditions"
and "--Capital Resources");
34
- plans and objectives of management;
- performance of contracts (see "--Industry Conditions,"
"--Operations Outside the United States" and "--Integrated
Services");
- outcomes of legal proceedings;
- compliance with applicable laws; and
- adequacy of insurance or indemnification.
Such statements inherently are subject to a variety of risks and
uncertainties that could cause actual results to differ materially from those
expected, projected or expressed in forward-looking statements. Such risks and
uncertainties include, among others, the following:
- general economic and business conditions;
- worldwide demand for oil and natural gas;
- changes in foreign and domestic oil and gas exploration,
development and production activity;
- oil and natural gas price fluctuations and related market
expectations;
- the ability of the Organization of Petroleum Exporting
Countries, commonly called OPEC, to set and maintain
production levels and pricing, and the level of production in
non-OPEC countries;
- policies of the various governments regarding exploration and
development of oil and gas reserves;
- advances in exploration and development technology;
- the political environment of oil-producing regions;
- casualty losses;
- operating hazards inherent in drilling for oil and gas
offshore;
- industry fleet capacity;
- market conditions in the offshore contract drilling industry,
including dayrates and utilization levels;
- competition;
- changes in foreign, political, social and economic conditions;
- risks of international operations, compliance with foreign
laws and taxation policies and expropriation or
nationalization of equipment and assets;
- risks of potential contractual liabilities pursuant to the
Company's various drilling contracts in effect from time to
time;
- foreign exchange and currency fluctuations and regulations,
and the inability to repatriate income or capital;
- risks of war, military operations, other armed hostilities,
terrorist acts and embargoes;
- changes in offshore drilling technology, which could require
significant capital expenditures in order to maintain
competitiveness;
- regulatory initiatives and compliance with governmental
regulations;
- compliance with environmental laws and regulations;
- customer preferences;
- effects of litigation;
- cost, availability and adequacy of insurance;
- adequacy of the Company's sources of liquidity;
- risks inherent in turnkey operations, including the risk of
failure to complete a well and cost overruns;
- the availability of qualified personnel to operate and service
the Company's drilling rigs; 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 additional factors that could adversely affect the Company's
business, results of operations and financial performance. Given these risks and
uncertainties, investors should not place undue reliance on forward-looking
statements. Forward-looking statements included in this report speak only as of
the date of this report. 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.
35
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The information included in this Item 3 is considered to constitute
"forward-looking statements" for purposes of the statutory safe harbor provided
in Section 27A of the Securities Act and Section 21E of the Exchange Act. 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.
The Company's measure of market risk exposure represents an estimate of
the change in fair value of its financial instruments. Market risk exposure is
presented for each class of financial instrument held by the Company at
September 30, 2003 and December 31, 2002 assuming immediate adverse market
movements of the magnitude described below. The Company believes that the
various rates of adverse market movements represent a measure of exposure to
loss under hypothetically assumed adverse conditions. The estimated market risk
exposure represents the hypothetical loss to future earnings and does not
represent the maximum possible loss or any expected actual loss, even under
adverse conditions, because actual adverse fluctuations would likely differ. In
addition, since the Company's investment portfolio is subject to change based on
its portfolio management strategy as well as in response to changes in the
market, these estimates are not necessarily indicative of the actual results
which may occur.
Exposure to market risk is managed and monitored by senior management.
Senior management approves the overall investment strategy employed by the
Company and has responsibility to ensure that the investment positions are
consistent with that strategy and the level of risk acceptable to it. The
Company may manage risk by buying or selling instruments or entering into
offsetting positions.
Interest Rate Risk
The Company has exposure to interest rate risk arising from changes in
the level or volatility of interest rates. The Company's investments in
marketable securities are primarily in fixed maturity securities. The Company
monitors its sensitivity to interest rate risk by evaluating the change in the
value of its financial assets and liabilities due to fluctuations in interest
rates. The evaluation is performed by applying an instantaneous change in
interest rates by varying magnitudes on a static balance sheet to determine the
effect such a change in rates would have on the recorded market value of the
Company's investments and the resulting effect on stockholders' equity. The
analysis presents the sensitivity of the market value of the Company's financial
instruments to selected changes in market rates and prices which the Company
believes are reasonably possible over a one-year period.
The sensitivity analysis estimates the change in the market value of
the Company's interest sensitive assets and liabilities that were held on
September 30, 2003 and December 31, 2002 due to instantaneous parallel shifts in
the yield curve of 100 basis points, with all other variables held constant.
The interest rates on certain types of assets and liabilities may
fluctuate in advance of changes in market interest rates, while interest rates
on other types may lag behind changes in market rates. Accordingly the analysis
may not be indicative of, is not intended to provide, and does not provide a
precise forecast of the effect of changes of market interest rates on the
Company's earnings or stockholders' equity. Further, the computations do not
contemplate any actions the Company could undertake in response to changes in
interest rates.
The Company's long-term debt, as of September 30, 2003 and December 31,
2002 is denominated in U.S. dollars. The Company's debt has been primarily
issued at fixed rates, and as such, interest expense would not be impacted by
interest rate shifts. The impact of a 100 basis point increase in interest rates
on fixed rate debt would result in a decrease in market value of $152.0 million
and $153.8 million, respectively. A 100 basis point decrease would result in an
increase in market value of $189.1 million and $192.7 million, respectively.
Foreign Exchange Risk
Foreign exchange rate risk arises from the possibility that changes in
foreign currency exchange rates will impact the value of financial instruments.
In mid-2002, the Company had contracted 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. As of September 30, 2003 the Company had satisfied all obligations
under this contract and no new forward exchange contracts had been entered into.
These foreign exchange forward contracts are recorded at their fair value
determined by discounting future cash flows at current forward rates. An asset
of $0.2 million reflecting the fair value of the forward contracts was included
with
36
"Prepaid expenses and other" in the Consolidated Balance Sheet at December 31,
2002. The sensitivity analysis assumes an instantaneous 20% change in the
foreign currency exchange rates versus the U.S. dollar from their levels at
December 31, 2002, with all other variables held constant.
The following table presents the Company's market risk by category
(interest rates and foreign currency exchange rates):
FAIR VALUE ASSET (LIABILITY) MARKET RISK
----------------------------------- ------------------------------
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30, DECEMBER 31,
CATEGORY OF RISK EXPOSURE: 2003 2002 2003 2002
- --------------------------------------------------------------------------------- ------------------------------
(IN THOUSANDS)
Interest rate: .......................
Marketable securities................ $ 405,447 (a) $ 627,614 (a) $ 800 (c) $ 21,500 (c)
(901,800)(b)
Long-term debt ...................... (919,529)(b)
Foreign Exchange -- 151 -- (d) 2,300 (d)
- -------------------------------
(a) The fair market value of the Company's investment in marketable
securities is based on the quoted closing market prices on September 30, 2003
and December 31, 2002.
(b) The fair values of the Company's 1.5% convertible senior debentures
due 2031 and zero coupon convertible debentures due 2020 are based on the quoted
closing market prices on September 30, 2003 and December 31, 2002. The fair
value of the Company's Ocean Alliance lease-leaseback agreement is based on the
present value of estimated future cash flows using a discount rate of 4.57% for
September 30, 2003 and 6.62% for December 31, 2002.
(c) The calculation of estimated market risk exposure is based on
assumed adverse changes in the underlying reference price or index of an
increase in interest rates of 100 basis points at September 30, 2003 and
December 31, 2002.
(d) The calculation of estimated market risk exposure is based on
assumed adverse changes in the underlying reference price or index of a decrease
in foreign exchange rates of 20% at December 31, 2002.
37
ITEM 4. CONTROLS AND PROCEDURES.
The Company's management formed a disclosure controls and procedures
committee (the "Disclosure Committee") in 2002. The purpose and responsibility
of the Disclosure Committee is to coordinate and review the process by which
information is recorded, processed, summarized and reported on a timely basis as
required to be disclosed by the Company in its reports filed, furnished or
submitted under the Exchange Act. In addition, the Disclosure Committee is
responsible for ensuring that this information is accumulated and communicated
to the Company's management, including its principal executive officer and
principal financial officer, as appropriate, to allow timely decisions regarding
required disclosure.
Evaluation of Disclosure Controls and Procedures
Based upon their evaluation, as of the end of the period covered by
this report, of the effectiveness of the Company's disclosure controls and
procedures (as defined in Exchange Act Rule 13a-15(e)), the Company's principal
executive officer and principal financial officer concluded that the Company's
disclosure controls and procedures are adequate to ensure that information the
Company is required to disclose in reports it files or submits under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the Securities and Exchange Commission's rules and forms.
Changes in Internal Controls
In connection with such evaluation, no change was identified in the
Company's internal control over financial reporting that occurred during the
Company's most recent fiscal quarter that has materially affected, or is
reasonably likely to materially affect, the Company's internal control over
financial reporting.
38
PART II. OTHER INFORMATION
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 made the following reports on Form 8-K during the third
quarter of 2003:
Date of Report Description of Report
- -------------- ---------------------
July 8, 2003 Item 9 Regulation FD disclosure (informational only)
July 17, 2003 Item 12 Results of Operations and Financial Condition
for the fiscal quarter ended June 30, 2003
July 21, 2003 Item 9 Regulation FD disclosure (informational only)
August 5, 2003 Item 9 Regulation FD disclosure (informational only)
August 19, 2003 Item 9 Regulation FD disclosure (informational only)
September 2, 2003 Item 9 Regulation FD disclosure (informational only)
September 16, 2003 Item 9 Regulation FD disclosure (informational only)
September 30, 2003 Item 9 Regulation FD disclosure (informational only)
39
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 04-Nov-2003 By: \s\ Gary T. Krenek
------------------------------
Gary T. Krenek
Vice President and Chief Financial Officer
Date 04-Nov-2003
\s\ Beth G. Gordon
------------------------------------
Beth G. Gordon
Controller (Chief Accounting Officer)
40
EXHIBIT INDEX
Exhibit No. Description
- ----------- -----------
3.1 Amended and Restated Certificate of Incorporation of the
Company (incorporated by reference to Exhibit 3.1 to the
Company's Quarterly Report on Form 10-Q for the quarterly
period ended June 30, 2003).
3.2 Amended and Restated By-laws of the Company (incorporated by
reference to Exhibit 3.2 to the Company's Quarterly Report on
Form 10-Q for the quarterly period ended March 31, 2001).
31.1* Rule 13a-14(a) Certification of the Chief Executive Officer.
31.2* Rule 13a-14(a) Certification of the Chief Financial Officer.
32.1* Section 1350 Certification of the Chief Executive Officer.
32.2* Section 1350 Certification of the Chief Financial Officer.
* Filed or furnished herewith.
41