DIAMOND OFFSHORE DRILLING INC - 10-K Annual Report

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

FORM 10-K

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 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 and zip code of principal executive offices)

(281) 492-5300
(Registrant's telephone number, including area code)

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
NONE

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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [X] No [ ]

State the aggregate market value of the voting and non-voting common equity
held by non-affiliates computed by reference to the price at which the common
equity was last sold as of the last business day of the registrant's most
recently completed second fiscal quarter.

As of June 30, 2003 $1,264,363,190

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

As of February 24, 2004 Common Stock, $0.01 par value per 129,322,455 shares
share

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive proxy statement relating to the 2004 Annual
Meeting of Stockholders of Diamond Offshore Drilling, Inc., which will be filed
within 120 days of December 31, 2003, are incorporated by reference in Part III
of this form.
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DIAMOND OFFSHORE DRILLING, INC.
FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2003

TABLE OF CONTENTS

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PART I

ITEM 1. BUSINESS.

GENERAL

Diamond Offshore Drilling, Inc., incorporated in Delaware in 1989, engages
principally in the contract drilling of offshore oil and gas wells. Unless the
context otherwise requires, references herein to the "Company" mean Diamond
Offshore Drilling, Inc. and its consolidated subsidiaries. The Company is a
leader in deep water drilling with a fleet of 45 offshore rigs consisting of 30
semisubmersibles, 14 jack-ups and one drillship.

THE FLEET

The Company's fleet includes some of the most technologically advanced rigs
in the world, enabling it to offer a broad range of services worldwide in
various markets, including the deep water, harsh environment, conventional
semisubmersible and the jack-up market.

Semisubmersibles. The Company owns and operates 30 semisubmersibles.
Semisubmersible rigs consist of an upper working and living deck resting on
vertical columns connected to lower hull members. Such rigs operate in a
"semi-submerged" position, remaining afloat, off bottom, in a position in which
the lower hull is approximately 55 feet to 90 feet below the water line and the
upper deck protrudes well above the surface. Semisubmersibles are typically
anchored in position and remain stable for drilling in the semi-submerged
floating position due in part to their wave transparency characteristics at the
water line. Semisubmersibles can also be held in position through the use of a
computer controlled thruster (dynamic-positioning) system to maintain the rig's
position over a drillsite. Three semisubmersible rigs in the Company's fleet
have this capability.

The Company owns and operates nine high specification semisubmersibles.
These semisubmersibles are larger than many other semisubmersibles, are capable
of working in water depths of 4,000 feet or greater or in harsh environments and
have other advanced features. As of February 2, 2004, six of the nine high
specification semisubmersibles were located in the U.S. Gulf of Mexico, while
one each of the remaining three rigs were located offshore Brazil, Indonesia and
Malaysia.

The Company owns and operates 21 other semisubmersibles which work in
maximum water depths up to 4,000 feet. The diverse capabilities of many of these
semisubmersibles enable them to provide both shallow and deep water service in
the U.S. and in other markets outside the U.S. As of February 2, 2004, the
Company was actively marketing 17 of these semisubmersibles. Three of these
semisubmersibles were located in the U.S. Gulf of Mexico; four were located
offshore Mexico; three were located in the North Sea; two each were located
offshore Brazil and Australia; and one each was located offshore South Africa,
West Africa and Vietnam.

The remaining four of the Company's 21 other semisubmersible rigs are cold
stacked; two since March 2002 and two since December 2002. When the Company
anticipates that a rig will be idle for an extended period of time, it cold
stacks the unit by ceasing to actively market the rig. This eliminates all
expenditures associated with keeping the rig ready to go to work. See additional
discussion in "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Results of Operations -- Operating Income" in Item 7 of
this report.

Jack-ups. The Company owns 14 jack-ups, 13 of which were being actively
marketed as of February 2, 2004. Jack-up rigs are mobile, self-elevating
drilling platforms equipped with legs that are lowered to the ocean floor until
a foundation is established to support the drilling platform. The rig hull
includes the drilling rig, jacking system, crew quarters, loading and unloading
facilities, storage areas for bulk and liquid materials, heliport and other
related equipment. The Company's jack-ups are used for drilling in water depths
from 20 feet to 350 feet. The water depth limit of a particular rig is
principally determined by the length of the rig's legs. A jack-up rig is towed
to the drillsite with its hull riding in the sea, as a vessel, with its legs
retracted. Once over a drillsite, the legs are lowered until they rest on the
seabed and jacking continues until the hull is
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elevated above the surface of the water. After completion of drilling
operations, the hull is lowered until it rests in the water and then the legs
are retracted for relocation to another drillsite.

As of February 2, 2004, 12 of the Company's jack-up rigs were located in
the Gulf of Mexico. Of these rigs, nine are independent-leg cantilevered units,
two are mat-supported cantilevered units, and one (which has been cold stacked
since February 2002) is a mat-supported slot unit. Both of the Company's
remaining jack-up rigs are internationally based and are independent-leg
cantilevered rigs; one was located offshore Indonesia while the other one was
mobilizing to Ecuador.

Drillship. The Company has one drillship, the Ocean Clipper, which is
located offshore Brazil. Drillships, which are typically self-propelled, are
positioned over a drillsite through the use of either an anchoring system or a
dynamic-positioning system similar to those used on certain semisubmersible
rigs. Deep water drillships compete in many of the same markets as do high
specification semisubmersible rigs.

Fleet Enhancements. The Company's strategy of economically upgrading its
fleet to meet customer demand for advanced, efficient, high-tech rigs,
particularly deepwater semisubmersibles is intended to maximize the utilization
and dayrates earned by the rigs in its fleet. Since 1995, the Company has
increased the number of rigs capable of operating in 3,500 feet of water or
greater, from 3 to 12 (9 of which are high specification units), primarily by
upgrading its existing fleet. Five of these upgrades were to its Victory-class
semisubmersible rigs; most recently the Ocean Rover which was completed on time
and under budget in July 2003 at an approximate cost of $188 million. The design
of the Company's Victory-class semisubmersible rigs with its cruciform hull
configurations, long fatigue-life and advantageous stress characteristics, makes
this class of rig particularly well-suited for significant upgrade projects.

In early 2004, the Company completed a two-year program designed to expand
the capabilities of its jack-up fleet by significantly upgrading six of its 14
jack-up rigs for an estimated total cost of $94 million. The Ocean Titan and
Ocean Tower, both 350-foot water depth capable independent-leg slot rigs prior
to their upgrades, had cantilever packages installed. The cantilever systems
enable a rig to cantilever or extend its drilling package over the aft end of
the rig. This is particularly important when attempting to drill over existing
platforms. Cantilever rigs have historically enjoyed higher dayrates and greater
utilization compared to slot rigs. The Ocean Tower completed its upgrade in
March 2003 for approximately $27 million. The Ocean Titan upgrade was completed
in January 2004 for approximately $22 million. The Ocean Spartan, Ocean Spur and
Ocean Heritage leg extension installations were completed in the fourth quarter
of 2002, enabling these rigs to work in water depths up to 300 feet, compared to
250 feet prior to the upgrades, at a combined approximate cost of $34 million.
The Ocean Sovereign, a 250-foot water depth independent-leg cantilever rig prior
to its upgrade, completed its leg extension installations in May 2003 at an
approximate cost of $11 million, allowing the rig to work in water depths up to
300 feet.

Fleet Additions. Another of the Company's business strategies is to
acquire assets at attractive levels particularly during cyclical downturns. The
Company most recently purchased two third-generation semisubmersible drilling
rigs, the Ocean Vanguard in late 2002 for $68.5 million and the Ocean Patriot,
formerly the Omega, in March 2003 for $65.0 million.

The Company continues to evaluate further rig acquisition and upgrade
opportunities. However, there can be no assurance whether or to what extent rig
acquisitions or upgrades will continue to be made to the Company's fleet. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Capital Resources" in Item 7 of this report.

Fleet Retirements. In December 2003 the Company sold two of its second
generation semisubmersible drilling rigs, the Ocean Century and Ocean
Prospector, for a total of $750,000 pre-tax. These rigs had been cold stacked in
the Gulf of Mexico since July 1998 and October 1998, respectively, and in
September 2003, were written down by $1.6 million to their fair market values of
$375,000 each.

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More detailed information concerning the Company's fleet of mobile offshore
drilling rigs, as of February 2, 2004, is set forth in the table below.

ATTRIBUTES

DP = Dynamically-Positioned/Self-
Propelled
IC = Independent-Leg Cantilevered
Rig
MC = Mat-Supported Cantilevered Rig
MS = Mat-Supported Slot Rig
VC = Victory-Class
SP = Self-Propelled
3M = Three Mud Pumps
4M = Four Mud Pumps
15K = 15,000 psi well control system

Top-Drive Drilling System included on all rigs except Champion
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(a) Such enhancements may include the installation of top-drive drilling
systems, water depth upgrades, mud pump additions and increases in deck
load capacity.

(b) For ease of presentation in this table, customer names have been shortened
or abbreviated.
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MARKETS

The Company's principal markets for its offshore contract drilling services
are the Gulf of Mexico, including the United States and offshore Mexico, Europe,
principally the U.K. and Norway, South America, Africa and Australia/Southeast
Asia. The Company actively markets its rigs worldwide. From time to time the
Company's fleet operates in various other markets throughout the world as the
market demands. See Note 16 to the Company's Consolidated Financial Statements
in Item 8 of this report.

The Company believes its presence in multiple markets is valuable in many
respects. For example, the Company believes that its experience with safety and
other regulatory matters in the U.K. has been beneficial in Australia and in the
Gulf of Mexico, while production experience gained through Brazilian and North
Sea operations has potential application worldwide. Additionally, the Company
believes its performance for a customer in one market segment or area enables it
to better understand that customer's needs and better serve that customer in
different market segments or other geographic locations.

OFFSHORE CONTRACT DRILLING SERVICES

The Company's contracts to provide offshore drilling services vary in their
terms and provisions. The Company often obtains its contracts through
competitive bidding, although it is not unusual for the Company to be awarded
drilling contracts without competitive bidding. Drilling contracts generally
provide for a basic drilling rate on a fixed dayrate basis regardless of whether
or not such drilling results in a productive well. Drilling contracts may also
provide for lower rates during periods when the rig is being moved or when
drilling operations are interrupted or restricted by equipment breakdowns,
adverse weather conditions or other conditions beyond the control of the
Company. Under dayrate contracts, the Company generally pays the operating
expenses of the rig, including wages and the cost of incidental supplies.
Dayrate contracts have historically accounted for a substantial portion of the
Company's revenues. In addition, the Company has worked some of its rigs under
dayrate contracts that include the ability to earn an incentive bonus based upon
performance.

A dayrate drilling contract generally extends over a period of time
covering either the drilling of a single well or a group of wells (a
"well-to-well contract") or a stated term (a "term contract") and may be
terminated by the customer in the event the drilling unit is destroyed or lost
or if drilling operations are suspended for a period of time as a result of a
breakdown of equipment or, in some cases, due to other events beyond the control
of either party. In addition, certain of the Company's contracts permit the
customer to terminate the contract early by giving notice, and in some
circumstances may require the payment of an early termination fee by the
customer. The contract term in many instances may be extended by the customer
exercising options for the drilling of additional wells at fixed or mutually
agreed terms, including dayrates.

The duration of offshore drilling contracts is generally determined by
market demand and the respective management strategies of the offshore drilling
contractor and its customers. In periods of rising demand for offshore rigs,
contractors typically prefer well-to-well contracts that allow contractors to
profit from increasing dayrates. In contrast, during these periods customers
with reasonably definite drilling programs typically prefer longer term
contracts to maintain dayrate prices at a consistent level. Conversely, in
periods of decreasing demand for offshore rigs, contractors generally prefer
longer term contracts to preserve dayrates at existing levels and ensure
utilization, while customers prefer well-to-well contracts that allow them to
obtain the benefit of lower dayrates. To the extent possible, the Company seeks
to have a foundation of long-term contracts with a reasonable balance of
single-well, well-to-well and short-term contracts to minimize the downside
impact of a decline in the market while still participating in the benefit of
increasing dayrates in a rising market. However, no assurance can be given that
the Company will be able to achieve or maintain such a balance from time to
time.

CUSTOMERS

The Company provides offshore drilling services to a customer base that
includes major and independent oil and gas companies and government-owned oil
companies. Several customers have accounted for 10.0% or more of the Company's
annual consolidated revenues, although the specific customers may vary from year
to
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year. During 2003, the Company performed services for 52 different customers
with Petroleo Brasileiro S. A. ("Petrobras") and BP accounting for 20.3% and
11.9% of the Company's annual total consolidated revenues, respectively. During
2002, the Company performed services for 46 different customers with Petrobras,
BP, and Murphy Exploration and Production Company accounting for 19.0%, 18.9%
and 10.4% of the Company's annual total consolidated revenues, respectively.
During 2001, the Company performed services for 44 different customers with BP
and Petrobras accounting for 21.8% and 17.3% of the Company's annual total
consolidated revenues, respectively. During periods of low demand for offshore
drilling rigs, the loss of a single significant customer could have a material
adverse effect on the Company's results of operations.

The Company's services in North America are marketed principally through
its Houston, Texas office, with support for U.S. Gulf of Mexico activities
coming from its regional office in New Orleans, Louisiana. The Company's
services in other geographic locations are marketed principally from its office
in The Hague, Netherlands with support from its regional offices in Aberdeen,
Scotland and Perth, Western Australia. Technical and administrative support
functions for the Company's operations are provided by its Houston office.

COMPETITION

The offshore contract drilling industry is highly competitive and is
influenced by a number of factors, including the current and anticipated prices
of oil and natural gas, the expenditures by oil and gas companies for
exploration and development of oil and natural gas and the availability of
drilling rigs. In addition, demand for drilling services remains dependent on a
variety of political and economic factors beyond the Company's control,
including worldwide demand for oil and natural gas, the ability of the
Organization of Petroleum Exporting Countries ("OPEC") to set and maintain
production levels and pricing, the level of production of non-OPEC countries and
the policies of the various governments regarding exploration and development of
their oil and natural gas reserves.

Customers often award contracts on a competitive bid basis, and although a
customer selecting a rig may consider, among other things, a contractor's safety
record, crew quality, rig location and quality of service and equipment, an
oversupply of rigs can create an intensely competitive market in which price is
the primary factor in determining the selection of a drilling contractor. In
periods of increased drilling activity, rig availability often becomes a
consideration, particularly with respect to technologically advanced units. The
Company believes competition for drilling contracts will continue to be intense
in the foreseeable future. Contractors are also able to adjust localized supply
and demand imbalances by moving rigs from areas of low utilization and dayrates
to areas of greater activity and relatively higher dayrates. Such movements,
reactivations or a decrease in drilling activity in any major market could
depress dayrates and could adversely affect utilization of the Company's rigs.
See "-- Offshore Contract Drilling Services."

GOVERNMENTAL REGULATION

The Company's operations are subject to numerous international, U.S., state
and local laws and regulations that relate directly or indirectly to its
operations, including certain regulations controlling the discharge of materials
into the environment, requiring removal and clean-up under certain
circumstances, or otherwise relating to the protection of the environment. For
example, the Company may be liable for damages and costs incurred in connection
with oil spills for which it is held responsible. Laws and regulations
protecting the environment have become increasingly stringent in recent years
and may, in certain circumstances, impose "strict liability" rendering a company
liable for environmental damage without regard to negligence or fault on the
part of such company. Liability under such laws and regulations may result from
either governmental or citizen prosecution. Such laws and regulations may expose
the Company to liability for the conduct of or conditions caused by others, or
for acts of the Company that were in compliance with all applicable laws at the
time such acts were performed. The application of these requirements or the
adoption of new requirements could have a material adverse effect on the
Company.

The United States Oil Pollution Act of 1990 ("OPA '90"), and similar
legislation enacted in Texas, Louisiana and other coastal states, addresses oil
spill prevention and control and significantly expands liability

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exposure across all segments of the oil and gas industry. OPA '90 and such
similar legislation and related regulations impose a variety of obligations on
the Company related to the prevention of oil spills and liability for damages
resulting from such spills. OPA '90 imposes strict and, with limited exceptions,
joint and several liability upon each responsible party for oil removal costs
and a variety of public and private damages.

INDEMNIFICATION AND INSURANCE

The Company's operations are subject to hazards inherent in the drilling of
oil and gas wells such as blowouts, reservoir damage, loss of production, loss
of well control, cratering or fires, the occurrence of which could result in the
suspension of drilling operations, injury to or death of rig and other personnel
and damage to or destruction of the Company's, the Company's customer's or a
third party's property or equipment. Damage to the environment could also result
from the Company's operations, particularly through oil spillage or uncontrolled
fires. In addition, offshore drilling operations are subject to perils peculiar
to marine operations, including capsizing, grounding, collision and loss or
damage from severe weather. The Company has insurance coverage and contractual
indemnification for certain risks, but there can be no assurance that such
coverage or indemnification will adequately cover the Company's loss or
liability in certain circumstances or that the Company will continue to carry
such insurance or receive such indemnification.

The Company's retention of liability for property damage is between $1.0
million and $2.5 million per incident, depending on the value of the equipment,
with an aggregate annual deductible of $5.0 million. In addition, the Company is
self-insured for 10% of its property damage losses.

OPERATIONS OUTSIDE THE UNITED STATES

Operations outside the United States accounted for approximately 51.6%,
55.5% and 37.3% of the Company's total consolidated revenues for the years ended
December 31, 2003, 2002 and 2001, respectively. The Company's non-U.S.
operations are subject to certain political, economic and other uncertainties
not 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 international 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. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Industry Conditions" and
"-- Other -- Currency Risk" in Item 7 of this report and Note 16 to the
Company's Consolidated Financial Statements in Item 8 of this report.

During 2003, the Company entered into contracts to operate four of its
semisubmersible rigs offshore Mexico for Pemex-Exploracion Y Produccion, the
national oil company of Mexico. 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.

EMPLOYEES

As of December 31, 2003, the Company had approximately 3,740 workers,
including international crew personnel furnished through independent labor
contractors. The Company has experienced satisfactory labor relations and
provides comprehensive benefit plans for its employees. The Company does not
currently consider the possibility of a shortage of qualified personnel to be a
material factor in its business.

ACCESS TO COMPANY FILINGS, CODE OF ETHICS AND CORPORATE GOVERNANCE GUIDELINES

Access to the Company's filings of its annual reports on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to
those reports filed or furnished pursuant to Section 13(a) or
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15(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"),
with the United States Securities and Exchange Commission ("SEC") may be
obtained through the Company's website (http://www.diamondoffshore.com). The
Company's website provides a hyperlink to a third-party SEC filings website
where these reports may be viewed and printed at no cost as soon as reasonably
practicable after the Company has electronically filed such material with the
SEC.

The text of the Company's code of ethics has been posted to and is
available on the Company's Internet website as disclosed above. The code of
ethics applies to the Company's principal executive officer, principal financial
officer and controller. The contents of the Company's website are not, and shall
not be deemed to be, incorporated into this report. Any future amendments to the
Company's code of ethics, and any waiver of the code of ethics that applies to
the Company's principal executive officer, principal financial officer or
controller, will be posted to the Company's Internet website. In addition, the
Company's Internet website contains a corporate governance section that includes
the Company's corporate governance guidelines. The Company will provide printed
copies of its code of ethics and corporate governance guidelines to any
stockholder upon request.

ITEM 2. PROPERTIES.

The Company owns an eight-story office building containing approximately
182,000-net rentable square feet on approximately 6.2 acres of land located in
Houston, Texas, where the Company has its corporate headquarters, two buildings
totaling 39,000 square feet and 20 acres of land in New Iberia, Louisiana, for
its offshore drilling warehouse and storage facility, and a 13,000-square foot
building and five acres of land in Aberdeen, Scotland, for its North Sea
operations. Additionally, the Company currently leases various office, warehouse
and storage facilities in Louisiana, Australia, Brazil, Indonesia, Scotland,
Vietnam, Netherlands, Malaysia, South Africa, West Africa, Ecuador and Mexico to
support its offshore drilling operations.

ITEM 3. LEGAL PROCEEDINGS.

Not applicable.

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

Not applicable.

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EXECUTIVE OFFICERS OF THE REGISTRANT

In reliance on General Instruction G (3) to Form 10-K, information on
executive officers of the Registrant is included in this Part I. The executive
officers of the Company are elected annually by the Board of Directors to serve
until the next annual meeting of the Board of Directors, or until their
successors are duly elected and qualified, or until their earlier death,
resignation, disqualification or removal from office. Information with respect
to the executive officers of the Company is set forth below.

James S. Tisch has served as Chief Executive Officer of the Company since
March 1998. Mr. Tisch has served as Chairman of the Board since 1995 and as a
director of the Company since June 1989. Mr. Tisch has served as Chief Executive
Officer of Loews Corporation ("Loews"), a diversified holding company and the
Company's controlling stockholder, since November 1998. Mr. Tisch, a director of
Loews since 1986, also serves as a director of CNA Financial Corporation, a 90%
owned subsidiary of Loews, BKF Capital Group, Inc. and Vail Resorts, Inc.

Lawrence R. Dickerson has served as President, Chief Operating Officer and
Director of the Company since March 1998. Mr. Dickerson has also served on the
United States Commission on Ocean Policy since 2001.

David W. Williams has served as Executive Vice President of the Company
since March 1998.

Rodney W. Eads has served as Senior Vice President of the Company since May
1997.

John L. Gabriel, Jr. has served as Senior Vice President of the Company
since November 1999. Previously, Mr. Gabriel served as a Marketing Vice
President of the Company from April 1993.

John M. Vecchio has served as Senior Vice President of the Company since
April 2002. Previously, Mr. Vecchio served as Technical Services Vice President
of the Company from October 2000 through March 2002 and as Engineering Vice
President of the Company from July 1997 through September 2000.

Gary T. Krenek has served as Vice President and Chief Financial Officer of
the Company since March 1998.

Beth G. Gordon has served as Controller and Chief Accounting Officer of the
Company since April 2000. Previously, Ms. Gordon was employed by Pool Energy
Services Co. from December 1978 through March 2000 where her most recent
position was Vice President-Finance -- Pool Well Services Co.

William C. Long has served as Vice President, General Counsel and Secretary
of the Company since March 2001. Previously, Mr. Long served as General Counsel
and Secretary of the Company from March 1999 and acting General Counsel and
Secretary of the Company from June 1998 through February 1999.

9

PART II

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.

PRICE RANGE OF COMMON STOCK

The Company's common stock is listed on the New York Stock Exchange
("NYSE") under the symbol "DO." The following table sets forth, for the calendar
quarters indicated, the high and low closing prices of common stock as reported
by the NYSE.

As of February 24, 2004 there were approximately 340 holders of record of
the Company's common stock. This number does not include the stockholders for
whom shares are held in a "nominee" or "street name" name.

DIVIDEND POLICY

In 2003 the Company paid cash dividends of $0.125 per share of the
Company's common stock on March 3, June 2 and September 2 and $0.0625 per share
on December 1. The Company elected to reduce the dividend rate in October 2003
in an effort to maintain its strong liquidity position in light of the decline
in earnings during 2003. On January 26, 2004, the Company declared a dividend of
$0.0625 per share of the Company's common stock payable March 1, 2004 to
stockholders of record on February 2, 2004. In 2002 the Company paid cash
dividends of $0.125 per share of the Company's common stock on March 1, June 3,
September 3 and December 2. Any future determination as to payment of dividends
will be made at the discretion of the Board of Directors of the Company and will
depend upon the Company's operating results, financial condition, capital
requirements, general business conditions and such other factors that the Board
of Directors deems relevant.

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ITEM 6. SELECTED FINANCIAL DATA.

The following table sets forth certain historical consolidated financial
data relating to the Company. The selected consolidated financial data are
derived from the financial statements of the Company as of and for the periods
presented. Prior periods have been reclassified to conform to the
classifications currently followed. Such reclassifications do not affect
earnings. The selected consolidated financial data below should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" in Item 7 and the Company's Consolidated Financial
Statements (including the Notes thereto) in Item 8 of this report.

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(1) In March 2003 the Company spent $65.0 million ($63.5 million capitalized to
rig equipment and $1.5 million added to inventory) for the acquisition of
the Ocean Patriot, a third-generation semisubmersible drilling rig. In
December 2002 the Company spent $68.5 million ($67.0 million capitalized to
rig equipment and $1.5 million added to inventory) for the acquisition of
another third-generation semisubmersible drilling rig, the Ocean Vanguard.

(2) The deficiency in the Company's earnings available for fixed charges for the
year ended December 31, 2003 was approximately $55.3 million. For all
periods presented, the ratio of earnings to fixed charges has been computed
on a total enterprise basis. Earnings represent income from continuing
operations plus income taxes and fixed charges. Fixed charges include (i)
interest, whether expensed or capitalized, (ii) amortization of debt
issuance costs, whether expensed or capitalized, and (iii) a portion of rent
expense, which the Company believes represents the interest factor
attributable to rent.

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ITEM 7. 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) in Item 8 of
this report.

OVERVIEW

INDUSTRY CONDITIONS

The offshore drilling industry continues to be extremely competitive, and
demand for the Company's drilling services remains challenging. The Company had
all of its actively marketed deep and mid-water semisubmersibles in the U.S.
Gulf of Mexico ("U.S. GOM") operating during at least part of the fourth quarter
of 2003. However, these semisubmersibles continue to work under well-to-well
contracts and dayrates are currently flat. For the Company's jack-up fleet in
the U.S. GOM, dayrates and utilization improved significantly during 2003
compared to 2002 and this market continues to do well as the effect of high gas
prices and the repositioning of jack-ups to the Mexican Gulf of Mexico have had
a positive effect. However, the Company can make no assurances that these
favorable market conditions will persist.

In the North Sea, the Company has two of its three semisubmersibles
committed through most of 2004 and a fourth North Sea rig, the Ocean Nomad has
moved to West Africa where it is contracted to operate through the middle of the
year. The Company is actively pursuing opportunities for the Ocean Vanguard,
which is currently stacked at Invergordon. In Southeast Asia, all of the
Company's semisubmersibles are committed through mid-year. In addition, the
Ocean Sovereign, a jack-up, will operate in Indonesia through the end of the
first quarter, and the Ocean Heritage has mobilized to Ecuador where it is
operating under a three-well contract. In Brazil, the Company renewed its
contracts for two of its semisubmersibles, although the renewal dayrates for the
Ocean Yatzy and the Ocean Winner were lower than previous contracts that were
set during a peak market cycle. Both of these semisubmersibles will begin
required surveys during the first quarter of 2004. The Company also successfully
renewed the contract for the Ocean Clipper drillship in Brazil at the same
dayrate as the unit's previous contract. All of the new Brazilian contracts are
for 700 days each. Although the Company is encouraged by the currently favorable
outlook in its international markets, the Company offers no assurance that a
favorable outcome will be achieved.

RESULTS OF OPERATIONS

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, generally no dayrate is earned and revenues will decrease as a result.
Revenues can also increase or decrease as a result of the acquisition or
disposal of rigs, required surveys and shipyard upgrades. In order to improve
utilization or realize higher dayrates, the Company may mobilize its rigs from
one market to another. However, during periods of unpaid mobilization, revenues
may be adversely affected. As a response to changes in demand, the Company may
withdraw a rig from the market by cold 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, in excess of 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 reimbursements received for the purchase of supplies,
equipment, personnel services and other services provided at the request of the
customer 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.

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. The Company has
12

elected not to pursue contracts for integrated services, which includes turnkey
contracts, except in very limited circumstances.

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, few decreases in operating expenses
may actually occur since the rig is typically maintained in a prepared or "ready
stacked" 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 costs of the operator when a rig is under 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, which meet certain criteria, that
maintain rather than upgrade its rigs. These expenses vary from period to
period. Costs of rig enhancements are capitalized and depreciated over the
expected useful lives of the enhancements. Higher depreciation expense decreases
operating income in periods subsequent to capital upgrades.

Operating income is negatively impacted when the Company performs certain
regulatory inspections that are due every five years ("5-year survey") for all
of the Company's rigs. Operating revenue decreases because these surveys are
performed during scheduled down-time in a shipyard. Operating expenses increase
as a result of these surveys due to the cost to mobilize the rigs to a shipyard,
inspection costs incurred and repair and maintenance costs. Repair and
maintenance costs may be required resulting from the survey or may have been
previously planned to take place during this mandatory down-time. The number of
rigs undergoing a 5-year survey will vary from year to year.

CRITICAL ACCOUNTING ESTIMATES

The Company's significant accounting policies are included in Note 1 of its
Notes to Consolidated Financial Statements in Item 8 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 to evaluate the economic
lives of its drilling rigs. As a result of this study, effective April 1, 2003,
the Company recorded changes in accounting estimates by increasing the estimated
service lives to 25 years for jack-ups and 30 years for semisubmersibles and the
Company's drillship and by increasing salvage values to 5% for most of the
Company's drilling rigs. The change in estimate was made to better reflect the
remaining economic lives and salvage values of the Company's fleet. The effect
of this change in accounting estimate resulted in an increase to net income
(after-tax) for the year ended December 31, 2003 of $20.4 million, or $0.16 per
share. 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. In September 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 subsequent to a decision
to offer the rigs for sale. These rigs were sold in December 2003 for $375,000
each (pre-tax). 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.

13

Personal Injury Claims. The Company's retention of liability for personal
injury claims, which primarily result from Jones Act liability in the Gulf of
Mexico, is $0.5 million per claim with an additional 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.

Income Taxes. The Company accounts for income taxes in accordance with
Statement of Financial Accounting Standards No. 109 "Accounting for Income
Taxes," which requires the recognition of the amount of taxes payable or
refundable for the current year; and an asset and liability approach in
recognizing the amount of deferred tax liabilities and assets for the future tax
consequences of events that have been currently recognized in its financial
statements or tax returns. The application of this accounting standard requires
that management make judgments regarding future events and related estimations
especially as they pertain to forecasting of the Company's effective tax rate,
the potential realization of deferred tax assets such as utilization of foreign
tax credits, and exposure to the disallowance of items deducted on tax returns
upon audit.

In 2003 a valuation allowance of $10.2 million, which resulted in a charge
against earnings, was established for certain of the Company's foreign tax
credit carryforwards which will begin to expire in 2006. Although the Company
intends to make use of all available tax planning strategies in order to be able
to utilize these carryforwards, under the "more likely than not" approach of
evaluating the associated deferred tax asset the Company deemed that a valuation
allowance was necessary.

14

YEARS ENDED DECEMBER 31, 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.

HIGH SPECIFICATION FLOATERS.

Revenues. Revenues from high specification floaters decreased $1.0 million
during the year ended December 31, 2003, compared to the same period in 2002.

Lower average operating dayrates for most of the rigs in this
classification resulted in a $39.0 million reduction in revenue. Average
operating dayrates fell from $109,500 during 2002 to $95,300 (excluding the

15

Ocean Rover) during 2003. Significant reductions in average operating dayrates
were experienced by certain rigs located in:

SOUTHEAST ASIA:

- the Ocean Baroness ($149,800 to $104,100);

U.S. GULF OF MEXICO:

- the Ocean Valiant ($81,400 to $52,600); and

- the Ocean Victory ($96,800 to $66,600).

An overall improvement in utilization for high specification floaters
during 2003 contributed $18.7 million to revenues and partially offset the
negative effect of lower average operating dayrates. Utilization improved to 87%
for the year ended December 31, 2003 from 83% for the same period in 2002
(excluding the Ocean Rover). Utilization improved for:

- the Ocean America, which worked most of 2003 but was stacked for almost
half of 2002;

- the Ocean Baroness, which worked most of 2003 but spent most of the first
quarter of 2002 in a shipyard completing its upgrade to high
specification capabilities; and

- the Ocean Star, which worked all of 2003 but was stacked four months
during the same period in 2002.

Partially offsetting the overall improvement in utilization was a decline
in utilization for the Ocean Valiant, which was stacked in 2003 for
approximately three more months than in 2002.

The unfavorable revenue variance for high specification rigs in 2003
compared to 2002 was also partially offset by $12.7 million in revenue
contributed by the Ocean Rover, which began its drilling program offshore
Malaysia in July 2003 upon completion of its upgrade to high specification
capabilities. The rig spent all of 2002 undergoing its upgrade.

Contract Drilling Expense. Contract drilling expense for high
specification floaters for the year ended December 31, 2003 increased $3.7
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 compared to 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 2002, when most of this rig's costs were
capitalized in connection with its upgrade; and

- mobilization, 5-year survey and repair costs incurred by the Ocean
Valiant during 2003.

These higher contract drilling expenses were partially offset by lower
expenses in 2003 compared to 2002 primarily due to:

- higher costs incurred during 2002 for the recovery of the Ocean
Baroness's marine riser, net of costs charged to an associated insurance
claim; and

- 5-year survey and repair costs for the Ocean Victory and the Ocean Star
incurred during 2002.

OTHER SEMISUBMERSIBLES.

Revenues. Revenues from other semisubmersibles for the year ended December
31, 2003 were $57.1 million lower compared to the same period in 2002.

16

A decline in the average operating dayrate (excluding the Ocean Patriot and
the Ocean Vanguard), from $67,900 during 2002 to $60,900 during 2003, resulted
in lower revenues of $42.5 million. The most significant decreases in average
operating dayrates were to certain rigs located in:

the North Sea:

- the Ocean Guardian ($90,300 to $53,700);

- the Ocean Princess ($72,700 to $40,900);

- the Ocean Nomad ($64,800 to $42,700); and

SOUTHEAST ASIA:

- the Ocean General ($75,100 to $54,200).

Lower utilization of 57% (excluding the Ocean Patriot and the Ocean
Vanguard) during 2003 compared to 61% during 2002 resulted in a $27.3 million
revenue decrease. Utilization declined primarily due to:

- the Ocean Epoch, which was stacked the majority of 2003 but worked most
of 2002;

- the Ocean Guardian and the Ocean Yorktown, which were each stacked
approximately three months during 2003 compared to 2002 when both rigs
worked most of the year; and

- the Ocean Liberator, which was cold stacked all of 2003 but worked
approximately three months during 2002.

Partially offsetting the decline in revenue in 2003 compared to 2002 were
improvements in revenue from:

- the Ocean Worker which worked most of 2003 but spent approximately three
months in 2002 in a shipyard for its 5-year survey and repairs; and

- $12.7 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 year ended December 31, 2003 was higher by $16.4
million compared to the same period in 2002 primarily due to additional costs
during 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, Ocean Yorktown
and the Ocean Whittington to Mexico in 2003;

- the inspection of the Ocean Guardian; and

- the 5-year surveys of the Ocean Ambassador, Ocean Nomad and the Ocean
Bounty during 2003.

Partially offsetting the higher contract drilling expenses during 2003 were
lower expenses from the Ocean Liberator, Ocean New Era, Ocean Voyager and the
Ocean Endeavor which were cold stacked all of 2003 but were ready stacked during
most or part of 2002.

JACK-UPS.

Revenues. Revenues from jack-ups decreased $1.6 million during the year
ended December 31, 2003, compared to the same period in 2002.

Utilization fell to 68% during 2003 from 71% during 2002, resulting in a
$6.3 million reduction in revenue. The decline in utilization was primarily
from:

- the Ocean Sovereign, which spent most of 2003 in a shipyard completing
its leg extension upgrade but operated offshore Indonesia all of 2002;
and
17

- the Ocean Titan, which was in a Gulf of Mexico shipyard from May 2003
through December 2003 for a cantilever conversion but worked almost all
of the same period in 2002.

The lower overall revenue in 2003 was partially offset by a $13.6 million
increase in revenue due to utilization improvements from:

- the Ocean Spartan, Ocean Spur and the Ocean Heritage, which operated most
of 2003 but were undergoing leg extension upgrades during 2002; and

- the Ocean Crusader, which worked almost all of 2003 but was stacked
approximately three months in 2002.

Also offsetting the unfavorable revenue variance for jack-up rigs was an
overall improvement in the average operating dayrate, from $27,300 during 2002
to $28,100 during 2003, which increased revenue by $4.7 million in 2003.

Contract Drilling Expense. Contract drilling expense for jack-ups during
2003 increased $4.6 million from 2002 primarily due to:

- operating costs incurred in 2003 for the Ocean Spartan, Ocean Spur, Ocean
Tower and the Ocean Heritage compared to 2002 costs that were capitalized
in connection with their leg extension upgrades; and

- costs associated with the 5-year surveys of the Ocean Drake and Ocean
Warwick in 2003.

Partially offsetting the higher contract drilling expenses were:

- reduced costs for the Ocean Champion, which was cold stacked 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
and continued through its completion in January 2004.

INTEGRATED SERVICES.

Integrated services had an operating loss of $0.5 million in 2003 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 that
was more than offset by operating overhead costs. During 2002, an operating loss
of $0.6 million resulted primarily from an unprofitable turnkey project in the
Gulf of Mexico. The Company has elected not to pursue contracts for integrated
services except in very limited circumstances.

OTHER.

Other operating expense of $136,000 for the year ended December 31, 2003,
decreased $7.4 million compared to operating income of $7.3 million for the year
ended December 31, 2002. For the year ended December 31, 2003 other operating
expense of $2.4 million was primarily due to the write off of a contract dispute
with a customer and a reserve for pending litigation. These operating expenses
in 2003 were partially offset by operating income of $2.3 million primarily from
the reimbursement of foreign taxes paid by the Company's customers on its
behalf, settlements with the Company's customers related to prior years'
disputes and the reversal of a reserve related to a prior year customer contract
audit.

Other operating income of $7.3 million for the year ended December 31,
2002, resulted primarily from a $5.9 million reimbursement of prior year foreign
income tax to be received by the Company from its customers and related to a tax
settlement made between the Company and the Norwegian tax authorities in
December 2002. The corresponding income tax expense is reflected in "Income tax
benefit (expense)" in the Company's Consolidated Statement of Operations.

Other operating income in 2002 also included a $2.4 million reversal of an
accrual made in a prior year for personal injury claims and the elimination of a
$1.0 million reserve for inventory obsolescence, from prior years, that was
deemed no longer necessary.

18

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
$2.8 million in 2003 compared to $2.5 million in 2002.

DEPRECIATION.

Depreciation expense for the year ended December 31, 2003, decreased $1.9
million to $175.6 million compared to $177.5 million in 2002. A $22.9 million
pre-tax 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 partially 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 increased due to
additional depreciation for five of the Company's recently upgraded jack-up
rigs, additional depreciation for the Ocean Rover, which completed its upgrade
in July 2003 and additional depreciation for the Ocean Baroness, which completed
its upgrade in March 2002.

(LOSS) GAIN ON SALE AND DISPOSITION OF ASSETS.

A loss on the sale and disposition of assets of $0.9 million occurred
during 2003 primarily due to the sale of two of the Company's second generation
semisubmersible drilling rigs, the Ocean Century and Ocean Prospector. These
rigs, which had been cold stacked since July 1998 and October 1998,
respectively, were permanently retired from service as offshore drilling rigs
and written down by $1.6 million to their fair market values in September 2003
and subsequently sold for $375,000 each (pre-tax) in December 2003. A gain on
the sale of assets of approximately $84,000 occurred in 2002.

INTEREST INCOME.

Interest income of $12.0 million earned in 2003 declined $17.8 million,
from $29.8 million earned in 2002. These earnings were lower primarily due to
lower interest rates earned on cash and marketable securities compared to 2002
and less cash investment during 2003.

(LOSS) GAIN ON SALE OF MARKETABLE SECURITIES.

A loss on the sale of marketable securities of $6.9 million occurred in
2003 compared to a $36.5 million gain on the sale of marketable securities in
2002. See Note 3 "Marketable Securities" in Item 8 of this report.

OTHER INCOME AND EXPENSE (OTHER, NET).

Other income of $2.9 million for the year ended December 31, 2003 increased
$1.4 million from other income of $1.5 million for the same period in 2002.
Other income for both years ended December 31, 2003 and 2002 was primarily from
a pre-tax gain on foreign exchange forward contracts of $2.5 million and $1.1
million, respectively. See Note 4 "-- Derivative Financial
Instruments -- Forward Exchange Contracts" to the Company's Consolidated
Financial Statements in Item 8 of this report.

INCOME TAX BENEFIT (EXPENSE).

An income tax benefit of $5.8 million was recognized on a pre-tax loss of
$54.2 million for the year ended December 31, 2003, compared to tax expense of
$33.7 million recognized on pre-tax income of $96.2 million in 2002.

In 2002 the Company formed a Cayman Island corporation, Diamond Offshore
International Limited, which is a wholly owned subsidiary of the Company.
Certain of the Company's rigs that operate internationally are now owned and
operated, directly or indirectly, by Diamond Offshore International Limited.
Effective January 1, 2003, the Company began to postpone remittance of the
earnings from this subsidiary to the U.S.

19

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 2003.

In 2003 a valuation allowance of $10.2 million, which resulted in a charge
against earnings, was established for certain of the Company's foreign tax
credit carryforwards which will begin to expire in 2006. Although the Company
intends to make use of all available tax planning strategies in order to be able
to utilize these carryforwards, under the "more likely than not" approach of
evaluating the associated deferred tax asset the Company deemed that a valuation
allowance was necessary. In addition, in 2003 the Company reduced its deferred
tax liability by $3.7 million related to the deductibility of goodwill
associated with a 1996 acquisition.

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. The effect of the indefinite reinvestment of
the U.K. earnings in 2002 was to lower the annual effective tax rate but this
decline was more than offset by prior year foreign tax expense recorded in 2002,
primarily $5.9 million for a Norwegian income tax settlement. See "-- Other."
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 2003 are part of the earnings and losses of the Cayman Island
subsidiary on which no U.S. taxes are provided.

20

YEARS ENDED DECEMBER 31, 2002 AND 2001

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

HIGH SPECIFICATION FLOATERS.

Revenues. Despite the rise in oil and natural gas prices that began in
late 2001 and continued throughout 2002, improvements in dayrates and
utilization for the Company's equipment did not materialize. As a result,
revenues from high specification floaters decreased $35.0 million during the
year ended December 31, 2002 from the same period in 2001.

21

Revenue generated from the operation of the Ocean Baroness in 2002 of $35.7
million partially offset revenue shortfalls caused by lower average dayrates and
utilization for this fleet during the year ended 2002. The Ocean Baroness began
operations in mid-March 2002 after completing an upgrade to high specification
capabilities. The rig was in a Singapore shipyard undergoing its upgrade
throughout 2001.

Excluding the Ocean Baroness, average operating dayrates dropped from
$117,700 per day during 2001 to $105,500 per day during 2002 resulting in a
$38.7 million revenue decline. Significant declines to average operating
dayrates were experienced by the following rigs (all located in the U.S. Gulf of
Mexico):

- the Ocean Valiant ($122,900 to $81,400);

- the Ocean Victory ($124,100 to $96,800);

- the Ocean America ($108,300 to $84,400); and

- the Ocean Star ($104,200 to $87,100).

Utilization declined from 95% in 2001 to 83% in 2002 resulting in a $32.0
million decrease in revenue (excluding the Ocean Baroness). Significant
utilization reductions resulted from:

- the Ocean America, which was idle for approximately five months during
2002 but worked most of 2001;

- the Ocean Star, which spent three and one-half months during 2002 in a
shipyard for its 5-year survey and repairs but worked all of 2001; and

- the Ocean Victory which spent two months during 2002 in a shipyard for
its 5-year survey and repairs but worked all of 2001.

Contract Drilling Expense. Contract drilling expense for high
specification floaters during the year ended December 31, 2002 increased $29.3
million from the same period in 2001. Higher contract drilling expenses were
primarily due to:

- operating expenses for the Ocean Baroness of $16.7 million for 2002 which
included costs incurred in connection with the recovery of its marine
riser, net of insurance recoveries, as well as its normal operating
costs;

- 5-year surveys and repairs of the Ocean Star, Ocean Victory, and the
Ocean Quest in 2002 which increased expenses by $4.9 million;

- higher Brazilian customs fees in 2002 of $1.3 million for the importation
of spare parts and supplies for the Ocean Alliance and the Ocean Clipper;

- approximately $1.0 million for repairs to the Ocean America including
boat and fuel costs while the rig was idle during 2002; and

- higher comparative costs in 2002 for the Ocean Clipper resulted from a
$1.8 million reduction in an insurance deductible, which lowered overall
operating costs in 2001.

OTHER SEMISUBMERSIBLES.

Revenues. Revenues from other semisubmersibles decreased $60.4 million
from the year ended December 31, 2001 compared to the same period of 2002.

Lower utilization accounted for $38.4 million of the decrease, dropping to
61% for the year ended December 31, 2002 from 70% for the same period in 2001.
Significant declines in utilization were experienced by:

- the Ocean Voyager and the Ocean Endeavor both of which have been cold
stacked since March 2002 but worked the majority of 2001;

- the Ocean New Era which was idle or cold stacked all of 2002 but worked
almost half of 2001;

22

- the Ocean Worker which was in a shipyard for a 5-year survey and repairs
during part of 2002 but worked most of 2001; and

- the Ocean Saratoga which was in a shipyard for its 5-year survey during
part of 2002 but worked most of 2001.

Partially offsetting the negative impact of these declines in utilization
was an improvement in utilization for the Ocean Bounty, which operated most of
2002 compared to 2001 when the rig was stacked for approximately two months.

Lower overall average dayrates caused $22.0 million of the unfavorable
variance in other semisubmersibles revenue. However, the average operating
dayrate for this fleet increased to $67,900 during the year ended December 31,
2002 from $66,900 during the same period of 2001. This occurred because several
of the rigs that were contracted at lower dayrates in 2001 were stacked
throughout parts of 2002. Consequently, the average operating dayrate rose in
2002 for the working rigs in this class.

Rigs in this fleet with significant changes to average operating dayrates
were experienced by certain rigs located in the:

U.S. GULF OF MEXICO:

- the Ocean Worker ($127,700 to $49,800);

AFRICA:

- the Ocean Whittington, which operated in Brazil during 2001 ($89,800 to
$59,100);

NORTH SEA:

- the Ocean Guardian ($62,000 to $90,300); and

- the Ocean Princess ($51,800 to $72,700).

Contract Drilling Expense. Contract drilling expense for other
semisubmersibles was $12.1 million lower in 2002 than in 2001 primarily due to:

- cost savings of $14.5 million in 2002 from the Ocean Endeavor and the
Ocean Voyager, both of which have been cold stacked since March 2002;

- a $4.3 million reduction in 2002 costs resulting from the Ocean New Era
and the Ocean Ambassador which were stacked with reduced crews for most
of 2002; and

- contract drilling expenses lower by $2.8 million in 2002 for the Ocean
Whittington compared to 2001 expenses which included a 5-year survey,
repairs and preparation for its mobilization from the U.S. Gulf of Mexico
to Namibia in December 2001.

Partially offsetting the overall lower contract drilling expenses in 2002
were:

- higher operating costs ($3.0 million) for the Ocean Nomad compared to
2001 operating costs which were lower because this rig was in a shipyard
being upgraded;

- additional expenses ($2.1 million) in 2002 due to a 5-year survey and
repairs to the Ocean Worker; and

- additional expenses ($1.4 million) in 2002 from higher Brazilian customs
fees for the importation of spare parts and supplies for the Ocean Yatzy,
Ocean Yorktown and the Ocean Winner.

JACK-UPS.

Revenues. Revenues from jack-ups during the year ended December 31, 2002
decreased $75.1 million from the same period of 2001.

23

A reduction in the average operating dayrate from $41,000 in 2001 to
$27,300 in 2002, contributed $48.6 million to the overall revenue decline. All
of the Gulf of Mexico jack-up rigs experienced lower average operating dayrates
in 2002. Only the Ocean Heritage, a rig which operated offshore Indonesia and
Australia, experienced a significant improvement in its dayrate, from $34,700 in
2001 to $85,100 in 2002.

Revenues decreased $26.5 million from a decline in utilization from 83% in
2001 to 71% in 2002 primarily due to:

- the Ocean Champion, which was idle and/or cold stacked throughout 2002,
but worked most of 2001; and

- the Ocean Spartan, Ocean Spur, Ocean Tower and the Ocean Heritage all of
which spent time in shipyards undergoing upgrades during 2002 but worked
most of 2001.

The unfavorable utilization variance in 2002 was partially offset by higher
revenue for the Ocean Sovereign which worked all of 2002 but spent most of 2001
in a shipyard for repairs.

Contract Drilling Expense. Contract drilling expense for jack-ups
decreased $17.7 million in 2002 compared to 2001. Significant reductions in 2002
expenses were as follows:

- $8.2 million for the Ocean Spartan, Ocean Spur, Ocean Tower and the Ocean
Heritage resulting from reduced operating costs while these rigs were in
shipyards undergoing upgrades;

- $8.0 million for the Ocean Champion which was idle and/or cold stacked
during all of 2002 but worked most of 2001; and

- lower comparative costs in 2002 for the Ocean Nugget, Ocean Crusader, and
the Ocean Summit due to repairs that contributed to higher contract
drilling expenses during the first half of 2001.

Partially offsetting the lower contract drilling expenses in 2002 were
higher costs from the mobilization of the Ocean Heritage from Indonesia to
Australia and higher labor costs in Australia.

INTEGRATED SERVICES.

Operating income for integrated services decreased $1.2 million during the
year ended December 31, 2002 compared to the same period of 2001 resulting from
the difference in type and magnitude of projects during those periods. During
2002, an operating loss of $0.6 million resulted primarily from an unprofitable
turnkey project in the Gulf of Mexico. During the same period in 2001, operating
income of $0.6 million was primarily due to the completion of one international
turnkey project and three turnkey permanent plug and abandonment projects in the
Gulf of Mexico.

OTHER.

Other operating income of $7.3 million for the year ended December 31, 2002
increased $9.3 million from the same period in 2001. The increase resulted
primarily from a $5.9 million reimbursement of prior year foreign income tax to
be received by the Company from its customers and relates to a tax settlement
made between the Company and the Norwegian tax authorities in December 2002. The
corresponding income tax expense is reflected in "Income tax benefit (expense)"
in the Company's Consolidated Statements of Operations.

Also contributing to the higher "Other operating income" in 2002 was a $2.4
million reversal of an accrual made in a prior year for personal injury claims
and the elimination of a $1.0 million reserve for inventory obsolescence, from
prior years, that was deemed no longer necessary.

REIMBURSABLES, NET.

Revenues related to reimbursable items that the Company purchases and/or
services it performs at the request of its customers offset by the related
expenditures for these items were $2.5 million in 2002 compared to $2.8 million
in 2001.

24

DEPRECIATION AND AMORTIZATION EXPENSE.

Depreciation and amortization expense for the year ended December 31, 2002
increased $7.5 million over the same period of 2001. Higher 2002 depreciation
resulted primarily from depreciation for 2002 capital additions and additional
depreciation for the Ocean Baroness, which completed its deepwater upgrade and
began operations in March 2002. The suspension of goodwill amortization on
January 1, 2002 partially offset this increase. Goodwill amortization during the
year ended December 31, 2001 was $3.3 million. See Note 1 "-- Goodwill" and Note
6 to the Company's Consolidated Financial Statements in Item 8 of this report.

GENERAL AND ADMINISTRATIVE EXPENSE.

General and administrative expense was $3.5 million higher in 2002 than in
the comparable period in 2001 primarily due to higher personnel costs and
professional expenses, including legal fees, tax and accounting fees and
security consulting.

INTEREST INCOME.

Interest income of $29.8 million for the year ended December 31, 2002
decreased $18.9 million from $48.7 million for the same period in 2001 primarily
due to a reduction in marketable securities held and lower interest rates earned
on cash and marketable securities in 2002 compared to 2001.

INTEREST EXPENSE.

Interest expense of $23.6 million for the year ended December 31, 2002 was
$14.5 million lower than in the same period of 2001 primarily due to an $11.9
million pre-tax charge that resulted from the April 2001 redemption of the
Company's 3.75% Convertible Subordinated Notes Due 2007 ("3.75% Notes"). In
addition, the Company's weighted-average interest rate in 2002 was lower than in
2001 resulting from the redemption in 2001 of the 3.75% Notes and the issuance
of the 1.5% Convertible Senior Debentures due 2031 (the "1.5% Debentures") on
April 11, 2001. Interest expense was also lower in 2002 than in 2001 due to more
interest capitalized to rig upgrades in 2002. Interest capitalized to rig
upgrades was $2.9 million in 2002 compared to $2.6 million in 2001. In 2002
interest was capitalized to the Ocean Baroness during the final three months of
its upgrade and during the entire year for the Ocean Rover. See "-- Liquidity."

GAIN ON SALE OF MARKETABLE SECURITIES.

Gain on sale of marketable securities of $36.5 million for the year ended
December 31, 2002 increased $9.4 million from $27.1 million for the same period
in 2001.

OTHER INCOME AND EXPENSE (OTHER, NET).

Other income of $1.5 million for the year ended December 31, 2002 increased
$4.2 million from other expense of $2.7 million for the same period in 2001.
Other income in 2002 included a $1.1 million pre-tax gain on foreign exchange
forward contracts. See Note 4 "-- Derivative Financial Instruments -- Forward
Exchange Contracts" to the Company's Consolidated Financial Statements in Item 8
of this report. Other expense in 2001 included a $10.0 million reserve
established for a class action lawsuit which was ultimately settled in June 2002
and was partially offset by a $7.3 million receipt for the settlement of an
unrelated lawsuit.

INCOME TAX EXPENSE.

Income tax expense of $33.7 million for the year ended December 31, 2002
decreased $53.0 million from $86.7 million for the same period in 2001 primarily
as a result of a $164.3 million decrease in "Income before income tax expense"
in 2002. The annual effective tax rate increased from 33% in 2001 to 35% in
2002. In 2001 the Company made the decision to indefinitely reinvest part of the
earnings of its U.K. subsidiaries and the annual effective rate for the year
2001 reflects this decision. The effect of the indefinite reinvestment of the
U.K. earnings in 2002 was to lower the annual effective tax rate but this
decline was more than offset by prior

25

year foreign tax expense recorded in 2002, primarily $5.9 million for a
Norwegian income tax settlement. See "-- Other."

LIQUIDITY

A discussion of the sources and uses of cash for the year ended December
31, 2003 compared to the same period in 2002 follows.

Cash generated by a net loss adjusted for non-cash items, including
depreciation, for the year ended December 31, 2003 decreased $125.9 million
compared to the same period in 2002 primarily due to a decline in the results of
operations in 2003.

Net cash used in investing activities decreased $222.4 million during the
year ended December 31, 2003 compared to the same period in 2002. During the
years ended December 31, 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 2003 was for the purchase of the
semisubmersible rig, Omega, renamed the Ocean Patriot, and capital expenditures
primarily to complete the upgrade of the Ocean Rover and the upgrades of three
of the Company's jack-up rigs. During the year ended December 31, 2002, $199.1
million was used for the repurchase of securities sold under repurchase
agreements in 2001 and $273.8 million was used for capital expenditures
(primarily the Ocean Baroness and Ocean Rover upgrades). There were no
outstanding loaned

26

debt securities sold under repurchase agreements at December 31, 2003. In
December 2002 the Company spent $68.5 million ($67.0 million excluding
inventory) for the purchase of the Ocean Vanguard.

The Company paid cash dividends of $57.0 million to stockholders in 2003
compared to $65.7 million in 2002. Cash dividends paid in 2003 were lower
primarily due to a reduction in the dividend rate for dividends paid in December
2003 ($0.0625 per share of common stock) compared to the dividend rate used for
payments made in March, June and September of 2003 ($0.125 per share of common
stock). The Company reduced the dividend rate due to declines in earnings and in
an effort to maintain the Company's strong liquidity position.

During the year ended December 31, 2003, the Company purchased 1,014,000
shares of its common stock at an aggregate cost of $18.2 million, or at an
average cost of $17.96 per share. During the year ended December 31, 2002, the
Company purchased 1,716,700 shares of its common stock at an aggregate cost of
$43.4 million, or at an average cost of $25.30 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 used in financing activities in 2003 and 2002 included payments of
$11.2 million and $10.4 million, respectively, in accordance with the Company's
December 2000 lease-leaseback agreement with a European bank. As of December 31,
2003, three of five annual installments of $13.7 million each (including
principal and interest) had been made. The lease-leaseback agreement provided
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. This financing agreement has an
effective interest rate of 7.13% and is an unsecured obligation of the Company.

Cash was also used during 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 2002. See "-- Treasury Stock and Common Equity Put
Options" in Note 1 to the Company's Consolidated Financial Statements in Item 1
of this report.

27

CONTRACTUAL CASH OBLIGATIONS.

Purchase obligations at December 31, 2003 related to direct rig operations
are excluded from the above table as there are no purchase obligations for major
rig upgrades or any other significant obligations other than those necessary for
the normal course of business that existed at December 31, 2003.

Payments of the Company's long-term debt, including interest, could be
accelerated due to certain rights that holders of the Company's debentures have
to put the securities to the Company. See discussion below.

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 certain circumstances. Upon conversion, the Company has
the right to deliver cash in lieu of shares of the Company's common stock.

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.

28

The aggregate principal amount at maturity will be $805.0 million assuming
no conversions or redemptions occur prior to the maturity date.

LETTERS OF CREDIT.

The Company is contingently liable as of December 31, 2003 in the amount of
$69.0 million under certain performance, bid, customs and export bonds. On the
Company's behalf, banks have issued letters of credit securing certain of these
bonds. Agreements with these banks contain terms that allow the banks to require
cash collateralization of the entire line for any reason.

CREDIT RATINGS.

As of the date of this report, the Company's current credit rating is Baa1
for Moody's Investors Services ("Moody's") and A for Standard & Poor's. In 2003
Moody's lowered its ratings of the Company's long-term debt to Baa1 from A3. In
addition, Standard & Poor's placed ratings of the Company's debt under review
for a possible downgrade. Moody's lowered the Company's ratings primarily due to
financial performance that was below Moody's expectations to be considered an A3
rating level. Although the Company's long-term ratings continue at investment
grade levels, lower ratings could result in higher interest rates on future debt
issuances.

OTHER.

The Company has the ability to issue an aggregate of approximately $117.5
million in debt, equity and other securities under a shelf registration
statement. In addition, the Company may issue, from time to time, up to eight
million shares of common stock, shares which 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 December 31, 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.

During the year ended December 31, 2003, the Company spent $102.7 million,
including capitalized interest expense, for rig upgrades, of which $67.0 million
was for the deepwater upgrade of the Ocean Rover and $35.7 million was for the
upgrade of six of the Company's jack-up rigs.

The Company has budgeted approximately $15 million during 2004 to upgrade
one of the Company's high specification semisubmersible units, the Ocean America
with capabilities making it more suitable for developmental drilling.

29

The upgrade of the Ocean Rover, which began in January 2002, was completed
early in July 2003 on time and under budget. The project was completed for
approximately $188 million, below management's original estimated cost of $200
million. The rig commenced its contract with Murphy Sabah Oil Company, Ltd. on
July 10, 2003 for a minimum three-well drilling program offshore Malaysia.

The Company's two-year program to expand the capabilities of its jack-up
fleet by significantly upgrading 6 of its 14 jack-up rigs has been completed.
Three of these upgrades were completed in 2002, two were completed in 2003 and
the one was completed early in 2004. 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 was completed in
early 2004 for approximately $22 million.

During the year ended December 31, 2003, the Company spent $105.8 million
on its continuing rig capital maintenance program (other than rig upgrades) and
to meet other corporate capital expenditure requirements. In addition, the
Company spent $65.0 million ($63.5 million capitalized to rig equipment) for the
purchase of the third-generation semisubmersible drilling rig, Omega, renamed
the Ocean Patriot.

The Company has budgeted $66 million for 2004 capital expenditures
associated with its ongoing rig equipment replacement and enhancement programs
and other corporate requirements.

The Company expects to finance its 2004 capital expenditures through the
use of existing cash balances or internally generated funds.

OTHER

Currency Risk. Certain of the Company's subsidiaries use the local
currency in the country where they conduct operations as their functional
currency. Currency environments in which the Company has material business
operations include Mexico, Brazil, the U.K., Australia, Indonesia, Malaysia and
Vietnam. When possible, the Company attempts to minimize its currency exchange
risk by seeking international contracts payable in local currency in amounts
equal to the Company's estimated operating costs payable in local currency with
the balance of the contract payable in U.S. dollars. At present, however, only a
limited number of the Company's contracts are payable both in U.S. dollars and
the local currency. The Company has not hedged its exposure to changes in the
exchange rate between U.S. dollars and the local currencies but it may seek to
do so in the future.

Currency translation adjustments are accumulated in a separate section of
stockholders' equity. When the Company ceases its operations in a currency
environment, the accumulated adjustments are recognized currently in results of
operations. The effect on results of operations from these translation gains and
losses has not been material and are not expected to have a significant effect
in the future.

Forward Exchange Contracts. In some instances, a foreign exchange forward
contract is used to minimize the forward exchange risk. A forward exchange
contract obligates the Company to exchange predetermined amounts of specified
foreign currencies at specified foreign exchange rates on specified dates. In
June 2002 the Company entered into forward contracts to purchase 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 Australian dollars to be
purchased on July 31, 2003. In July 2001 the Company entered into 12 forward
contracts to purchase 3.5 million Australian dollars at each month end through
July 31, 2002. As of December 31, 2003, the Company had satisfied all
obligations under these contracts and has not entered into any new forward
exchange contracts.

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
30

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 did not have an 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 did not have an 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 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 (see
"-- Liquidity" and "-- Capital Resources");

- interest rate and foreign exchange risk (see "-- other" and "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;

31

- 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");

- 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;

32

- 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 SEC 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.

33

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

The information included in this Item 7A 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 7 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 December
31, 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 December
31, 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 in 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 December 31, 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 $150.5 million and
$153.8 million, respectively. A 100-basis point decrease would result in an
increase in market value of $186.8 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,
34

2002 through June 26, 2003, and 3.8 million Australian dollars to be purchased
on July 31, 2003. These foreign exchange forward contracts are recorded at their
fair value determined by discounting future cash flows at current forward rates.
As of December 31, 2003, the Company had satisfied all obligations under these
contracts and has not entered into any new forward exchange contracts. At
December 31, 2002, an asset of $0.2 million reflecting the fair value of the
forward contracts was included with "Prepaid expenses and other" in the
Consolidated Balance Sheet. The 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):

- ---------------

(a) The fair market value of the Company's investment in marketable securities
is based on the quoted closing market prices on December 31, 2003 and
December 31, 2002.

(b) The fair values of the Company's 1.5% Debentures due 2031 and zero coupon
convertible debentures due 2020 are based on the quoted closing market
prices on December 31, 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 2.08% for
December 31, 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 December 31, 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.

35

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

INDEPENDENT AUDITORS' REPORT

Board of Directors and Stockholders
Diamond Offshore Drilling, Inc. and subsidiaries
Houston, Texas

We have audited the accompanying consolidated balance sheets of Diamond
Offshore Drilling, Inc. and subsidiaries (the "Company") as of December 31, 2003
and 2002, and the related consolidated statements of operations, stockholders'
equity, comprehensive income (loss) and cash flows for each of the three years
in the period ended December 31, 2003. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of Diamond Offshore Drilling, Inc.
and subsidiaries as of December 31, 2003 and 2002, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2003, in conformity with accounting principles generally accepted
in the United States of America.

As discussed in Note 1 to the financial statements, in 2002 the Company
changed its method of accounting for goodwill to conform to Statement of
Financial Accounting Standards No. 142.

DELOITTE & TOUCHE LLP

Houston, Texas
February 26, 2004

36

DIAMOND OFFSHORE DRILLING, INC.
AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

The accompanying notes are an integral part of the consolidated financial
statements.
37

DIAMOND OFFSHORE DRILLING, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

The accompanying notes are an integral part of the consolidated financial
statements.
38

DIAMOND OFFSHORE DRILLING, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

The accompanying notes are an integral part of the consolidated financial
statements.
39

DIAMOND OFFSHORE DRILLING, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

The accompanying notes are an integral part of the consolidated financial
statements.
40

DIAMOND OFFSHORE DRILLING, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

The accompanying notes are an integral part of the consolidated financial
statements.
41

DIAMOND OFFSHORE DRILLING, INC.
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

ORGANIZATION AND BUSINESS

Diamond Offshore Drilling, Inc. (the "Company") was incorporated in
Delaware on April 13, 1989. As of February 23, 2004, Loews Corporation ("Loews")
owned 54.2% of the outstanding shares of common stock of the Company.

The Company, through wholly owned subsidiaries, engages in the worldwide
contract drilling of offshore oil and gas wells and is a leader in deep water
drilling. Currently, the fleet is comprised of 30 semisubmersible rigs, 14
jack-up rigs and one drillship.

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of the Company
and its subsidiaries after elimination of significant intercompany transactions
and balances.

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
losses" 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)."

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.

SUPPLEMENTARY CASH FLOW INFORMATION

Cash payments made for interest on long-term debt, including commitment
fees, totaled $9.5 million, $10.2 million, and $17.1 million during the years
ended December 31, 2003, 2002, and 2001, respectively.

Cash payments for foreign income taxes, net of foreign tax refunds, were
$8.5 million, $14.7 million, and $4.3 million during the years ended December
31, 2003, 2002, and 2001, respectively. A $39.0 million and $17.3 million net
cash refund of U.S. income tax was received during the years ended December 31,
2003 and 2002, respectively. Cash payments for U.S. income taxes totaling $28.8
million were made during the year ended December 31, 2001.

RIG INVENTORY AND SUPPLIES

Inventories primarily consist of replacement parts and supplies held for
use in the operations of the Company. Inventories are stated at the lower of
cost or estimated value.

42

DIAMOND OFFSHORE DRILLING, INC.
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

DRILLING AND OTHER PROPERTY 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. Costs incurred for
major rig upgrades are accumulated in construction work-in-progress, with no
depreciation recorded on the additions, until the month the upgrade is completed
and the rig is placed in service. Upon retirement or sale of a rig, the cost and
related accumulated depreciation are removed from the respective accounts and
any gains or losses are included in the results of operations. Depreciation is
amortized up to applicable salvage values by applying the straight-line method
over the remaining estimated useful lives from the year the asset is placed in
service.

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:

Interest on the Ocean Rover was capitalized through July 10, 2003, when its
upgrade was complete. As of December 31, 2003, there were no capital projects in
progress for which interest was being capitalized.

IMPAIRMENT OF LONG-LIVED ASSETS

The Company reviews its long-lived assets for impairment when changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. The Company evaluated all of the cold stacked rigs in its fleet
during 2003 and, as a result, the Ocean Century and Ocean Prospector were
written down $1.6 million to their fair market values of $375,000 each. These
rigs were subsequently sold for $375,000 each (pre-tax) in December 2003. No
other instance of impairment was noted.

GOODWILL

Prior to January 1, 2002, goodwill from the merger with Arethusa
(Off-Shore) Limited ("Arethusa") had been amortized on a straight-line basis
over 20 years. The Company adopted Statement of Financial Accounting Standards
("SFAS") No. 142, "Goodwill and Other Intangible Assets," on January 1, 2002
and, accordingly, suspended amortization of goodwill. On January 1, 2002,
goodwill and accumulated amortization was $69.0 million and $30.7 million,
respectively.

Adjustments of $13.6 million during each of the years ended December 31,
2003, 2002 and 2001 were 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 in the fourth quarter of
2004. See Note 6.

43

DIAMOND OFFSHORE DRILLING, INC.
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

DEBT ISSUANCE COSTS

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

DEFERRED INCOME TAXES

Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. The Company's non-U.S.
income tax liabilities are based upon the results of operations of the various
subsidiaries and foreign branches in those jurisdictions in which they are
subject to taxation.

In 2002 the Company formed a Cayman Island 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 (which included its U.K. subsidiaries) 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 year ended 2003. Beginning in 2001, the Company
decided to indefinitely reinvest a portion of the earnings of its U.K.
subsidiaries. Consequently, no U.S. deferred taxes were provided on these
earnings in 2002 or in 2001.

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. The
purchase of treasury stock is accounted for using the cost method which reports
the cost of the shares acquired in "Treasury stock" as a deduction from
stockholders' equity in the Consolidated Balance Sheets.

During the year ended December 31, 2003, the Company purchased 1,014,000
shares of its common stock at an aggregate cost of $18.2 million, or at an
average cost of $17.96 per share.

During the year ended December 31, 2002, the Company purchased 1,716,700
shares of its common stock at an aggregate cost of $43.4 million, or at an
average cost of $25.30 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." During the year ended December 31, 2001, the
Company purchased 1,403,900 shares of its common stock at an aggregate cost of
$37.8 million, or at an average cost of $26.90 per share.

As of December 31, 2003, Loews owned 54.2% of the outstanding shares of
common stock of the Company. The Company had been a wholly owned subsidiary of
Loews prior to its initial public offering in October 1995. The increase of
Loews ownership from 53.8% at December 31, 2002 to 54.2% at December 31, 2003 is
a result of the Company's purchase of its common stock during 2003.

The Company settled put options which covered 1,000,000 shares of its
common stock during the year ended December 31, 2002, with cash payments
totaling $1.2 million and reduced "Additional paid-in-capital" in the
Consolidated Balance Sheet for amounts paid to settle these put options. The
Company's remaining put options sold in 2001, which covered 187,321 shares of
the Company's common stock, expired during 2002. There were no common equity put
option transactions during 2003 and none outstanding at December 31, 2003 and
2002.

44

DIAMOND OFFSHORE DRILLING, INC.
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

STOCK-BASED COMPENSATION

In 2000 the Company adopted a stock option plan ("2000 Stock Option Plan")
whereby certain of the Company's employees, consultants and non-employee
directors may be granted options to purchase stock. The Company accounts for the
2000 Stock Option Plan under Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees," and related Interpretations. See
Note 13. No stock-based employee compensation cost is reflected in net income,
as all options granted under this plan had an exercise price equal to the market
value of the underlying common stock on the date of grant.

The following table illustrates the effect on net (loss) income and (loss)
earnings per share if the Company had applied the fair value recognition
provisions of SFAS No. 123, "Accounting for Stock-Based Compensation," to
stock-based employee compensation.

COMPREHENSIVE INCOME

Comprehensive income is the change in equity of a business enterprise
during a period from transactions and other events and circumstances except
those transactions resulting from investments by owners and distributions to
owners. Comprehensive income includes net income, foreign currency translation
gains and losses, minimum pension liability adjustments and unrealized holding
gains and losses on marketable securities. See Note 9.

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 year-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
losses." Currency transaction gains and losses are included in the Consolidated
Statements of Operations in "Other income (expense)." Additionally, translation
gains and losses of subsidiaries operating in hyperinflationary economies are
included in operating results.

45

DIAMOND OFFSHORE DRILLING, INC.
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

REVENUE RECOGNITION

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

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

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 did not
have an 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 did not have an impact on the Company's consolidated results of
operations, financial position or cash flows.

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.

46

DIAMOND OFFSHORE DRILLING, INC.
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

RECLASSIFICATIONS

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

FAIR VALUE OF FINANCIAL INSTRUMENTS

The Company provides fair value information of its financial instruments in
the notes to the consolidated financial statements. See Note 11. The carrying
amount of the Company's current financial instruments approximate fair value
because of the short maturity of these instruments. For non-current financial
instruments the Company uses quoted market prices when available and discounted
cash flows to estimate fair value.

2. (LOSS) EARNINGS PER SHARE

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

The computation of diluted earnings per share ("EPS") for the years ended
December 31, 2003, 2002 and 2001 excludes approximately 6.9 million potentially
dilutive shares issuable upon conversion of the Company's zero coupon
convertible debentures due 2020 (the "Zero Coupon Debentures"), issued in June
2000. The computation of diluted EPS for the year ended December 31, 2003
excludes approximately 9.4 million potentially dilutive shares issuable upon
conversion of the Company's 1.5% Debentures. Potentially

47

DIAMOND OFFSHORE DRILLING, INC.
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

dilutive shares were excluded from the computation of diluted EPS 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 2002 prior to their
expiration or settlement. All of these put options were outstanding at December
31, 2001. However, the computation of diluted EPS for the years ended December
31, 2002 and 2001 excluded put options covering 187,321 shares of common stock.
Certain put options were excluded from the computation of diluted EPS because
the options' exercise prices were less than the average market price per share
of the common stock.

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 464,275 shares, 377,525
shares and 182,700 shares of common stock were excluded for the years ended
December 31, 2003, 2002 and 2001, respectively.

Incremental shares calculated from 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 for the year ended December
31, 2003 because potential shares of common stock are not included when a loss
from continuing operations exists.

3. MARKETABLE SECURITIES

Investments classified as available for sale are summarized as follows:

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

48

DIAMOND OFFSHORE DRILLING, INC.
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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

In November 2003 the requirement for disclosure of investments
held-to-maturity or available-for-sale that are impaired at the balance sheet
date but for which an "other-than-temporary" loss has not been recognized was
announced by the Emerging Issues Task Force ("EITF") under EITF Issue 03-1. At
December 31, 2003, the Company held the following impaired investments:

Collateralized mortgage obligations ("CMOs") at December 31, 2003 consisted
solely of one security that has been in a continuous unrealized loss position
for 18 months. CMOs consist of a bundle of mortgage backed securities, or in
some cases pools of mortgages. Although CMOs have a stated maturity, the full
repayment of principal could occur well in advance of that date if many
homeowners sell their property, refinance their mortgages, default on their
mortgages, or prepay the underlying loans faster than scheduled. This lack of
payment certainty is referred to as prepayment risk. The decline in mortgage
rates over the past year has accelerated prepayments and has contributed to the
decrease in the market value of CMOs.

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. A
technique the Company uses for minimizing its foreign exchange risk involves
structuring customer contracts to provide for payment in both the U.S. dollar
and the foreign currency. 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 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 Australian
dollars to be purchased on July 31, 2003. In July 2001 the Company entered into
12 forward contracts to purchase 3.5 million Australian dollars at each month
end through July 31, 2002. These

49

DIAMOND OFFSHORE DRILLING, INC.
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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 $2.3 million and $1.1 million was recorded in the
Consolidated Statements of Operations for the years ended December 31, 2003 and
2002, respectively, in "Other income (expense)." As of December 31, 2003, the
Company had satisfied all obligations under these contracts and has not entered
into any new forward exchange contracts.

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 or at December 31, 2003 and December
31, 2002.

5. DRILLING AND OTHER PROPERTY AND EQUIPMENT

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

Construction work-in-progress at December 31, 2003 consists of costs
related to the Ocean Titan cantilever conversion project which was completed in
January 2004.

In December 2003 the Company sold two of its early second generation
semisubmersible drilling rigs, the Ocean Century and Ocean Prospector, for a
total of $750,000 pre-tax. These rigs, had been cold stacked in the Gulf of
Mexico since July 1998 and October 1998, respectively, and in September 2003,
were written down by $1.6 million to their fair market values of $375,000 each
and subsequently retired from service as offshore drilling units.

In July 2003 approximately $175.7 million was reclassified from
construction work-in-progress to drilling rigs and equipment upon completion of
the significant upgrade of the Ocean Rover to high specification capabilities.
The upgrade was completed on time and under budget in July 2003 at which time
the rig began a drilling program for Murphy Sabah Oil Company, Ltd. offshore
Malaysia.

50

DIAMOND OFFSHORE DRILLING, INC.
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

In April 2003 the Company commissioned a study to evaluate the economic
lives of its drilling rigs. As a result of this study the Company recorded
changes in accounting estimates by increasing the estimated service lives to 25
years for jack-ups and 30 years for semisubmersibles and the Company's drillship
and by increasing salvage values to 5% for most of the Company's drilling rigs.
The change in estimate was made to better reflect the remaining economic lives
and salvage values of the Company's fleet. The effect of this change in
accounting estimates resulted in an increase to net income (after-tax) for the
year ended December 31, 2003 of $20.4 million, or $0.16 per share. Prior years
were not affected.

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 Diamond Offshore Drilling Limited, a subsidiary of the
Company, completed the acquisition of the third-generation semisubmersible
drilling rig, West Vanguard, renamed Ocean Vanguard, for $68.5 million. The
Company capitalized $67.0 million to drilling rigs and equipment and $1.5
million to rig inventory.

In March 2002 approximately $157.4 million was reclassified from
construction work-in-progress to drilling rigs and equipment upon completion of
the significant upgrade of the Ocean Baroness to high specification
capabilities.

6. GOODWILL

Goodwill from the merger with Arethusa in 1996 was generated from an excess
of the purchase price over the net assets acquired. Prior to January 1, 2002,
the Company 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 in 2002.

The Company's net income and earnings per share, adjusted to exclude
amortization expense (net of its related tax benefit) for the years ended
December 31, 2003, 2002 and 2001 are as follows:

51

DIAMOND OFFSHORE DRILLING, INC.
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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, 2003, 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.

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

During each of the years ended December 31, 2003, 2002 and 2001, an
adjustment of $13.6 million was recorded to reduce goodwill before accumulated
amortization. The adjustments represent tax benefits not previously recognized
for the excess of tax deductible goodwill over the book goodwill amount. The
Company will continue to reduce goodwill in future periods as the tax benefits
of excess tax goodwill over book goodwill is recognized. Goodwill is expected to
be reduced to zero in the fourth quarter of 2004.

7. ACCRUED LIABILITIES

Accrued liabilities consist of the following:

8. LONG-TERM DEBT

Long-term debt consists of the following:

52

DIAMOND OFFSHORE DRILLING, INC.
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The aggregate maturities of long-term debt for each of the five years
subsequent to December 31, 2003, are as follows (see discussion following table
for a description of the rights that holders of the debentures have to put the
securities to the Company):

CONVERTIBLE SENIOR DEBENTURES

The Company's $460.0 million principal amount of 1.5% Debentures that were
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 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 April 15 and October 15 of each year, beginning
October 15, 2001. The 1.5% Debentures are unsecured obligations of the Company
and rank equally with all of the Company's other unsecured senior indebtedness.

The Company will pay contingent interest to holders of the 1.5% Debentures
during any six-month period commencing after April 15, 2008, if the average
market price of a 1.5% Debenture for a measurement period preceding such
six-month period equals 120% or more of the principal amount of such 1.5%
Debenture and the Company pays a regular cash dividend during such six-month
period. The contingent interest payable per $1,000 principal amount of 1.5%
Debentures, in respect of any quarterly period, will equal 50% of regular cash
dividends paid by the Company per share on its common stock during that
quarterly period multiplied by the conversion rate. This contingent interest
component is an embedded derivative, which had no fair value at issuance or on
December 31, 2003 or December 31, 2002.

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 CONVERTIBLE DEBENTURES

The Company's Zero Coupon Debentures issued on June 6, 2000 at a price of
$499.60 per $1,000 debenture are due June 6, 2020, which represents a yield to
maturity of 3.50% per year. The Company will not

53

DIAMOND OFFSHORE DRILLING, INC.
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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
Zero Coupon Debenture, subject to adjustments in certain events. 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.

The aggregate principal amount at maturity will be $805.0 million assuming
no conversions or redemptions occur prior to the maturity date.

OCEAN ALLIANCE LEASE-LEASEBACK

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.
Three of the five annual payments have been made as of December 31, 2003. This
financing arrangement has an effective interest rate of 7.13% and is an
unsecured subordinated obligation of the Company.

9. COMPREHENSIVE (LOSS) INCOME

The income tax effects allocated to the components of other comprehensive
(loss) income are as follows:

54

DIAMOND OFFSHORE DRILLING, INC.
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

10. COMMITMENTS AND CONTINGENCIES

The Company leases office facilities under operating leases, which expire
through the year 2007. Total rent expense amounted to $1.8 million, $1.4 million
and $1.0 million for the years ended December 31, 2003, 2002 and 2001,
respectively. Minimum future rental payments under leases are approximately $1.4
million, $0.3 million, $0.2 million and $32,000 for the years 2004 through 2007,
respectively. There are no minimum future rental payments under leases after the
year 2007.

The Company is contingently liable as of December 31, 2003, in the amount
of $69.0 million under certain performance, bid, customs and export bonds. On
the Company's behalf, banks have issued letters of credit securing certain of
these bonds. As of December 31, 2002, the Company was contingently liable for
these same types of bonds in the amount of $16.1 million.

Various claims have been filed against the Company in the ordinary course
of business, including claims by offshore workers alleging personal injuries. 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.

11. FINANCIAL INSTRUMENTS

CONCENTRATIONS OF CREDIT AND MARKET RISK

Financial instruments which potentially subject the Company to significant
concentrations of credit or market risk consist primarily of periodic temporary
investments of excess cash and trade accounts receivable and investments in debt
securities, including treasury inflation-indexed protected bonds and CMO's. The

55

DIAMOND OFFSHORE DRILLING, INC.
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Company places its temporary excess cash investments in high quality short-term
money market instruments through several financial institutions. At times, such
investments may be in excess of the insurable limit. The Company's periodic
evaluations of the relative credit standing of these financial institutions are
considered in the Company's investment strategy.

Concentrations of credit risk with respect to trade accounts receivable are
limited primarily due to the entities comprising the Company's customer base.
Since the market for the Company's services is the offshore oil and gas
industry, this customer base consists primarily of major oil companies and
independent oil and gas producers. The Company provides allowances for potential
credit losses when necessary. No such allowances were deemed necessary for the
years presented and, historically, the Company has not experienced significant
losses on trade receivables.

All of the Company's investments in debt securities are U.S. government
securities or U.S. government-backed with minimal credit risk. However, the
Company is exposed to market risk due to price volatility associated with
interest rate fluctuations.

FAIR VALUES

The amounts reported in the Consolidated Balance Sheets for cash and cash
equivalents, marketable securities, accounts receivable, and accounts payable
approximate fair value. Fair values and related carrying values of the Company's
debt instruments are shown below:

The estimated fair value amounts have been determined by the Company using
appropriate valuation methodologies and information available to management as
of December 31, 2003 and 2002. Considerable judgment is required in developing
these estimates, and accordingly, no assurance can be given that the estimated
values are indicative of the amounts that would be realized in a free market
exchange. The following methods and assumptions were used to estimate the fair
value of each class of financial instrument for which it was practicable to
estimate that value:

Cash and cash equivalents -- The carrying amounts approximate fair
value because of the short maturity of these instruments.

Marketable securities -- The fair values of the debt securities,
including CMO's, available for sale were based on the quoted closing market
prices on December 31, 2003 and 2002.

Accounts receivable and accounts payable -- The carrying amounts
approximate fair value based on the nature of the instruments.

Long-term debt -- The fair value of the Zero Coupon Debentures and the
1.5% Debentures was based on the quoted closing market price on December
31, 2003 and 2002 from brokers of these instruments. The fair value of the
Ocean Alliance lease-leaseback agreement was based on the present value of
estimated future cash flows using a discount rate of 2.08% and 6.62% at
December 31, 2003 and 2002, respectively.

56

DIAMOND OFFSHORE DRILLING, INC.
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

12. RELATED-PARTY TRANSACTIONS

The Company and Loews entered into a services agreement which was effective
upon consummation of the Common Stock Offering (the "Services Agreement")
pursuant to which Loews agreed to continue to perform certain administrative and
technical services on behalf of the Company. Such services include personnel,
telecommunications, purchasing, internal auditing, accounting, data processing
and cash management services, in addition to advice and assistance with respect
to preparation of tax returns and obtaining insurance. Under the Services
Agreement, the Company is required to reimburse Loews for (i) allocated
personnel costs (such as salaries, employee benefits and payroll taxes) of the
Loews personnel actually providing such services and (ii) all out-of-pocket
expenses related to the provision of such services. The Services Agreement may
be terminated at the Company's option upon 30 days' notice to Loews and at the
option of Loews upon six months' notice to the Company. In addition, the Company
has agreed to indemnify Loews for all claims and damages arising from the
provision of services by Loews under the Services Agreement unless due to the
gross negligence or willful misconduct of Loews. The Company was charged $0.4
million, $0.3 million and $0.3 million by Loews for these support functions
during the years ended December 31, 2003, 2002 and 2001, respectively.

In November 2003 the Company began leasing office space to a subsidiary of
Loews, Texas Gas Transmission, LLC. The lease is on a month-to-month basis for
$1,380 per month. The Company received $2,760 during the year ended December 31,
2003.

13. STOCK OPTION PLAN

The Company's 2000 Stock Option Plan provides for issuance of either
incentive stock options or non-qualified stock options to the Company's
employees, consultants and non-employee directors. Options may be granted to
purchase stock at no less than 100% of the market price of the stock on the date
the option is granted. Such plan is reserved for issuance up to 750,000 shares
of the Company's common stock, none of which had been issued as of December 31,
2003. Unless otherwise specified by the Board of Directors at the time of the
grant, stock options have a maximum term of ten years, subject to earlier
termination under certain conditions and vest over four years.

The following table summarizes the stock option activity related to the
2000 Stock Option Plan:

57

DIAMOND OFFSHORE DRILLING, INC.
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following table summarizes information for options outstanding and
exercisable at December 31, 2003:

The Company accounts for the 2000 Stock Option Plan in accordance with
Accounting Principle Board Opinion No. 25, "Accounting for Stock Issued to
Employees." Accordingly, no compensation expense has been recognized for the
options granted 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 SFAS No. 123, "Accounting for
Stock-Based Compensation," the Company's net income and earnings per share would
have been reduced to the pro forma amounts indicated below:

The per share weighted-average fair value of stock options granted during
2003, 2002 and 2001 was $7.32, $10.59 and $14.60, respectively. The fair value
of options granted in 2003, 2002 and 2001 has been estimated at the date of
grant using a Binomial Option Pricing Model with the following weighted-average
assumptions:

58

DIAMOND OFFSHORE DRILLING, INC.
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

14. INCOME TAXES

The components of income tax expense (benefit) are as follows:

The difference between actual income tax expense and the tax provision
computed by applying the statutory federal income tax rate to income before
taxes is attributable to the following:

59

DIAMOND OFFSHORE DRILLING, INC.
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Significant components of the Company's deferred income tax assets and
liabilities are as follows:

- ---------------

(1) Reflected in "Prepaid expenses and other" in the Company's Consolidated
Balance Sheets.

In 2002 the Company formed a Cayman Island 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 year
ended 2003. Undistributed losses from subsidiaries (which included its U.K.
subsidiaries) for which no U.S. deferred income tax benefit has been made were
$26.3 million in 2003.

In 2001 the Company decided to postpone remittance of a portion of the
earnings of its U.K. subsidiaries. The Company plans to indefinitely reinvest
these earnings internationally and no U.S. taxes were provided on these earnings
in 2001 or 2002. Undistributed earnings of the U.K. subsidiaries for which no
U.S. deferred income tax provision has been made were $21.1 million in 2002 and
$14.9 million in 2001.

The Company's practice prior to 1997 was to reinvest the unremitted
earnings of all of its non-U.S. subsidiaries and postpone their remittance
indefinitely except for selective dividends between the Company's subsidiaries.
Thus, no additional U.S. taxes were provided on such earnings. Undistributed
earnings of non-U.S. subsidiaries generated prior to 1997 for which no U.S.
deferred income tax provision has been made for possible future remittances
totaled approximately $14 million at December 31, 2003. In addition, the Company
has negative undistributed earnings of non-U.S. subsidiaries generated prior to
1997 of $37 million

60

DIAMOND OFFSHORE DRILLING, INC.
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

at December 31, 2003, for which no deferred tax benefit has been recognized. It
is not practicable to estimate the amount of unrecognized U.S. deferred taxes,
if any, that might be payable on the actual or deemed remittance of such
earnings. On actual remittance, certain countries impose withholding taxes that,
subject to certain limitations, are then available for use as tax credits
against a U.S. tax liability, if any.

Deferred income taxes are not recorded on differences between financial
reporting and tax bases of investments in stock of the Company's subsidiaries,
unless realization of the effect is probable in the foreseeable future.

In 2003 a valuation allowance of $10.2 million, which resulted in a charge
against earnings, was established for certain of the Company's foreign tax
credit carryforwards which will begin to expire in 2006. Although the Company
intends to make use of all available tax planning strategies in order to be able
to utilize these carryforwards, under the "more likely than not" approach of
evaluating the associated deferred tax asset the Company deemed that a valuation
allowance was necessary.

During 2003, the Company was able to utilize $93.1 million of net operating
losses generated in 2002 through carrybacks to prior year tax returns. As of
December 31, 2003, the Company had net operating loss ("NOL") carryforwards of
approximately $166.6 million available to offset future taxable income.
Approximately $21.5 million of the NOL carryforwards were acquired in 1996 with
the Arethusa merger. The utilization of the NOL carryforwards acquired in the
Arethusa merger is limited pursuant to Section 382 of the Internal Revenue Code
of 1986, as amended (the "Code"). None of the NOL carryforwards acquired from
Arethusa were utilized in 2003. The remaining $145.1 million of NOL
carryforwards were generated during 2003 and are not subject to a limitation
under Code Section 382. The Company expects to fully utilize all of the NOL
carryforwards in future taxable years primarily from the future reversal of
existing taxable temporary differences. The Company has recognized a tax benefit
of $50.8 million related to the tax loss generated in 2003.

The Company has recorded a deferred tax asset of $58.3 million for the
benefit of the NOL carryforwards. The NOL carryforwards will expire as follows:

15. EMPLOYEE BENEFIT PLANS

DEFINED CONTRIBUTION PLANS

The Company maintains defined contribution retirement plans for its U.S. ,
U.K. and third-country national ("TCN") employees. The plan for U.S. employees
(the "401k Plan") is designed to qualify under Section 401(k) of the Code. Under
the 401k Plan, each participant may elect to defer taxation on a portion of his
or her eligible earnings, as defined by the 401k Plan, by directing the Company
to withhold a percentage of such earnings. A participating employee may also
elect to make after-tax contributions to the 401k Plan. The Company contributes
3.75% of a participant's defined compensation and matches 25% of the first 6% of
each employee's compensation contributed. Participants are fully vested
immediately upon enrollment in the plan.

61

DIAMOND OFFSHORE DRILLING, INC.
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

For the years ended December 31, 2003, 2002 and 2001, the Company's provision
for contributions was $6.9 million, $7.0 million and $6.9 million, respectively.

The plan for U.K. employees provides that the Company contributes amounts
equivalent to the employee's contributions generally up to a maximum of 5.25% of
the employee's defined compensation per year. The Company's provision for
contributions for the years ended December 31, 2003, 2002 and 2001 was $0.7
million, $0.7 million and $0.5 million, respectively.

The plan for the Company's TCN employees was effective April 1, 1998, and
is similar to the 401k Plan. The Company contributes 3.75% of a participant's
defined compensation and matches 25% of the first 6% of each employee's
compensation contributed. For the year ended December 31, 2003, the Company's
provision for contributions was $0.7 million, and $0.6 million for the years
ended December 31, 2002 and 2001, respectively.

DEFERRED COMPENSATION AND SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN

The Company established its Deferred Compensation and Supplemental
Executive Retirement Plan in December 1996. The Company contributes to this plan
any portion of the 3.75% of the base salary contribution and the matching
contribution to the 401k Plan that cannot be contributed because of the
limitations within the Code and because of elective deferrals that the
participant makes under the plan. Additionally, the plan provides that
participants may defer up to 10% of base compensation and/or up to 100% of any
performance bonus. Participants in this plan are a select group of management or
highly compensated employees of the Company and are fully vested in all amounts
paid into the plan. The Company's provision for contributions for the years
ended December 31, 2003, 2002 and 2001 was not material.

PENSION PLAN

The defined benefit pension plan established by Arethusa effective October
1, 1992 was frozen on April 30, 1996. At that date all participants were deemed
fully vested in the plan, which covered substantially all U.S. citizens and U.S.
permanent residents who were employed by Arethusa. Benefits are calculated and
paid based on an employee's years of credited service and average compensation
at the date the plan was frozen using an excess benefit formula integrated with
social security covered compensation.

Pension costs are determined actuarially and at a minimum funded as
required by the Code. During 2003 and 2002, the Company made voluntary
contributions to the plan of $0.5 million and $3.7 million, respectively. As a
result of freezing the plan, no service cost has been accrued for the years
presented.

The Company uses a September 30 measurement date for the plan.

62

DIAMOND OFFSHORE DRILLING, INC.
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following provides a reconciliation of benefit obligations:

Amounts recognized in the Consolidated Balance Sheets consisted of prepaid
benefit cost as follows:

The accumulated benefit obligation was as follows:

Weighted-average assumptions used to determine benefit obligations were:

The long-term rate of return for plan assets is determined based on widely
accepted capital market principles, long-term return analysis for global fixed
income and equity markets as well as the active total return oriented portfolio
management style. Long-term trends are evaluated relative to current market
factors such as inflation, interest rates and fiscal and monetary policies, in
order to assess the capital market assumptions as applied to the plan.
Consideration of diversification needs and rebalancing is maintained.

63

DIAMOND OFFSHORE DRILLING, INC.
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Components of net periodic benefit costs were as follows:

Weighted-average assumptions used to determine net periodic benefit costs
were:

The weighted-average asset allocation for the Company's pension plan by
asset category is as follows:

The Company employs a total return approach whereby a mix of equities and
fixed income investments are used to maximize the long-term return of plan
assets for a prudent level of risk. The intent of this strategy is to minimize
plan expenses by outperforming plan liabilities over the long run. Risk
tolerance is established through careful consideration of the plan liabilities,
plan funded status and corporate financial conditions. The investment portfolio
contains a diversified blend of U.S. and non-U.S. fixed income and equity
investments. Alternative investments, including hedge funds, may be used
judiciously to enhance risk adjusted long-term returns while improving portfolio
diversification. Derivatives may be used to gain market exposure in an efficient
and timely manner. Investment risk is measured and monitored on an ongoing basis
through annual liability measurements, periodic asset/liability studies and
quarterly investment portfolio reviews.

The plan assets at September 30, 2003 and 2002, do not include any
securities of the Company.

The Company does not expect to make a contribution to its pension plan in
2004.

16. SEGMENTS AND GEOGRAPHIC AREA ANALYSIS

The Company manages its business on the basis of 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.

64

DIAMOND OFFSHORE DRILLING, INC.
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

SIMILAR SERVICES

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

GEOGRAPHIC AREAS

At December 31, 2003, the Company had drilling rigs located offshore nine
countries outside of the United States. As a result, the Company is exposed to
the risk of changes in social, political and economic 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 where the services were performed.

An individual foreign country may, from time to time, contribute a material
percentage of the Company's total revenues from unaffiliated customers. For the
years ended December 31, 2003, 2002 and 2001, individual

65

DIAMOND OFFSHORE DRILLING, INC.
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

countries that contributed 5% or more of the Company's total revenues from
unaffiliated customers are listed below.

Long-lived tangible assets located in the United States and all foreign
countries in which the Company holds assets as of December 31, 2003, 2002 and
2001 are listed below. A substantial portion of the Company's assets are mobile,
therefore asset locations at the end of the period are not necessarily
indicative of the geographic distribution of the earnings generated by such
assets during the periods.

Besides the United States, Brazil is currently the only country with a
material concentration of the Company's assets. Approximately 12.5% and 15.3% of
the Company's total drilling and other property and equipment were located in or
offshore Brazil as of December 31, 2003 and 2002, respectively.

MAJOR CUSTOMERS

The Company's customer base includes major and independent oil and gas
companies and government-owned oil companies. Revenues from major customers for
the periods presented that contributed more than 10% of the Company's total
revenues as follows:

66

DIAMOND OFFSHORE DRILLING, INC.
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

17. UNAUDITED QUARTERLY FINANCIAL DATA

Unaudited summarized financial data by quarter for the years ended December
31, 2003 and 2002 is shown below.

67

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.

Not applicable.

ITEM 9A. 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 SEC'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.

PART III

Reference is made to the information responsive to Items 10, 11, 12, 13 and
14 of this Part III contained in the Company's definitive proxy statement for
its 2004 Annual Meeting of Stockholders, which is incorporated herein by
reference.

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

ITEM 11. EXECUTIVE COMPENSATION.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.

68

PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.

(a) Index to Financial Statements, Financial Statement Schedules and
Exhibits

(1) Financial Statements

(2) Financial Statement Schedules

No schedules have been included herein because the information required
to be submitted has been included in the Company's Consolidated
Financial Statements or the notes thereto or the required information is
inapplicable.

(3) Index of Exhibits........................................ 69

See the Index of Exhibits for a list of those exhibits filed herewith,
which index also includes and identifies management contracts or
compensatory plans or arrangements required to be filed as exhibits to
this Form 10-K by Item 601 of Regulation S-K.

(b) Reports on Form 8-K

The Company made the following reports on Form 8-K during the fourth
quarter of fiscal year 2003:

- ---------------

* Filed or furnished herewith.

+ Management contracts or compensatory plans or arrangements.

70

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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, on March 1, 2004.

DIAMOND OFFSHORE DRILLING, INC.

By: /s/ GARY T. KRENEK
------------------------------------
Gary T. Krenek
Vice President and Chief Financial
Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.

71

EXHIBIT INDEX

- ---------------

* Filed or furnished herewith.

+ Management contracts or compensatory plans or arrangements.

73