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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___________ to ______________
Commission file number 1-13926
DIAMOND OFFSHORE DRILLING, INC.
(Exact name of registrant as specified in its charter)
Delaware 76-0321760
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)
15415 Katy Freeway
Houston, Texas
77094
(Address of principal executive offices)
(Zip Code)
(281) 492-5300
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
As of October 27, 2004 Common stock, $0.01 par value per share 128,544,903 shares
DIAMOND OFFSHORE DRILLING, INC.
TABLE OF CONTENTS FOR FORM 10-Q
QUARTER ENDED SEPTEMBER 30, 2004
PAGE NO.
COVER PAGE....................................................................................... 1
TABLE OF CONTENTS................................................................................ 2
PART I. FINANCIAL INFORMATION................................................................... 3
ITEM 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets................................................... 3
Consolidated Statements of Operations......................................... 4
Consolidated Statements of Cash Flows......................................... 5
Notes to Unaudited Consolidated Financial Statements.......................... 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS..................................................... 19
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK .................... 39
ITEM 4. CONTROLS AND PROCEDURES....................................................... 40
PART II. OTHER INFORMATION...................................................................... 41
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.................... 41
ITEM 6. EXHIBITS....................................................................... 41
SIGNATURES....................................................................................... 42
EXHIBIT INDEX.................................................................................... 43
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
DIAMOND OFFSHORE DRILLING, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
SEPTEMBER 30, DECEMBER 31,
------------------------------
2004 2003
-------------- -------------
(UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents ................................................. $ 213,875 $ 106,345
Investments and marketable securities ..................................... 669,284 503,995
Accounts receivable ....................................................... 153,952 154,124
Rig inventory and supplies ................................................ 48,099 48,035
Prepaid expenses and other ................................................ 34,144 22,764
----------- -----------
Total current assets .............................................. 1,119,354 835,263
DRILLING AND OTHER PROPERTY AND EQUIPMENT, NET OF
ACCUMULATED DEPRECIATION .................................................. 2,190,616 2,257,876
GOODWILL .................................................................... 887 11,099
OTHER ASSETS ................................................................ 30,719 30,781
----------- -----------
Total assets ...................................................... $ 3,341,576 $ 3,135,019
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt ......................................... $ 479,190 $ 11,969
Accounts payable .......................................................... 18,687 15,653
Accrued liabilities ....................................................... 82,112 65,617
Taxes payable ............................................................. 3,847 6,761
----------- -----------
Total current liabilities ......................................... 583,836 100,000
LONG-TERM DEBT .............................................................. 722,220 928,030
DEFERRED TAX LIABILITY ...................................................... 373,584 384,505
OTHER LIABILITIES ........................................................... 42,111 42,004
----------- -----------
Total liabilities ................................................. 1,721,751 1,454,539
----------- -----------
COMMITMENTS AND CONTINGENCIES (NOTE 9) -- --
STOCKHOLDERS' EQUITY:
Preferred stock (par value $0.01, 25,000,000 shares authorized, none
issued and outstanding) ............................................... -- --
Common stock (par value $0.01, 500,000,000 shares authorized,
133,458,303 shares and 133,457,055 shares issued at September 30, 2004 and
at December 31, 2003, respectively, and 128,541,503 shares and 129,322,455
shares outstanding at September 30, 2004 and at
December 31, 2003, respectively) ........................................ 1,335 1,335
Additional paid-in capital ................................................ 1,263,724 1,263,692
Retained earnings ......................................................... 473,131 515,906
Accumulated other comprehensive losses .................................... (3,952) (4,117)
Treasury stock, at cost (4,916,800 shares at September 30, 2004
and 4,134,600 shares at December 31, 2003) ............................... (114,413) (96,336)
----------- -----------
Total stockholders' equity ........................................ 1,619,825 1,680,480
----------- -----------
Total liabilities and stockholders' equity ........................ $ 3,341,576 $ 3,135,019
=========== ===========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED
FINANCIAL STATEMENTS.
3
DIAMOND OFFSHORE DRILLING, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except per share data)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- ------------------
2004 2003 2004 2003
---- ---- ---- ----
REVENUES:
Contract drilling ...................... $ 200,610 $ 174,923 $ 554,535 $ 471,820
Revenues related to reimbursable
expenses .............................. 7,588 8,984 22,807 21,436
--------- --------- --------- ---------
Total revenues ....................... 208,198 183,907 577,342 493,256
--------- --------- --------- ---------
OPERATING EXPENSES:
Contract drilling .......................... 140,607 126,934 408,768 365,210
Reimbursable expenses ...................... 6,620 8,208 20,373 19,471
Depreciation and amortization .............. 45,043 43,256 134,117 132,086
General and administrative ................. 6,728 7,181 24,277 22,595
Loss on sale and disposition of assets ..... 1,536 1,509 1,341 1,451
------- ------- ------- -------
Total operating expenses .............. 200,534 187,088 588,876 540,813
------- ------- ------- -------
OPERATING INCOME (LOSS) ........................... 7,664 (3,181) (11,534) (47,557)
OTHER INCOME (EXPENSE):
Interest income ............................ 2,899 2,742 7,581 10,235
Interest expense ........................... (7,657) (6,432) (20,384) (17,385)
Gain (loss) on sale of marketable
securities ................................ (27) (6,179) 231 (7,310)
Other, net ................................. 78 (140) (333) 2,891
------- ------- ------- -------
INCOME (LOSS) BEFORE INCOME TAX (EXPENSE)
BENEFIT .......................................... 2,957 (13,190) (24,439) (59,126)
INCOME TAX (EXPENSE) BENEFIT ...................... (16) 1,727 5,913 9,410
--------- --------- --------- ---------
NET INCOME (LOSS) ................................. $ 2,941 $ (11,463) $ (18,526) $ (49,716)
========= ========= ========= =========
EARNINGS (LOSSES) PER SHARE:
BASIC ...................................... $ 0.02 $ (0.09) $ (0.14) $ (0.38)
========= ========= ========= =========
DILUTED .................................... $ 0.02 $ (0.09) $ (0.14) $ (0.38)
========= ========= ========= =========
WEIGHTED AVERAGE SHARES OUTSTANDING:
Shares of common stock ..................... 128,899 130,336 129,180 130,336
Dilutive potential shares of common stock .. 42 - - -
------- ------- ------- -------
Total weighted average shares
outstanding .......................... 128,941 130,336 129,180 130,336
======= ======= ======= =======
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED
FINANCIAL STATEMENTS.
4
DIAMOND OFFSHORE DRILLING, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------------
2004 2003
------------ -----------
OPERATING ACTIVITIES:
Net loss .......................................................... $ (18,526) $ (49,716)
Adjustments to reconcile net loss to net cash provided by operating
activities:
Depreciation .................................................... 134,117 132,086
Gain on sale and disposition of assets .......................... 1,341 1,451
(Gain) loss on sale of marketable securities, net ............... (231) 7,310
Deferred tax benefit ............................................ (1,025) (11,785)
Accretion of discounts on marketable securities ................. (2,256) (2,000)
Amortization of debt issuance costs ............................. 819 891
Amortization of discount on zero coupon convertible
debentures ..................................................... 12,010 11,600
Changes in operating assets and liabilities:
Accounts receivable ............................................. 201 (21,542)
Rig inventory and supplies and other current assets ............. (11,444) 4,426
Other assets, non-current ....................................... 812 2,583
Accounts payable and accrued liabilities ........................ 19,525 (15,921)
Taxes payable ................................................... (2,914) (2,148)
Other liabilities, non-current .................................. 107 7,959
Other items, net ................................................ 254 (2,972)
----------- -----------
Net cash provided by operating activities ................... 132,790 62,222
----------- -----------
INVESTING ACTIVITIES:
Capital expenditures (excluding rig acquisitions) ................. (69,719) (177,416)
Rig acquisitions .................................................. -- (63,500)
Proceeds from sale of assets ...................................... 1,521 879
Proceeds from sale and maturities of marketable securities ........ 2,773,630 2,571,618
Purchases of marketable securities ................................ (2,913,971) (2,359,460)
Purchases of Australian dollar time deposits ...................... (42,073) --
Proceeds from maturities of Australian dollar time deposits ....... 19,846 --
Proceeds from settlement of forward contracts ..................... -- 2,492
----------- -----------
Net cash used by investing activities ....................... (230,766) (25,387)
----------- -----------
FINANCING ACTIVITIES:
Issuance of 5.15% senior unsecured notes .......................... 249,397 --
Debt issue costs - 5.15% senior unsecured notes ................... (1,565) --
Acquisition of treasury stock ..................................... (18,077) --
Payment of dividends .............................................. (24,249) (48,876)
----------- -----------
Net cash provided (used) by financing activities ............ 205,506 (48,876)
----------- -----------
NET CHANGE IN CASH AND CASH EQUIVALENTS ................................. 107,530 (12,041)
Cash and cash equivalents, beginning of period .................... 106,345 182,453
----------- -----------
Cash and cash equivalents, end of period .......................... $ 213,875 $ 170,412
=========== ===========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED
FINANCIAL STATEMENTS.
5
DIAMOND OFFSHORE DRILLING, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
1. GENERAL INFORMATION
The consolidated financial statements of Diamond Offshore Drilling, Inc.
and subsidiaries (the "Company") should be read in conjunction with the Annual
Report on Form 10-K for the year ended December 31, 2003 (File No. 1-13926).
As of October 27, 2004, Loews Corporation ("Loews") owned 54.5% of the
outstanding shares of common stock of Diamond Offshore Drilling, Inc., which was
a wholly owned subsidiary of Loews prior to its initial public offering in
October 1995.
Interim Financial Information
The accompanying consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of
America for interim financial information and with the instructions to Form 10-Q
and Article 10 of Regulation S-X. Accordingly, they do not include all
disclosures required by generally accepted accounting principles for complete
financial statements. The consolidated financial information has not been
audited but, in the opinion of management, includes all adjustments (consisting
only of normal recurring accruals) necessary for a fair presentation of the
consolidated balance sheets, statements of operations, and statements of cash
flows at the dates and for the periods indicated. Results of operations for
interim periods are not necessarily indicative of results of operations for the
respective full years.
Cash and Cash Equivalents, Marketable Securities and Other Investments
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 in marketable securities 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 judged to be other than temporary, if any, are reported in the
Consolidated Statements of Operations in "Other income (expense)."
"Investments and marketable securities" in the Consolidated Balance Sheet
at September 30, 2004 also included $21.8 million of time deposits (converted
from 30.0 million Australian dollars) which mature over the next two quarters.
These securities do not meet the definition of debt securities under Statement
of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain
Investments in Debt and Equity Securities," and are therefore carried at cost.
Derivative Financial Instruments
Derivative financial instruments of the Company include forward exchange
contracts and a contingent interest provision that is embedded in the 1.5%
convertible senior debentures due 2031 (the "1.5% Debentures") issued on April
11, 2001. See Note 4.
6
Supplementary Cash Flow Information
Cash payments made for interest on long-term debt totaled $3.5 million for
the nine months ended September 30, 2004 and $3.4 million for the nine months
ended September 30, 2003.
Cash refunds received for foreign income taxes, net of foreign tax
payments made, were $0.8 million during the nine months ended September 30,
2004. Cash payments made for foreign income taxes, net of foreign tax refunds,
were $7.1 million during the same period in 2003. A $0.4 million refund of U.S.
income tax was received during the first nine months of 2004. There were no
payments or refunds of U.S. income taxes during the nine months ended September
30, 2003.
Capitalized Interest
Interest cost for construction and upgrade of qualifying assets is
capitalized. A reconciliation of the Company's total interest cost to "Interest
expense" as reported in the Consolidated Statements of Operations is as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------------------------
2004 2003 2004 2003
---------------------------------------------
(IN THOUSANDS)
Total interest cost including amortization of
debt issuance costs ...................... $ 7,657 $ 6,567 $ 20,384 $ 19,584
Capitalized interest ........................ -- (135) -- (2,199)
--------- ------- -------- --------
Total interest expense as reported ...... $ 7,657 $ 6,432 $ 20,384 $ 17,385
========= ======= ======== ========
Interest on the upgrade cost of the Ocean Rover was capitalized through
July 10, 2003 when its upgrade was completed. Currently, there are no capital
projects for which interest is being capitalized.
Debt Issuance Costs
Debt issuance costs are included in the Consolidated Balance Sheets in
"Other assets" and are amortized over the respective terms of the related debt.
Treasury Stock
Depending on market conditions, the Company may, from time to time,
purchase shares of its common stock in the open market or otherwise. The
purchase of treasury stock is accounted for using the cost method which reports
the cost of the shares acquired in "Treasury stock" as a deduction from
stockholders' equity in the Consolidated Balance Sheets. During the nine months
ended September 30, 2004, the Company purchased 782,200 shares of its common
stock at an aggregate cost of $18.1 million, or at an average cost of $23.11 per
share. 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.
7
Comprehensive Income (Loss)
A reconciliation of net income (loss) to comprehensive income (loss) is as
follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------------------------
2004 2003 2004 2003
---------------------------------------------
(IN THOUSANDS)
Net income (loss) ............................. $2,941 $(11,463) $(18,526) $(49,716)
Other comprehensive gains (losses), net of tax:
Foreign currency translation gain (loss) ... 138 (164) (294) (313)
Unrealized holding (loss) gain on
investments ................................... 32 (49) 484 (4,263)
Reclassification adjustment for gain (loss)
included in net income (loss) ............ -- 1,218 (25) 1,209
------ -------- -------- --------
Comprehensive income (loss) ................... $3,111 $(10,458) $(18,361) $(53,083)
====== ======== ======== ========
Currency Translation
The Company's primary functional currency is the U.S. dollar. Certain of
the Company's subsidiaries use the local currency in the country where they
conduct operations as their functional currency. These subsidiaries translate
assets and liabilities at period-end exchange rates while income and expense
accounts are translated at average exchange rates. Translation adjustments are
reflected in the Consolidated Balance Sheets in "Accumulated other comprehensive
losses." Currency transaction gains and losses are included in the Consolidated
Statements of Operations in "Other income (expense)." Re-measurement translation
gains and losses of subsidiaries operating in hyperinflationary economies, when
applicable, are included in operating results.
Stock-Based Compensation
The Company accounts for its Amended and Restated 2000 Stock Option Plan
in accordance with Accounting Principles Board ("APB") Opinion No. 25,
"Accounting for Stock Issued to Employees." Accordingly, no compensation expense
has been recognized for the options granted to employees under the plan. Had
compensation expense for the Company's stock options been recognized based on
the fair value of the options at the grant dates, valued using the Binomial
Option pricing model, the Company's net income (loss) and earnings (loss) per
share would have been as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------------------------------
2004 2003 2004 2003
---------------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net income (loss) as reported ...................... $ 2,941 $ (11,463) $ (18,526) $ (49,716)
Add: Stock-based employee compensation
expense included in reported net loss,
net of related tax effects ...................... -- -- -- --
Deduct: Total stock-based employee compensation
expense determined under fair value based method,
net of related tax effects ...................... (234) (288) (792) (825)
--------- ---------- ---------- ----------
Pro forma net income (loss) ........................ $ 2,707 $ (11,751) $ (19,318) $ (50,541)
========= ========== ========== ==========
Earnings (loss) per share of common stock:
As reported ..................................... $ 0.02 $ (0.09) $ (0.14) $ (0.38)
Pro forma ....................................... $ 0.02 $ (0.09) $ (0.15) $ (0.39)
Earnings (loss) per share of common stock -
assuming dilution:
As reported ..................................... $ 0.02 $ (0.09) $ (0.14) $ (0.38)
Pro forma ....................................... $ 0.02 $ (0.09) $ (0.15) $ (0.39)
8
Revenue Recognition
Revenue from dayrate drilling contracts is recognized as services are
performed. In connection with such drilling contracts, the Company may receive
lump-sum fees for the mobilization of equipment and personnel. These fees are
earned as services are performed over the initial term of the related drilling
contracts. The Company previously accounted for the excess of mobilization fees
received over costs incurred to mobilize an offshore rig from one market to
another as revenue over the term of the related drilling contracts. Effective
July 1, 2004 the Company changed its accounting to defer mobilization fees
received as well as direct and incremental mobilization costs incurred and began
to amortize each, on a straight line basis, over the term of the related
drilling contracts (which is the period estimated to be benefited from the
mobilization activity). Straight line amortization of mobilization revenues and
related costs over the term of the related drilling contracts (which generally
range from two to 60 months) is consistent with the timing of net cash flows
generated from the actual drilling services performed. If the Company had used
this method of accounting in prior periods, operating income (loss) and net
income (loss) would not have changed and the impact on contract drilling
revenues and expenses would have been immaterial. Absent a contract,
mobilization costs are recognized currently.
Revenue 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.
Reimbursements received for the purchase of supplies, equipment, personnel
services and other services provided at the request of the Company's customers
in accordance with a contract or agreement is recorded, for the gross amount
billed to the customer, as "Revenues related to reimbursable expenses" in the
Consolidated Statements of Operations.
Changes in Accounting Estimates
In April 2003 the Company commissioned a study to evaluate the economic
lives of its drilling rigs because several of its rigs had reached or were
approaching the end of their depreciable lives, yet were still operating and
were expected to operate for many more years. 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 the Company's net income for the three months ended September 30, 2004 of
$3.9 million, or $0.03 per share, and a reduction to the Company's net loss for
the nine months ended September 30, 2004 of $11.5 million, or $0.09 per share.
The effect of this change in accounting estimate resulted in a reduction to the
Company's net loss for the three and nine month periods ended September 30, 2003
of $6.9 million, or $0.05 per share, and $12.7 million, or $0.10 per share,
respectively.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amount of revenues and
expenses during the reporting period. Actual results could differ from those
estimated.
Reclassifications
Certain amounts applicable to prior periods have been reclassified to
conform to the classifications currently followed. Such reclassifications do not
affect earnings.
9
2. EARNINGS (LOSSES) PER SHARE
A reconciliation of the numerators and the denominators of the basic and
diluted per-share computations follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------------------------
2004 2003 2004 2003
---------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net income (loss) - basic (numerator): ........ $ 2,941 $ (11,463) $ (18,526) $ (49,716)
Effect of dilutive potential shares
1.5% Debentures ...................... -- -- -- --
Zero Coupon Debentures ............... -- -- -- --
-------- --------- --------- ---------
Net income (loss) including conversions -
diluted (numerator) ........................... $ 2,941 $ (11,463) $ (18,526) $ (49,716)
======== ========= ========= =========
Weighted average shares - basic (denominator): 128,899 130,336 129,180 130,336
Effect of dilutive potential shares
1.5% Debentures ...................... -- -- -- --
Zero Coupon Debentures ............... -- -- -- --
Stock options ........................ 42 -- -- --
------- ------- ------- -------
Weighted average shares including conversions -
diluted (denominator) ........................ 128,941 130,336 129,180 130,336
======== ========= ========= =========
Earnings (losses) per share:
Basic ................................ $ 0.02 $ (0.09) $ (0.14) $ (0.38)
======== ========= ========= =========
Diluted .............................. $ 0.02 $ (0.09) $ (0.14) $ (0.38)
======== ========= ========= =========
The computation of diluted earnings per share ("EPS") for both quarters
and nine month periods ended September 30, 2004 and 2003 excludes approximately
6.9 million potentially dilutive shares issuable upon conversion of the
Company's zero coupon convertible debentures due 2020 ("Zero Coupon
Debentures"). The computation of diluted EPS for both quarters and nine month
periods ended September 30, 2004 and 2003 also excludes approximately 9.4
million potentially dilutive shares issuable upon conversion of the Company's
1.5% Debentures. The inclusion of such shares from the Zero Coupon Debentures
and the 1.5% Debentures in the EPS computation for the quarter ended September
30, 2004 would be antidilutive. Such shares were not included in the EPS
computation for the quarter ended September 30, 2003 and both nine month periods
ended September 30, 2004 and 2003, respectively, because there was a net loss
for these periods. See Note 8 for a description of the Company's long-term debt.
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 302,550 shares of common
stock were excluded from the computation of diluted EPS for the quarter and nine
month periods ended September 30, 2004. Stock options representing 506,150
shares and 423,400 shares of common stock were excluded from the computation of
diluted EPS for the quarter and nine month periods ended September 30, 2003,
respectively.
Other stock options with average market prices that exceeded their
exercise prices during the period (in-the-money options) were excluded from the
computation of diluted EPS because potential shares of common stock are not
included when a loss from continuing operations exists. Stock options
representing 377,152 shares of common stock were excluded from the computation
of diluted EPS for the nine month period ended September 30, 2004. Stock options
representing 2,500 shares and 85,250 shares of common stock were excluded from
the computation of diluted EPS for the quarter and nine month period ended
September 30, 2003, respectively.
10
3. INVESTMENTS AND MARKETABLE SECURITIES
Investments classified as available for sale are summarized as follows:
SEPTEMBER 30, 2004
----------------------------------------------------------------------------
GROSS UNREALIZED LOSSES
------------------------------
GROSS
AMORTIZED UNREALIZED LESS THAN GREATER THAN MARKET
COST GAINS 12 MONTHS 12 MONTHS VALUE
--------- -------- ------------- ------------ -----------
(in thousands)
Debt securities issued by the U.S. Treasury
and other U.S. government agencies:
Due within one year..................... $ 644,001 $ 41 $ -- $ -- $ 644,042
Mortgage-backed securities............... 3,425 61 -- -- 3,486
--------- -------- ---------- ------------ -----------
Total................................... $ 647,426 $ 102 $ -- $ -- $ 647,528
========= ======== ========== ============ ===========
"Investments and marketable securities" in the Consolidated Balance Sheets
at September 30, 2004 also included $21.8 million of time deposits (converted
from 30.0 million Australian dollars) which mature over the next two quarters.
These securities do not meet the definition of debt securities under SFAS No.
115, "Accounting for Certain Investments in Debt and Equity Securities," and are
therefore carried at cost.
DECEMBER 31, 2003
------------------------------------------------------------------
GROSS UNREALIZED LOSSES
-------------------------
GROSS
AMORTIZED UNREALIZED LESS THAN GREATER THAN MARKET
COST GAINS 12 MONTHS 12 MONTHS VALUE
------------------------------------------------------------------
(in thousands)
Debt securities issued by the U.S.
Treasury and other U.S. government
agencies:
Due within one year ............................... $ 499,784 $ 44 $ -- $ -- $ 499,828
Mortgage-backed securities .......................... 4,812 -- -- (645) 4,167
---------- -------- ---------- ---------- ------------
Total ............................................. $ 504,596 $ 44 $ -- $ (645) $ 503,995
========== ======== ========== ========== ============
All of the Company's investments are included as current assets in the
Consolidated Balance Sheets in "Investments and marketable securities,"
representing the investment of cash available for current operations.
Proceeds from sales and maturities of marketable securities and gross
realized gains and losses are summarized as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------- ----------------------------
2004 2003 2004 2003
--------- ---------- ------------ -------------
(IN THOUSANDS)
Proceeds from sales............. $ 449,383 $ 518,612 $ 1,648,630 $ 746,618
Proceeds from maturities........ 375,000 450,000 1,125,000 1,825,000
Gross realized gains............ -- 2,259 2,558 2,367
Gross realized losses........... (27) (8,438) (2,327) (9,677)
11
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, when possible, 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
approximately 50.0 million Australian dollars, of which 4.2 million Australian
dollars to be purchased monthly from August 29, 2002 through June 26, 2003 and
3.8 million to be purchased on July 31, 2003. These forward contracts were
derivatives as defined by SFAS No. 133. SFAS No. 133 requires that each
derivative be stated in the balance sheet at its fair value with gains and
losses reflected in the income statement except that, to the extent the
derivative qualifies for hedge accounting, the gains and losses are reflected in
income in the same period as offsetting losses and gains on the qualifying
hedged positions. SFAS No. 133 further provides specific criteria necessary for
a derivative to qualify for hedge accounting. The forward contracts purchased by
the Company in 2002 did not qualify for hedge accounting. A pre-tax gain of $0.2
million and $2.5 million was recorded in the Consolidated Statements of
Operations for the quarter and nine month period ended September 30, 2003 in
"Other income (expense)." The Company had satisfied all obligations under these
contracts as of September 30, 2003 and has not entered into any new forward
exchange contracts since that time.
Contingent Interest
The Company's $460.0 million principal amount of 1.5% Debentures, which
were issued on April 11, 2001 and are due on April 15, 2031, contain a
contingent interest provision. The contingent interest component is an embedded
derivative as defined by SFAS No. 133 and accordingly must be split from the
host instrument and recorded at fair value on the balance sheet. The contingent
interest component had no value at issuance, at December 31, 2003, or at
September 30, 2004.
5. DRILLING AND OTHER PROPERTY AND EQUIPMENT
Cost and accumulated depreciation of drilling and other property and
equipment are summarized as follows:
SEPTEMBER 30, DECEMBER 31,
------------------------------
2004 2003
------------------------------
(IN THOUSANDS)
Drilling rigs and equipment........................ $ 3,540,318 $ 3,453,219
Construction work-in-progress...................... -- 21,274
Land and buildings................................. 15,764 15,220
Office equipment and other......................... 22,569 22,080
----------- -----------
Cost............................................. 3,578,651 3,511,793
Less: accumulated depreciation..................... (1,388,035) (1,253,917)
---------- ----------
Drilling and other property and equipment, net... $ 2,190,616 $ 2,257,876
=========== ===========
Construction work-in-progress at December 31, 2003 consisted 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. These rigs had been cold stacked in the Gulf of Mexico since
July 1998 and October 1998, respectively. In September 2003 they 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.
12
In April 2003 the Company commissioned a study to evaluate the economic
lives of its drilling rigs because several of its rigs had reached or were
approaching the end of their depreciable lives, yet were still operating and
were expected to operate for many more years. 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 the Company's net income for the three months ended September 30, 2004 of
$3.9 million, or $0.03 per share, and a reduction to the Company's net loss for
the nine months ended September 30, 2004 of $11.5 million, or $0.09 per share.
The effect of this change in accounting estimate resulted in a reduction to the
Company's net loss for the three and nine month periods ended September 30, 2003
of $6.9 million, or $0.05 per share, and $12.7 million, or $0.10 per share,
respectively.
6. GOODWILL
Goodwill from the merger with Arethusa (Off-Shore) Limited ("Arethusa") in
1996 was generated from an excess of the purchase price over the net assets
acquired. 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. Annual goodwill impairment testing is
performed at each year-end.
There were no recognized intangible assets other than goodwill associated
with the Arethusa merger.
During each of the nine-month periods ended September 30, 2004 and 2003,
an adjustment of $10.2 million was recorded to reduce goodwill. The adjustments
represent the tax benefits not previously recognized for the excess of tax
deductible goodwill over book goodwill. The Company will continue to reduce
goodwill in future periods as the tax benefits of excess tax goodwill over book
goodwill are recognized. Goodwill is expected to be reduced to zero in the
fourth quarter of 2004.
7. ACCRUED LIABILITIES
Accrued liabilities consist of the following:
SEPTEMBER 30, DECEMBER 31,
---------------------------
2004 2003
---------------------------
(IN THOUSANDS)
Payroll and benefits............................... $ 32,425 $ 31,058
Personal injury and other claims................... 8,139 7,455
Interest payable................................... 5,647 1,537
Deferred revenue................................... 4,977 3,068
Accrued repairs (Hurricane Ivan damage)............ 4,636 --
Other.............................................. 26,288 22,499
-------- ----------
Total........................................ $ 82,112 $ 65,617
======== ==========
13
8. LONG-TERM DEBT
Long-term debt consists of the following:
SEPTEMBER 30, DECEMBER 31,
-----------------------------
2004 2003
-----------------------------
(IN THOUSANDS)
Zero Coupon Debentures............................. $ 467,221 $ 455,212
1.5% Debentures.................................... 460,000 460,000
5.15% Senior Notes................................. 249,402 --
Ocean Alliance Lease-leaseback Agreement........... 24,787 24,787
----------- -----------
1,201,410 939,999
Less: Current maturities........................... (479,190) (11,969)
----------- -----------
Total........................................ $ 722,220 $ 928,030
=========== ===========
The aggregate maturities of long-term debt for each of the five years
subsequent to December 31, 2003 are as follows (see discussions following table
for description of the rights that holders of the Zero Coupon Debentures have to
put the securities to the Company):
(IN THOUSANDS)
2004 ...................... $ 11,969
2005 ...................... 480,039
2006 ...................... --
2007....................... --
2008....................... --
Thereafter ................ 709,402
-----------
1,201,410
Less: Current
maturities............... (479,190)
------------
Total $ 722,220
===========
5.15% Senior Notes
On August 27, 2004, the Company issued $250 million aggregate principal
amount of 5.15% Senior Notes Due September 1, 2014 (the "5.15% Senior Notes").
The 5.15% Senior Notes were issued at an offering price of 99.759% of the
principal amount and resulted in net proceeds to the Company of $247.8 million.
The 5.15% Senior Notes bear interest at 5.15% per year, payable
semiannually in arrears on March 1 and September 1 of each year, beginning March
1, 2005, and mature on September 1, 2014. The 5.15% Senior Notes are unsecured
and unsubordinated obligations of the Company and they rank equal in right of
payment to the Company's existing and future unsecured and unsubordinated
indebtedness, although they will be effectively subordinated to all existing and
future obligations of the Company's subsidiaries. The Company has the right to
redeem all or a portion of the 5.15% Senior Notes for cash at any time or from
time to time on at least 15 days but not more than 60 days prior written notice,
at the redemption price specified in the governing indenture plus accrued and
unpaid interest on the principal amount of the 5.15% Senior Notes redeemed to
the date of redemption.
Zero Coupon Convertible Debentures
The Company's Zero Coupon Debentures that were 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 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 adjustment in certain events. The Zero Coupon Debentures
are senior unsecured obligations of the Company.
14
The Company has the right to redeem the Zero Coupon Debentures, in whole
or in part, on or 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 June 6, 2005, June 6, 2010 and June 6, 2015 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. As of September 30, 2004, the aggregate accreted value of the Zero
Coupon Debentures was $467.2 million. Because the holders of the debentures have
the right to require the Company to repurchase the debentures within one year,
the aggregate accreted value of $467.2 million is classified as a current
liability in the Company's Consolidated Balance Sheet at September 30, 2004.
On June 6, 2005, the aggregate accreted value of the Zero Coupon
Debentures currently outstanding will be approximately $478 million. The
aggregate principal amount at maturity will be $805.0 million assuming no
conversions or redemptions occur prior to the maturity date.
1.5% 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. 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 September 30, 2004.
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.
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 September 30, 2004. This
financing arrangement has an effective interest rate of 7.13% and is an
unsecured subordinated obligation of the Company.
15
9. COMMITMENTS AND CONTINGENCIES
Various claims have been filed against the Company in the ordinary course
of business, including claims by offshore workers alleging personal injuries.
Management believes that the Company has established adequate reserves for any
liabilities that may reasonably be expected to result from these claims. In the
opinion of management, no pending or threatened claims, actions or proceedings
against the Company are expected to have a material adverse effect on the
Company's consolidated financial position, results of operations, or cash flows.
Litigation. During the third quarter of 2004, the Company was notified
that certain of its subsidiaries have been named, along with other defendants,
in several complaints that have been filed in the Circuit Courts of the State of
Mississippi by approximately 800 persons alleging that they were employed by
some of the named defendants between approximately 1965 and 1986. The complaints
also name as defendants over 25 other companies that are not affiliated with the
Company. The complaints allege that the defendants manufactured, distributed or
utilized drilling mud containing asbestos, and in the case of the Company and
the several other offshore drilling companies named as defendants, that such
defendants allowed such drilling mud to have been utilized aboard their offshore
drilling rigs.
The plaintiffs seek, among other things, an award of unspecified
compensatory and punitive damages. At this time, however, the Company has not
been provided with sufficient information to determine the number of plaintiffs
who claim to have been employees of the Company's subsidiaries nor their period
of employment, particular information as to the period of their alleged exposure
to asbestos, nor their medical condition. Accordingly, the Company is unable to
estimate its potential exposure to these lawsuits.
The Company intends to defend these lawsuits vigorously and, based on the
information available to the Company at this time, does not expect the outcome
of these lawsuits to have a material adverse effect on the Company's financial
condition or results of operations. There can be no assurance, however, as to
the ultimate outcome of these lawsuits.
Personal Injury Claims. The Company's uninsured retention of liability for
personal injury claims, which primarily results from Jones Act liability in the
Gulf of Mexico, is $0.5 million per claim with an additional aggregate annual
deductible of $1.5 million. The Company's in-house claims department estimates
the amount of its liability for its retention. This department establishes a
reserve for each of the Company's personal injury claims by evaluating the
existing facts and circumstances of each claim and comparing the circumstances
of each claim to historical experiences with similar past personal injury
claims. The claims department also estimates the Company's liability for claims
which are incurred but not reported by using historical data. Historically, the
Company's ultimate liability for personal injury claims has not differed
materially from the Company's recorded estimates. At September 30, 2004 the
Company's estimated liability for personal injury claims was $32.5 million. Due
to uncertainties such as (a) the severity of personal injuries claimed, (b)
significant changes in the volume of personal injury claims, (c) the
unpredictability of legal jurisdictions where the claims will ultimately be
litigated, (d) inconsistent court decisions and (e) the risks and lack of
predictability inherent in personal injury litigation, eventual settlement or
adjudication of these claims could differ materially from the estimated amounts.
Letters of Credit and Other. The Company is contingently liable as of
September 30, 2004 in the amount of $74.3 million under certain performance,
bid, supersedeas and custom bonds, and letters of credit. Agreements related to
approximately $34.0 million of multi-year performance bonds can require cash
collateral for the full line at any time for any reason. Holders of agreements
related to another $23.2 million currently have the option to require cash
collateral due to the lowering of the Company's credit rating on April 27, 2004.
The remaining agreements cannot require cash collateral except in events of
default.
10. SEGMENTS AND GEOGRAPHIC AREA ANALYSIS
The Company reports its operations as one reportable segment, contract
drilling of offshore oil and gas wells. Although the Company provides contract
drilling services from different types of offshore drilling rigs and provides
such services in many geographic locations, these operations have been
aggregated into one reportable segment based on the similarity of economic
characteristics among all divisions and locations, including the nature of
services provided and the type of customers of such services.
16
Contract Drilling Services
Revenues from customers for contract drilling and similar services by
equipment-type are listed below (eliminations offset dayrate revenues earned
when the Company's rigs are utilized in its integrated services):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------------------------------------------
2004 2003 2004 2003
---------------------------------------------------------------
(IN THOUSANDS)
High Specification Floaters............ $ 75,502 $ 79,688 $ 199,342 $ 215,982
Other Semisubmersibles................. 79,357 72,588 225,620 185,556
Jack-ups............................... 45,268 23,006 128,391 69,688
Integrated Services.................... -- -- -- 1,189
Other.................................. 483 (359) 1,182 (362)
Eliminations........................... -- -- -- (233)
--------- --------- --------- ---------
Total Contract Drilling Revenues...... 200,610 174,923 554,535 471,820
Revenues Related to Reimbursable
Expenses.............................. 7,588 8,984 22,807 21,436
--------- --------- --------- ---------
Total revenues................... $ 208,198 $ 183,907 $ 577,342 $ 493,256
========= ========= ========= =========
Geographic Areas
At September 30, 2004, the Company had drilling rigs located offshore
eight countries other than the United States. As a result, the Company is
exposed to the risk of changes in social, political, economic and other
conditions inherent in foreign operations and the Company's results of
operations and the value of its foreign assets are affected by fluctuations in
foreign currency exchange rates. Revenues by geographic area are presented by
attributing revenues to the individual country or areas where the services were
performed.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------------------------------------------
2004 2003 2004 2003
---------------------------------------------------------------
(IN THOUSANDS)
United States.......................... $ 91,615 $ 84,441 $ 249,317 $ 248,115
Foreign:
South America....................... 32,186 37,909 89,953 119,188
Europe/Africa....................... 19,538 13,377 50,976 34,248
Australia/Southeast Asia............ 43,420 32,901 123,215 75,524
Mexico.............................. 21,439 15,279 63,881 16,181
--------- --------- --------- ---------
Total revenues................. $ 208,198 $ 183,907 $ 577,342 $ 493,256
========= ========= ========= =========
11. INCOME TAXES
Certain of the Company's rigs that operate internationally are owned and
operated, directly or indirectly, by Diamond Offshore International Limited, a
Cayman Islands corporation and wholly-owned subsidiary of the Company. Effective
January 1, 2003 the Company began to postpone remittance of the earnings from
Diamond Offshore International Limited 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 three months or nine
months ended September 30, 2004 and 2003. The estimated total Company annual
effective tax rate was 27.7% as of September 30, 2004 and 15.9% as of September
30, 2003. The estimated annual effective tax rate was greater in the 2004 period
than in the 2003 period primarily due to changes in the anticipated mix of
domestic and international earnings as well as the mix of international tax
jurisdictions in each period.
Tax expense for the nine months ended September 30, 2004 also included a
$0.9 million adjustment related to finalizing prior year tax returns in two
foreign jurisdictions. This additional expense is not included in the
calculation of the Company's current year estimated annual effective tax rate of
27.7%.
17
The 0.5% effective rate for the three months ended September 30, 2004
resulted from a revision of the estimated annual tax rate from 24.8% in the
second quarter of 2004 to 27.7% in the third quarter of 2004. Similarly, the
13.1% effective tax rate for the three months ended September 30, 2003 resulted
from a revision of the 16.7% effective tax rate in the second quarter of 2003 to
15.9% in the third quarter of 2003. The revisions in estimated rates were
primarily due to changes in the anticipated mix of domestic and international
earnings as well as the mix of international tax jurisdictions in each period.
The Company is under audit or has received an assessment for prior year
income taxes in certain of its international tax jurisdictions which exposes the
Company to claims of approximately $1.0 million of potential additional income
tax. The Company intends to contest any unfavorable judgment in these
jurisdictions and expects to prevail. Consequently, no income tax expense
related to this potential exposure has been recorded.
12. 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.
As a result of freezing the plan, no service cost has been accrued for the
years presented.
Components of net periodic benefit costs were as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------------------------------
2004 2003 2004 2003
---------------------------------------------------
(IN THOUSANDS)
Interest cost.................................... $ 256 $ 248 $ 766 $ 745
Expected return on plan assets................... (296) (316) (890) (947)
Amortization of unrecognized loss................ 76 69 230 205
------ ------- -------- --------
Net periodic pension expense..................... $ 36 $ 1 $ 106 $ 3
====== ======= ======== ========
During 2004 and 2003 the Company made voluntary contributions to the plan
of $0.2 million and $0.5 million, respectively. The Company is not required, nor
does it expect, to make further contributions to its pension plan in 2004.
18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following discussion should be read in conjunction with the Company's
Consolidated Financial Statements (including the Notes thereto) included
elsewhere herein. References to "Diamond Offshore" or the "Company" mean Diamond
Offshore Drilling, Inc., a Delaware corporation, and its subsidiaries.
The Company is a leader in deep water drilling with a fleet of 45 offshore
drilling rigs. The fleet consists of 30 semisubmersibles, 14 jack-ups and one
drillship.
OVERVIEW
RESULTS OF OPERATIONS AND INDUSTRY CONDITIONS
Overall demand for offshore contract drilling services improved during the
third quarter of 2004, and the Company reported net income of $2.9 million for
the period. However, net income for the period was negatively impacted by $6.5
million (pre-tax) for the deductible portion of insurance claims made for damage
caused by Hurricane Ivan. Additionally, the high-specification semisubmersible
Ocean Alliance incurred 29 days of downtime during the quarter due to equipment
repairs, which negatively impacted net income by $3.3 million (pre-tax). The
Company also recorded a provision for potential labor cost increases in the U.K.
related to mandated legislative benefits that negatively impacted net income by
$2.2 million (pre-tax). In addition, the Company incurred reactivation costs to
bring the jack-up Ocean Champion out of cold-stack and into the U.S. Gulf of
Mexico ("GOM") market, which negatively impacted net income by $1.9 million
(pre-tax).
Gulf of Mexico. In the U.S. GOM, commitments for Diamond Offshore's fourth
generation rigs have reached as high as $140,000 per day for work beginning in
2005. All six of the Company's high-specification semisubmersible rigs are
currently contracted or committed for the balance of 2004, with backlog
extending into 2005 at improving dayrates. The three mid-water semisubmersible
units the Company marketed in the GOM during the third quarter of 2004 are also
contracted or committed for the balance of 2004, with backlog extending into
2005 at improving dayrates. The improving dayrates and high committed
utilization were factors in the Company's decision to begin reactivation of the
previously cold-stacked semisubmersible Ocean Voyager for the mid-water GOM
market. The Ocean Voyager is expected to be ready to begin work by the end of
December. Reactivation costs are estimated to be approximately $8 million. The
Company views the deepwater and mid-water market in the GOM as under-supplied,
and believes that additional improvement in utilization, backlog and dayrates is
likely in these market segments during the balance of 2004 and into 2005.
Diamond Offshore's jack-up fleet in the GOM also continued to experience
high utilization and improving dayrates during the third quarter of 2004. The
Company views the jack-up market in the U.S. GOM as currently balanced, with
effective utilization near 100 percent and demand sporadically exceeding supply.
As a result, the Company believes the market and dayrates for this class of
equipment could improve further in the near term.
In the Mexican GOM, the Company's four semisubmersible rigs that mobilized
to that market in the latter half of 2003 continued to operate throughout the
third quarter of 2004 under long-term contracts. The Company believes that
future work for its other semisubmersibles and jack-ups in this market is
limited. The Company views the market for the Mexican GOM as in balance and
expects it to remain so this year.
Brazil. In Brazil, the high-specification semisubmersible Ocean Alliance
signed a one-year extension to its contract with Petrobras at a dayrate in the
high $90,000's that will employ the unit until early September 2005. The Ocean
Alliance incurred 29 days of downtime during the third quarter of 2004, due to
equipment repairs before returning to work, as previously noted. The Company
views the Brazilian semisubmersible market as balanced, and all four of the rigs
the Company operates in Brazil are working under long-term contracts that have
been renewed during 2004.
North Sea. In the North Sea, the mid-water semisubmersible Ocean Vanguard
mobilized to Norway where it began an approximately 15-month series of contracts
for a dayrate in the low $140,000's. Both mid-water semisubmersibles, the Ocean
Guardian and Ocean Princess have received one year extensions to their contracts
in the U.K. at approximately $80,000 dayrates. The mid-water semisubmersible
Ocean Nomad is in the process of mobilizing from West Africa to the U.K. where,
following shipyard work, it will begin a one year contract at a dayrate of
$80,000. Utilization of marketed semisubmersible rigs in the U.K. sector of the
North Sea remains at 100 percent, and the Company believes this market will
remain firm throughout the balance of 2004 and into 2005. Semisubmersible rig
19
utilization in Norway also continues near 100 percent with firm demand, and the
Company believes this market will remain balanced through the end of this year
and into 2005.
Africa. The Ocean Nomad worked in West Africa for most of the third
quarter and is now mobilizing to the U.K. sector of the North Sea as previously
noted. The Company views the West African floater market as improving, although
at a slower rate than the U.S. GOM and the North Sea.
Southeast Asia. The high-specification semisubmersible unit the Ocean
Baroness received a 180-day extension to its contract in Indonesia at a dayrate
in the mid-$130,000's for work ending in May 2005. Additionally, the jack-up rig
Ocean Heritage secured a contract for work in India at a dayrate in the low
$60,000's which began in late October 2004 and extends until mid-May 2005. The
Company's other rigs in the Southeast Asian market all operated during the third
quarter, and all of the Company's rigs in Southeast Asia currently have
contracts or commitments for work extending through the balance of 2004 and into
2005. The Company views demand in the Southeast Asian market as increasing, and
with high utilization, the Company believes dayrates could continue improving.
GENERAL
Revenues. The Company's revenues vary based upon demand, which affects the
number of days the fleet is utilized and the dayrates earned. When a rig is
idle, no dayrate is earned and revenues will decrease as a result. Revenues can
also be affected 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 mobilization, revenues may be adversely affected. As a
response to changes in demand, the Company may withdraw a rig from the market by
stacking it or may reactivate a rig stacked previously, which may decrease or
increase revenues, respectively. The two most significant variables affecting
revenues are dayrates for rigs and rig utilization rates, each of which is a
function of rig supply and demand in the marketplace. As utilization rates
increase, dayrates tend to increase as well reflecting the lower supply of
available rigs, and vice versa. The same factors, primarily demand for drilling
services, which is dependent upon the level of expenditures set by oil and gas
companies for offshore exploration and development as well as a variety of
political and economic factors, and availability of rigs in a particular
geographical region, affect both dayrates and utilization rates. These factors
are not within the Company's control and are difficult to predict.
Revenue from dayrate drilling contracts is recognized as services are
performed. In connection with such drilling contracts, the Company may receive
lump-sum fees for the mobilization of equipment and personnel. These fees are
earned as services are performed over the initial term of the related drilling
contracts. The Company previously accounted for the excess of mobilization fees
received over costs incurred to mobilize an offshore rig from one market to
another as revenue over the term of the related drilling contracts. Effective
July 1, 2004 the Company changed its accounting to defer mobilization fees
received as well as direct and incremental mobilization costs incurred and began
to amortize each, on a straight line basis, over the term of the related
drilling contracts (which is the period estimated to be benefited from the
mobilization activity). Straight line amortization of mobilization revenues and
related costs over the term of the related drilling contracts (which generally
range from two to 60 months) is consistent with the timing of net cash flows
generated from the actual drilling services performed. If the Company had used
this method of accounting in prior periods, operating income (loss) and net
income (loss) would not have changed and the impact on contract drilling
revenues and expenses would have been immaterial. Absent a contract,
mobilization costs are recognized currently.
Reimbursements received for the purchase of supplies, equipment, personnel
services and other services provided at the request of the Company's customers
in accordance with a contract or agreement are recorded for the gross amount
billed to the customer, as "Revenues related to reimbursable expenses" in the
Consolidated Statements of Operations.
Revenue 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 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 incurred operating expenses such as inspections, painting
projects and routine overhauls, meeting certain criteria, which maintain rather
than upgrade its rigs. These expenses vary from period to period. Costs of rig
enhancements are capitalized and depreciated over the expected useful lives of
the enhancements. Higher depreciation expense decreases operating income in
periods subsequent to capital upgrades.
20
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 1 of Part I 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.
Management makes judgments, assumptions and estimates regarding capitalization,
useful lives and salvage values. Changes in these judgments, assumptions and
estimates could produce results that differ from those reported.
The offshore drilling industry is a relatively young industry which began
developing just over 50 years ago. The Company has based its estimates of useful
lives and salvage values on the historical industry data available to it as well
as its own experience. In April 2003 the Company commissioned a study to
evaluate the economic lives of its drilling rigs because several of its rigs had
reached or were approaching the end of their depreciable lives, yet were still
operating and were expected to operate for many more years. 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 the Company's net income for the three months ended
September 30, 2004 of $3.9 million, or $0.03 per share, and a reduction to the
Company's net loss for the nine month period ended September 30, 2004 of $11.5
million, or $0.09 per share. The effect of this change in accounting estimate
resulted in a reduction to the Company's net loss for the three and nine month
periods ended September 30, 2003 of $6.9 million, or $0.05 per share, and $12.7
million, or $0.10 per share, respectively.
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.
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. At December 31, 2003 the Company determined that all five of its
cold stacked rigs should be tested for impairment. The impairment analysis at
December 31, 2003 consisted of a probability-weighted cash flow analysis for
each of the five cold stacked rigs. The assumptions and estimates underlying
this analysis included (a) dayrate by rig, (b) utilization rate by rig
(expressed as the actual percentage of time per year that the rig would be
used), (c) the per day operating cost for each rig if active, ready stacked or
cold stacked and (d) salvage value for each rig. Based on these assumptions and
estimates a matrix was developed assigning probabilities to various combinations
of assumed utilization rates and dayrates. In all cases, the
probability-weighted cash flows significantly exceeded the carrying value of
each rig. The impact of a 5% reduction in assumed dayrates for the cold stacked
rigs (holding all other assumptions and estimates in the model constant), or
alternatively the impact of a 5% reduction in utilization (again holding all
other assumptions and estimates in the model constant) would still have resulted
in probability-weighted cash flows that exceeded the carrying value of each rig.
Two of the Company's cold stacked rigs that were tested and found not to be
impaired at December 31, 2003 have since been reactivated and these rigs
currently have contracted dayrates that are within the range of dayrates used in
the Company's 2003 impairment analysis. Management's assumptions are an inherent
part of an asset impairment evaluation and the use of different assumptions
could produce results that differ from those reported.
Personal Injury Claims. The Company's uninsured retention of liability for
personal injury claims, which primarily results from Jones Act liability in the
Gulf of Mexico, is $0.5 million per claim with an additional aggregate annual
deductible of $1.5 million. The Company's in-house claims department estimates
the amount of its liability for its retention. This department establishes a
reserve for each of the Company's personal injury claims by evaluating the
existing facts and circumstances of each claim and comparing the circumstances
of each claim to historical experiences with similar past personal injury
claims. The claims department also estimates the Company's liability for claims
which are incurred but not reported by using historical data. Historically, the
Company's ultimate liability for personal injury claims has not differed
materially from the Company's recorded estimates. At September 30, 2004 the
Company's estimated liability for personal injury claims was $32.5 million. Due
to uncertainties such as (a) the severity of personal injuries claimed, (b)
significant changes in the volume of personal injury claims, (c) the
unpredictability of legal jurisdictions where the claims will ultimately be
litigated, (d) inconsistent court decisions and (e) the risks and lack of
predictability inherent in personal injury litigation, eventual settlement or
adjudication of these claims could differ materially from the estimated amounts.
21
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. In each of its tax jurisdictions the Company
recognizes a current tax liability or asset for the estimated taxes payable or
refundable on tax returns for the current year and a deferred tax asset or
liability for the estimated future tax effects attributable to temporary
differences and carryforwards. Deferred tax assets are reduced by a valuation
allowance, if necessary, which is determined by the amount of any tax benefits
that, based on available evidence, are not expected to be realized under a "more
likely than not" approach. For interim periods, the Company estimates its annual
effective tax rate by forecasting its annual income before income tax, taxable
income and tax expense in each of its tax jurisdictions. The Company makes
judgments regarding future events and related estimations 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 December 2003 the Company established a valuation allowance of $10.2
million, which resulted in a charge against earnings, for certain of the
Company's foreign tax credit carryforwards which were scheduled 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 determined that a valuation allowance was necessary.
22
THREE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
Comparative data relating to the Company's revenues and operating expenses
by equipment type are listed below (eliminations offset (i) dayrate revenues
earned when the Company's rigs are utilized in its integrated services and (ii)
intercompany expenses charged to rig operations). Certain amounts applicable to
the prior periods have been reclassified to conform to the classifications
currently followed. Such reclassifications do not affect earnings.
THREE MONTHS ENDED
SEPTEMBER 30,
------------------------- FAVORABLE/
2004 2003 (UNFAVORABLE)
--------- --------- -------------
(in thousands)
CONTRACT DRILLING REVENUE
High Specification Floaters ............. $ 75,502 $ 79,688 $ (4,186)
Other Semisubmersibles .................. 79,357 72,588 6,769
Jack-ups ................................ 45,268 23,006 22,262
Other ................................... 483 (359) 842
--------- --------- ---------
TOTAL CONTRACT DRILLING REVENUE ......... $ 200,610 $ 174,923 $ 25,687
========= ========= =========
REVENUES RELATED TO REIMBURSABLE EXPENSES $ 7,588 $ 8,984 $ (1,396)
CONTRACT DRILLING EXPENSE
High Specification Floaters ............. $ 43,697 $ 39,974 $ (3,723)
Other Semisubmersibles .................. 62,185 62,494 309
Jack-ups ................................ 34,354 23,677 (10,677)
Integrated Services ..................... -- (6) (6)
Other ................................... 371 795 424
--------- --------- ---------
TOTAL CONTRACT DRILLING EXPENSE ......... $ 140,607 $ 126,934 $ (13,673)
========= ========= =========
REIMBURSABLE EXPENSES ................... $ 6,620 $ 8,208 $ (1,588)
OPERATING INCOME (LOSS)
High Specification Floaters ............. $ 31,805 $ 39,714 $ (7,909)
Other Semisubmersibles .................. 17,172 10,094 7,078
Jack-ups ................................ 10,914 (671) 11,585
Integrated Services ..................... -- 6 (6)
Other ................................... 112 (1,154) 1,266
Reimbursable expenses, net .............. 968 776 192
Depreciation ............................ (45,043) (43,256) (1,787)
General and administrative expense ...... (6,728) (7,181) 453
(Loss) gain on sale of assets ........... (1,536) (1,509) (27)
--------- --------- ---------
TOTAL OPERATING INCOME (LOSS) ........... $ 7,664 $ (3,181) $ 10,845
========= ========= =========
High Specification Floaters.
Revenues. Revenues from high specification floaters decreased $4.2 million
during the quarter ended September 30, 2004 compared to the same period in 2003.
The overall average operating dayrate was $91,700 during the third quarter
of 2004 compared to $97,500 during the third quarter of 2003. This lower average
dayrate resulted in a $2.7 million decrease in high specification floater
revenue. Significant reductions in the average operating dayrates were:
- the Ocean Star ($84,700 to $60,000);
- the Ocean Victory ($65,950 to $46,400);
- the Ocean Quest ($55,200 to $43,900); and
- the Ocean Alliance ($112,300 to $104,400).
23
Utilization of 89% during the third quarter of 2004 remained relatively
unchanged from the same period in 2003. However, declines in utilization,
including lower utilization for the Ocean Alliance, which was stacked
approximately one-third of the current year quarter due to ongoing sub-sea and
electrical problems, and lower utilization for the Ocean Clipper which was
stacked for sub-sea repairs ten more days in the current year quarter than in
the same period of 2003, negatively affected revenue by $1.5 million.
Utilization improved in the third quarter of 2004 compared to the same
quarter of 2003 for:
- the Ocean Quest, which was stacked approximately one month more in
the third quarter of 2003 than in the third quarter of 2004; and
- the Ocean Rover, which was in the shipyard completing its major
upgrade for 10 days in the third quarter of 2003.
Both of these rigs operated during all or most of the third quarter of
2004.
Contract Drilling Expense. Contract drilling expense for high
specification floaters was higher by $3.7 million for the quarter ended
September 30, 2004 compared to the same period in 2003 primarily due to:
- repairs and other costs associated with damage done by Hurricane
Ivan to the Ocean America and Ocean Star; and
- repairs to the Ocean Alliance, due to a series of sub-sea and
electrical problems during the beginning of the third quarter of
2004.
Partially offsetting the higher comparable contract drilling expenses were
lower expenses for:
- the Ocean Victory, which incurred moving costs during the third
quarter of 2003; and
- the Ocean Confidence, which incurred costs to repair damaged
components of a hydrophone system during the third quarter of 2003.
Other Semisubmersibles.
Revenues. Revenues from other semisubmersibles for the quarter ended
September 30, 2004 decreased $6.8 million compared to the same period in 2003.
An improvement in utilization contributed $11.7 million to revenue.
Utilization increased from 64% during the third quarter of 2003 to 75% during
the third quarter of 2004.
Utilization improved for:
- the Ocean Vanguard and the Ocean Epoch, which both operated all of
the third quarter of 2004 but were stacked most of the third quarter
of 2003;
- the Ocean Yorktown, which worked the entire third quarter of 2004
but spent two-thirds of the comparable quarter of 2003 in a shipyard
preparing for and moving to the Mexican GOM; and
- the Ocean Patriot, which operated approximately 70 days in the third
quarter of 2004 compared to only 30 days during the third quarter of
2003.
The improvement in utilization was partially offset by the Ocean Concord
which was in a shipyard for life enhancement maintenance and 5-year survey the
entire third quarter of 2004 but operated throughout the same period in 2003.
Revenue was negatively impacted by $4.9 million due to a decline in the
average operating dayrate, which fell from $59,100 during the third quarter of
2003 to $55,000 during the third quarter of 2004. The Ocean Yatzy, one of the
Company's rigs operating offshore Brazil, experienced the most significant
change in dayrate (from $125,300 to $83,100) as its long-term contract expired
in late 2003 and was renewed at a lower dayrate. Partially offsetting the
24
overall decline in the average operating dayrate were improvements in average
operating dayrates for the Ocean Princess (from $40,400 to $53,600) and the
Ocean Epoch (from $50,000 to $64,100).
Contract Drilling Expense. Contract drilling expense for other
semisubmersibles decreased $0.3 million during the third quarter of 2004
compared to the same period in 2003 primarily due to:
- the Ocean Whittington, which incurred mobilization costs from
South Africa to the Gulf of Mexico during the third quarter 2003;
and
- the Ocean Ambassador, the Ocean Worker and the Ocean Yorktown,
which were all mobilizing to the Mexican GOM during the third
quarter 2003.
Partially offsetting the lower contract drilling expenses were higher
comparative expenses during the third quarter of 2004 for:
- the Ocean Vanguard, which incurred higher operating costs during
the third quarter of 2004 compared to minimal costs incurred
during the third quarter of 2003, when this rig was bareboat
chartered to its previous owner for most of the quarter;
- the Ocean Guardian, the Ocean Princess and the Ocean Vanguard,
which incurred higher labor costs associated with a contingent
liability for mandated benefits legislated in the U.K.; and
- the Ocean Epoch, which had normal operating expenses during the
third quarter of 2004 compared to reduced costs during the third
quarter of 2003 while it was stacked.
Jack-Ups.
Revenues. Revenues from jack-ups increased $22.3 million during the third
quarter of 2004 compared to the same quarter in 2003.
Utilization, which rose from 64% during the third quarter of 2003 to 89%
during the same quarter of 2004, contributed $14.4 million to the overall
increase in revenue. This improvement in utilization was primarily due to:
- the Ocean Sovereign and the Ocean Titan, which worked the entire
third quarter of 2004 compared to the third quarter of 2003 when
these rigs were undergoing major upgrades and other shipyard
projects;
- the Ocean Champion, which was reactivated from cold stack status and
worked 46 days during the third quarter of 2004; and
- the Ocean Heritage, which completed its contract in Ecuador and
began its demobilization back to Singapore in the third quarter of
2004 prior to its move to India for its new contract. During the
third quarter of 2003 this rig was stacked for most of the period.
Improvements in average operating dayrates contributed $7.9 million to the
overall revenue increase as average operating dayrates rose from $27,800 during
the third quarter of 2003 to $39,500 during the same period of 2004. All of the
Company's operating rigs in this classification experienced an increase in
average operating dayrates resulting primarily from a tighter jack-up market in
the U.S. GOM.
Contract Drilling Expense. Contract drilling expense for jack-ups
increased $10.7 million during the third quarter of 2004 over the same period in
2003 primarily due to:
- costs incurred for the demobilization of the Ocean Heritage from
Ecuador to Singapore compared to reduced expenses during the third
quarter of 2003 while this rig was stacked in a Singapore shipyard;
- higher costs for the Ocean Warwick during the 2004 period including
repairs and other costs associated with damages from Hurricane Ivan
compared to normal operating costs during the third quarter of 2003;
- expenses associated with the Ocean Champion reactivation and
operating costs during the third quarter of 2004 compared to cold
stack costs in the third quarter of 2003; and
25
- higher operating costs for the Ocean Titan during the third quarter
of 2004 compared to the same quarter in 2003 when most costs were
capitalized during its shipyard cantilever upgrade.
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
$1.0 million and $0.8 million for the quarters ended September 30, 2004 and
2003, respectively.
Depreciation.
Depreciation expense increased $1.7 million to $45.0 million in the third
quarter of 2004 compared to $43.3 million in the third quarter of 2003 primarily
due to depreciation associated with:
- the Ocean America, which completed its upgrade during the second
quarter 2004;
- the Ocean Titan, which completed its upgrade during the first
quarter of 2004; and
- third quarter 2003 capital additions associated with obtaining
contracts to operate four of the Company's rigs in Mexico.
General and Administrative Expense.
General and administrative expense for the quarter ended September 30,
2004 of $6.7 million decreased from $7.2 million for the same period in 2003.
This decrease was primarily due to reimbursements of legal costs associated with
ongoing litigation, partially offset by increased costs related to compliance
with the Sarbanes-Oxley Act of 2002, higher external audit fees and higher net
building expenses due to lower rental income from tenants.
Interest Expense.
Interest expense of $7.7 million during the third quarter of 2004 was $1.3
million higher than interest expense of $6.4 million in the same period in 2003
primarily from interest incurred due to the issuance of the Company's 5.15%
Senior Notes Due September 1, 2014 (the "5.15% Senior Notes") on August 27,
2004. See Note 8 " -- Long-Term Debt" in Item 1 of Part I of this report.
Gain (Loss) on Sale of Marketable Securities.
A loss on the sale of marketable securities of $27,000 occurred in the
third quarter of 2004 compared to a $6.2 million loss in the same quarter of
2003. See Note 3 "Marketable Securities" in Item 1 of Part I of this report.
Income Tax (Expense) Benefit.
Income tax expense of $16,000 was recognized on a pre-tax income of $3.0
million in the quarter ended September 30, 2004 compared to a tax benefit of
$1.7 million which was recognized on a pre-tax loss of $13.2 million in the
comparable period of 2003. The Company's estimated annual effective income tax
rate increased from 24.8% to 27.7% during the third quarter of 2004 and resulted
from a different mix of earnings and tax rates expected for 2004 than was
anticipated in the previous quarter. The Company's effective income tax rate of
0.5% for the three months ended September 30, 2004 resulted primarily from
applying the higher estimated annual effective rate to its June 30, 2004
year-to-date pre-tax losses which reduced tax expense for the three months ended
September 30, 2004 by $0.8 million. The 13.1% effective tax rate for the three
months ended September 30, 2003 resulted from a revision of the 2003 estimated
annual tax rate from 16.7% to 15.9% in the third quarter of 2003.
Certain of the Company's rigs that operate internationally are owned and
operated, directly or indirectly, by Diamond Offshore International Limited, a
Cayman Islands corporation and wholly-owned subsidiary of the Company. Effective
January 1, 2003 the Company began to postpone remittance of the earnings from
Diamond Offshore International Limited 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 nine months ended
September 30, 2004 and 2003. The Company's estimated annual effective tax rate
was 27.7% as of September 30,
26
2004 and 15.9% as of September 30, 2003. The estimated annual effective tax rate
was greater in the 2004 period than in the 2003 period primarily due to the
different anticipated mix of domestic and international earnings as well as the
mix of international tax jurisdictions in each period.
The Company is under audit or has received an assessment for prior year
income taxes in certain of its international tax jurisdictions which exposes the
Company to claims of approximately $1.0 million of potential additional income
tax. The Company intends to contest any unfavorable judgment in these
jurisdictions and expects to prevail. Consequently, no income tax expense
related to this potential exposure has been recorded.
27
NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
Comparative data relating to the Company's revenues and operating expenses
by equipment type are listed below (eliminations offset (i) dayrate revenues
earned when the Company's rigs are utilized in its integrated services and (ii)
intercompany expenses charged to rig operations). Certain amounts applicable to
the prior periods have been reclassified to conform to the classifications
currently followed. Such reclassifications do not affect earnings.
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------------- FAVORABLE/
2004 2003 (UNFAVORABLE)
--------- --------- -------------
(in thousands)
CONTRACT DRILLING REVENUE
High Specification Floaters ............. $ 199,342 $ 215,982 $ (16,640)
Other Semisubmersibles .................. 225,620 185,556 40,064
Jack-ups ................................ 128,391 69,688 58,703
Integrated Services ..................... -- 1,189 (1,189)
Other ................................... 1,182 (362) 1,544
Eliminations ............................ -- (233) 233
--------- --------- ---------
TOTAL CONTRACT DRILLING REVENUE ......... $ 554,535 $ 471,820 $ 82,715
========= ========= =========
REVENUES RELATED TO REIMBURSABLE EXPENSES $ 22,807 $ 21,436 $ 1,371
CONTRACT DRILLING EXPENSE
High Specification Floaters ............. $ 126,835 $ 116,805 $ (10,030)
Other Semisubmersibles .................. 193,137 170,021 (23,116)
Jack-ups ................................ 86,373 74,940 (11,433)
Integrated Services ..................... -- 2,084 2,084
Other ................................... 2,423 1,593 (830)
Eliminations ............................ -- (233) (233)
--------- --------- ---------
TOTAL CONTRACT DRILLING EXPENSE ......... $ 408,768 $ 365,210 $ (43,558)
========= ========= =========
REIMBURSABLE EXPENSES ................... $ 20,373 $ 19,471 $ (902)
OPERATING INCOME (LOSS)
High Specification Floaters ............. $ 72,507 $ 99,177 $ (26,670)
Other Semisubmersibles .................. 32,483 15,535 16,948
Jack-ups ................................ 42,018 (5,252) 47,270
Integrated Services ..................... -- (895) 895
Other ................................... (1,241) (1,955) 714
Reimbursable expenses, net .............. 2,434 1,965 469
Depreciation ............................ (134,117) (132,086) (2,031)
General and administrative expense ...... (24,277) (22,595) (1,682)
Loss on sale and disposition of assets .. (1,341) (1,451) 110
--------- --------- ---------
TOTAL OPERATING INCOME (LOSS) ........... $ (11,534) $ (47,557) $ 36,023
========= ========= =========
High Specification Floaters.
Revenues. Revenues from high specification floaters decreased $16.6
million during the nine months ended September 30, 2004 compared to the same
period in 2003.
Revenue was negatively impacted by $30.2 million as utilization fell from
88% during the first nine months of 2003 (excluding the Ocean Rover) to 75%
during the same period of 2004.
Utilization declined for:
- the Ocean Star, which was stacked for a majority of the first
nine months of 2004;
28
- the Ocean Alliance, which was off contract during the first
nine months of 2004 for approximately four months due to a
series of sub-sea and electrical problems following
approximately one month in a shipyard for a 5-year survey and
sub-sea equipment upgrade;
- the Ocean America, which spent approximately three of the
first nine months of 2004 in a shipyard undergoing a 5-year
survey and upgrade which were completed late in the second
quarter of 2004; and
- the Ocean Confidence, which had approximately four weeks of
unpaid downtime for repairs during the first nine months of
2004.
All of these rigs operated during all or most of the first nine months of 2003.
Partially offsetting the overall decline in utilization was an improvement
in utilization for the Ocean Valiant, which worked most of the first nine months
of 2004 but was idle for approximately 105 days during the first nine months of
2003.
Lower overall average operating dayrates during the first nine months of
2004, of $90,100 compared to $95,700 during the same period in 2003 (excluding
the Ocean Rover), reduced revenue by $9.6 million. The lower average dayrates
were primarily a consequence of soft market conditions in the U.S. GOM as
several of these high specification floaters accepted jobs in the mid-water
depth market.
The Ocean Rover contributed an additional $23.2 million to revenue during
the first nine months of 2004 as it continued its drilling program offshore
Malaysia. During the first nine months of 2003 this rig was undergoing an
upgrade to high specification capabilities which was completed in July 2003.
Contract Drilling Expense. Contract drilling expense for high
specification floaters increased by $10.0 million for the nine months ended
September 30, 2004 compared to the same period in 2003 primarily due to:
- operating costs for the Ocean Rover, which worked all of the
first nine months of 2004 but was undergoing a major upgrade
for the majority of the same period in 2003;
- repairs to the Ocean Alliance due to a series of sub-sea and
electrical problems and costs related to a 5-year survey and
sub-sea equipment upgrade, all occurring during the first nine
months of 2004; and
- costs in the third quarter of 2004 associated with damages
from Hurricane Ivan to the Ocean America and Ocean Star.
Partially offsetting the overall higher contract drilling expense during
the first nine months of 2004 were lower expenses for:
- the Ocean Valiant, which incurred higher costs during the
first nine months of 2003 for a 5-year survey and maintenance
repairs; and
- the Ocean Quest, which incurred normal operating costs during
the first nine months of 2004 compared to higher repair and
moving costs during the first nine months of 2003.
Other Semisubmersibles.
Revenues. Revenues from other semisubmersibles for the nine months ended
September 30, 2004 increased $40.1 million compared to the same period in 2003.
Utilization improvements contributed $44.1 million to the higher revenues.
Utilization rose to 71% during the first nine months of 2004 from 53% during the
same period of 2003 (excluding the Ocean Century and Ocean Prospector, which
were sold in December 2003, and the Ocean Vanguard, which was operating under a
bareboat charter). Utilization improved for:
- the Ocean Whittington, Ocean Epoch and Ocean Princess, all of
which worked a majority of the first nine months of 2004 but
were ready-stacked during most of the same period in 2003;
29
- the Ocean Ambassador, which worked throughout the first nine
months of 2004 but was stacked approximately 140 days of the
same period of 2003, during which time this rig was in a
shipyard for a 5-year survey and also prepared for its
contract in Mexico;
- the Ocean Guardian and Ocean Bounty, which worked most of the
first nine months of 2004 compared to the same period in 2003
when the Ocean Guardian spent three months in a shipyard for
repairs and inspection and the Ocean Bounty spent two months
in a shipyard for a 5-year survey; and
- the Ocean Yorktown, which worked most of the first nine months
of 2004 compared to spending approximately three months during
the same period of 2003 undergoing preparations for its
contract in Mexico.
These utilization improvements were partially offset by the Ocean Concord,
which was stacked for approximately 60 days for a 5-year survey and other
repairs and then entered a shipyard for life enhancement maintenance near the
end of June 2004 compared to the same period in 2003 when this rig worked most
of the period.
The average operating dayrate for other semisubmersibles (excluding the
Ocean Vanguard) fell from $58,500 during the first nine months of 2003 to
$55,600 during the first nine months of 2004, reducing revenues by $9.2 million.
The most significant reductions in average dayrates were to:
- the Ocean Yatzy (from $124,700 to $83,200), which renewed its
contract to operate offshore Brazil during the latter part of
2003 at a lower dayrate reflective of market conditions; and
- the Ocean Yorktown (from $69,600 to $47,900), which worked
offshore Brazil during the first half of 2003 but operated in
the Mexican GOM during the first nine months of 2004.
Partially offsetting the overall lower average operating dayrates was an
improvement in the average operating dayrate for the Ocean Worker ($52,000 to
$68,500). The Ocean Worker operated in the Mexican GOM during the first nine
months of 2004. In 2003 the Ocean Worker operated in the U.S. GOM for seven
months before moving to the Mexican GOM.
In addition, a revenue improvement of $5.2 million for the nine months
ended September 30, 2004 over the comparable period of 2003 was due to a higher
average operating dayrate for the Ocean Vanguard. This semisubmersible,
purchased in December 2002, had an average operating dayrate of $51,600 during
the 2004 period compared to an average operating dayrate of $10,000 which was
earned under a bareboat charter with its previous owner in the 2003 period.
Contract Drilling Expense. Contract drilling expense for other
semisubmersibles increased $23.1 million during the first nine months of 2004
compared to the same period in 2003 primarily due to:
- the four rigs currently working in the Mexican GOM, which
incurred higher labor, travel, and equipment rental expense,
as well as expenses associated with maintaining a Mexican
shorebase;
- the Ocean Vanguard, which incurred higher than normal
operating expenses during the first nine months of 2004 due to
preparations for work in the North Sea compared to minimal
costs during the same period in 2003 when it operated under a
bareboat charter for its previous owner;
- the Ocean Patriot, which incurred higher than normal operating
costs during the first nine months of 2004 due to preparations
for work in New Zealand and Australia compared to minimal
costs during the same period in 2003 following its March 2003
purchase;
- the Ocean Winner and Ocean Concord, both of which incurred
costs to mobilize to a shipyard for their 5-year surveys (the
Ocean Concord was also undergoing life enhancement
maintenance) during a part of the first nine months of 2004
compared to normal operations during the same period in 2003;
and
- the Ocean Epoch, which incurred normal operating costs as it
worked most of the first nine months of 2004 compared to
reduced costs while it was ready-stacked during most of the
first nine months of 2003.
30
Partially offsetting the increase in contract drilling expense were lower
costs for:
- the Ocean Nomad, which incurred normal operating costs during
the first nine months of 2004 compared to costs for
mobilization to a shipyard and an inspection during the same
period in 2003;
- the Ocean Guardian, which incurred normal operating costs
during the first nine months of 2004 compared to costs for
mobilization to a shipyard and an inspection during the same
period of 2003; and
- the Ocean Bounty, which incurred normal operating costs during
the first nine months of 2004 compared to operating costs for
the same period in 2003 which included a 5-year survey.
Jack-Ups.
Revenues. Revenues from jack-ups increased $58.7 million during the first
nine months of 2004 compared to the same period of 2003.
Utilization rose to 88% in the first nine months of 2004 from 67% in the
same period of 2003, resulting in a $32.7 million revenue improvement.
Utilization increased primarily due to:
- the Ocean Tower and Ocean Titan in the U.S. GOM, and the Ocean
Sovereign in Southeast Asia, which were in shipyards
undergoing major upgrades during most of the first nine months
of 2003 but were operating during most of the same period in
2004;
- the Ocean Heritage, Ocean Summit, Ocean Spartan, Ocean
Columbia, Ocean Drake and Ocean Warwick, all of which worked a
majority of the first nine months of 2004 compared to each
being stacked for part of the same period of 2003; and
- the Ocean Champion, which was reactivated from cold stack
status during the third quarter of 2004.
The average operating dayrate for jack-ups rose to $38,100 in the first
nine months of 2004 from $27,400 in the same period of 2003 resulting in a $26.0
million revenue improvement. All of the Company's jack-ups in the GOM
experienced an increase in average dayrate primarily due to a tighter market for
this class of equipment in the U.S. GOM.
Contract Drilling Expense. Contract drilling expense for jack-ups during
the first nine months of 2004 increased $11.4 million compared to the same
period in 2003 primarily due to:
- costs incurred for the mobilization of the Ocean Heritage from
Singapore to Ecuador in early 2004 and its subsequent
demobilization back to Singapore in the third quarter of 2004
prior to its move to India for its next contract;
- higher costs for the Ocean Warwick during the 2004 period
which included repairs and other costs associated with damages
from Hurricane Ivan compared to normal operating costs during
the same period of 2003;
- operating and reactivation costs for the Ocean Champion, which
was brought out of cold stack status during the third quarter
of 2004; and
- operating costs for the Ocean Titan during the first nine
months of 2004, compared to the same period in 2003 when most
costs were capitalized in connection with its cantilever
upgrade.
Lower contract drilling expenses for the Ocean Sovereign in the 2004
period were partially offsetting. The Ocean Sovereign incurred normal operating
expenses in the 2004 period compared to the first nine months of 2003, which
included non-upgrade shipyard projects in addition to its upgrade.
31
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
$2.4 million and $2.0 million for the nine months ended September 30, 2004 and
2003, respectively.
Depreciation.
Depreciation expense increased to $134.1 million in the first nine months
of 2004 compared to $132.1 million in the first nine months of 2003 primarily
due to depreciation associated with:
- the Ocean Rover, which completed its upgrade in July 2003;
- the Ocean Patriot, acquired in March 2003;
- upgrades to three jack-up rigs, two of which were completed
during the second quarter of 2003 and one of which was
completed in early 2004; and
- third quarter 2003 capital additions associated with obtaining
contracts to operate four of the Company's rigs in Mexico.
Partially offsetting the increase was a $5.3 million reduction in
depreciation expense for the first quarter of 2004 which resulted from
increasing the estimated service lives and salvage values for most of the
Company's drilling rigs, effective April 1, 2003, to better reflect their
remaining economic lives and salvage values.
General and Administrative Expense.
General and administrative expense for the nine months ended September 30,
2004 of $24.3 million increased $1.7 million over $22.6 million for the same
period in 2003. This increase was primarily due to costs related to compliance
with the Sarbanes-Oxley Act of 2002, higher external audit fees and higher net
building expenses due to lower rental income from tenants.
Gain (Loss) on Sale of Marketable Securities.
A gain on the sale of marketable securities of $0.2 million occurred
during the nine months ended September 30, 2004 compared to a $7.3 million loss
during the same period in 2003. See Note 3 "Marketable Securities" in Item 1 of
Part I of this report.
Interest Income.
Interest income of $7.6 million earned during the nine months ended
September 30, 2004 declined $2.6 million, from $10.2 million earned during the
same period in 2003, primarily due to lower interest rates earned on cash and
marketable securities compared to the same period in 2003.
Interest Expense.
Interest expense of $20.4 million during the nine months ended September
30, 2004 was $3.0 million higher than interest expense of $17.4 million in the
same period in 2003 primarily due to interest on the upgrade cost of the Ocean
Rover capitalized through July 10, 2003 when its upgrade was completed. Interest
expense was also higher due to the issuance of the 5.15% Senior Notes on August
27, 2004. See Note 1 " -- General Information -- Capitalized Interest" and Note
8 " -- Long-Term Debt" in Item 1 of Part I of this report.
Other Income (Expense) - Other, net
Other expense net of other income was $0.3 million for the nine months
ended September 30, 2004 compared to other income net of other expense of $2.9
million for the same period in 2003. Other income during the nine month period
in 2003 was primarily from a gain on forward exchange contracts to purchase
Australian dollars.
32
Income Tax Benefit.
An income tax benefit of $5.9 million was recognized on a pre-tax loss of
$24.4 million in the nine months ended September 30, 2004 compared to a tax
benefit of $9.4 million which was recognized on a pre-tax loss of $59.1 million
in the comparable period of 2003.
Certain of the Company's rigs that operate internationally are owned and
operated, directly or indirectly, by Diamond Offshore International Limited, a
Cayman Islands corporation and wholly-owned subsidiary of the Company. Effective
January 1, 2003 the Company began to postpone remittance of the earnings from
Diamond Offshore International Limited 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 nine month periods
ended September 30, 2004 and 2003. The Company's estimated annual effective tax
rate was 27.7% as of September 30, 2004 and 15.9% as of September 30, 2003. The
estimated annual effective tax rate was greater in the 2004 period than in the
2003 period primarily due to the different anticipated mix of domestic and
international earnings as well as the mix of international tax jurisdictions in
each period.
Tax expense for the nine months ended September 30, 2004 also included a
$0.9 million adjustment related to finalizing prior year tax returns in two
foreign jurisdictions. This additional expense is not included in the
calculation of the Company's current year estimated annual effective tax rate of
27.7%.
The Company is under audit or has received an assessment for prior year
income taxes in certain of its international tax jurisdictions which exposes the
Company to claims of approximately $1.0 million of potential additional income
tax. The Company intends to contest any unfavorable judgment in these
jurisdictions and expects to prevail. Consequently, no income tax expense
related to this potential exposure has been recorded.
OPERATIONS OUTSIDE THE UNITED STATES
The Company's non-U.S. operations are subject to certain political,
economic and other uncertainties not normally encountered in U.S. operations,
including risks of war and civil disturbances (or other risks that may limit or
disrupt markets), expropriation and the general hazards associated with the
assertion of national sovereignty over certain areas in which operations are
conducted. No prediction can be made as to what governmental regulations may be
enacted in the future that could adversely affect the Company's non-U.S.
operations or the international offshore contract drilling industry. The
Company's operations outside the United States may also face the additional risk
of fluctuating currency values, hard currency shortages, controls of currency
exchange and repatriation of income or capital.
During 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.
LIQUIDITY
A discussion of the sources and uses of cash for the nine months ended
September 30, 2004 compared to the same period in 2003 follows.
NINE MONTHS ENDED
SEPTEMBER 30,
------------------------------
2004 2003 CHANGE
--------- -------------- ----------
(IN THOUSANDS)
NET CASH PROVIDED BY OPERATING ACTIVITIES
Net loss .............................. $ (18,526) $ (49,716) $ 31,190
Depreciation .......................... 134,117 132,086 2,031
Deferred tax benefit .................. (1,025) (11,785) 10,760
Other non-cash items, net ............. 11,683 19,252 (7,569)
Net changes in operating assets and
liabilities ......................... 6,541 (27,615) 34,156
--------- --------- ---------
$ 132,790 $ 62,222 $ 70,568
========= ========= =========
33
Cash of $132.8 million was generated from operations during the nine
months ended September 30, 2004 compared to cash of $62.2 million generated
during the same period of 2003 primarily due to an improvement in results of
operations in the 2004 period.
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------------------
2004 2003 CHANGE
------------ -------------- -----------
(IN THOUSANDS)
NET CASH (USED IN) PROVIDED BY INVESTING ACTIVITIES
Capital expenditures (excluding rig acquisition) ........... $ (69,719) $ (177,416) $ 107,697
Rig acquisition ............................................ -- (63,500) 63,500
Proceeds from sale of assets ............................... 1,521 879 642
Proceeds from sale and maturities of marketable securities.. 2,773,630 2,571,618 202,012
Purchases of marketable securities ......................... (2,913,971) (2,359,460) (554,511)
Purchase of Australian dollar time deposits ................ (42,073) -- (42,073)
Proceeds from maturities of Australian dollar time
deposits .................................................. 19,846 -- 19,846
Proceeds from settlement of forward contracts .............. -- 2,492 (2,492)
----------- ----------- -----------
$ (230,766) $ (25,387) $ (205,379)
=========== =========== ===========
During the nine months ended September 30, 2004, the Company used $230.8
million for investing activities compared to $25.4 million used for investing
activities during the comparable period in 2003. In the first nine months of
2004, net purchases of investments in marketable securities and capital
expenditures used $140.3 million and $69.7 million of the Company's cash,
respectively. In addition, the Company invested $42.1 million (equivalent to
58.0 million Australian dollars) in Australian dollar time deposits with
expirations ranging from May 5, 2004 to March 9, 2005, $19.8 million (equivalent
to 32.0 million Australian dollars) of which matured during the period. Cash
proceeds of $1.5 million were generated by the sale of miscellaneous equipment.
During the nine months ended September 30, 2003, the Company spent $65.0
million ($1.5 million of which is included with inventory) for the purchase of
the semisubmersible rig, the Ocean Patriot, and used $177.4 million for capital
expenditures, primarily for the completion of the Ocean Rover upgrade and the
upgrade of three of the Company's jack-up rigs. Cash provided from investing
activities in the 2003 period included cash proceeds of $212.2 million from the
net sale and maturity of certain of the Company's investments in marketable
securities, $2.5 million provided from the settlement of forward contracts at
favorable exchange rates and $0.9 million provided from the sale of
miscellaneous equipment.
NINE MONTHS ENDED
SEPTEMBER 30,
-----------------------------
2004 2003 CHANGE
--------- -------------- ---------
(IN THOUSANDS)
NET CASH USED IN FINANCING ACTIVITIES
Issuance of 5.15% Senior Notes ......... $ 249,397 $ -- $ 249,397
Debt issue costs -- 5.15% Senior Notes.. (1,565) -- (1,565)
Payment of dividends ................... (24,249) (48,876) 24,627
Acquisition of treasury stock .......... (18,077) -- (18,077)
--------- --------- ---------
$ 205,506 $ (48,876) $ 254,382
========= ========= =========
5.15% Senior Notes
On August 27, 2004, the Company issued $250 million aggregate principal
amount of its 5.15% Senior Notes at an offering price of 99.759% of the
principal amount, resulting in net proceeds to the Company of $247.8 million.
The 5.15% Senior Notes bear interest at 5.15% per year, payable
semiannually in arrears on March 1 and September 1 of each year, beginning March
1, 2005, and mature on September 1, 2014. The 5.15% Senior Notes are unsecured
and unsubordinated obligations of the Company and they rank equal in right of
payment to the Company's existing and future unsecured and unsubordinated
indebtedness, although the 5.15% Senior Notes will be effectively subordinated
to all existing and future obligations of the Company's subsidiaries. The
Company has the right to redeem all or a portion of the 5.15% Senior Notes for
cash at any time or from time to time on at least 15 days but not more than 60
days prior written notice, at the redemption price specified in the governing
indenture
34
plus accrued and unpaid interest on the principal amount of the 5.15% Senior
Notes redeemed to the date of redemption.
Zero Coupon Debentures
The Company has the right to redeem its zero coupon convertible debentures
due 2020 (the "Zero Coupon Debentures"), in whole or in part, on or 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 June 6, 2005, June 6, 2010
and June 6, 2015 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. As
of September 30, 2004, the aggregate accreted value of the Zero Coupon
Debentures was $467.2 million.
Dividends
The Company paid cash dividends of $24.2 million to stockholders in the
first nine months of 2004 compared to $48.9 million in the same period of 2003.
Cash dividends paid in the first nine months of 2004 were lower primarily due to
a lower quarterly dividend rate of $0.0625 per share of common stock compared to
a quarterly dividend rate of $0.125 per share of common stock in the 2003
period.
Treasury Stock
Depending on market conditions, the Company may, from time to time,
purchase shares of its common stock in the open market or otherwise. The
purchase of treasury stock is accounted for using the cost method which reports
the cost of the shares acquired in "Treasury stock" as a deduction from
stockholders' equity in the Consolidated Balance Sheets. During the nine months
ended September 30, 2004, the Company purchased 782,200 shares of its common
stock at an aggregate cost of $18.1 million, or at an average cost of $23.11 per
share. See Item 2 in Part II of this report. 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.
Credit Ratings.
The Company's credit rating is Baa2 for Moody's Investors Services
("Moody's") and A- for Standard & Poor's ("S&P"). In 2003 Moody's lowered its
ratings of the Company's long-term debt to Baa1 from A3 and on April 27, 2004
lowered its rating from Baa1 to Baa2 and changed the rating outlook from
negative to stable. On July 27, 2004, S&P lowered the Company's debt rating from
A to A- and rated its outlook as stable. Although the Company's long-term debt
ratings continue at investment grade levels, lower ratings could result in
higher interest rates on future debt issuances.
Letters of Credit and Other.
The Company is contingently liable as of September 30, 2004 in the amount
of $74.3 million under certain performance, bid, supersedeas and custom bonds,
and letters of credit. Agreements related to approximately $34.0 million of
multi-year performance bonds can require cash collateral for the full line at
any time for any reason. Holders of agreements related to another $23.2 million
currently have the option to require cash collateral due to Moody's lowering the
Company's credit rating on April 27, 2004. The remaining agreements cannot
require cash collateral except in events of default.
Other.
At September 30, 2004 and December 31, 2003, the Company had no
off-balance sheet debt.
The Company has an effective shelf registration statement under which an
aggregate of approximately $117.5 million in debt, equity and other securities
may be issued. In addition, the Company has an acquisition shelf registration
statement where it may issue, from time to time, up to eight million shares of
common stock (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.
35
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.
The Company had 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.
The upgrade began near the end of the first quarter of 2004 and was completed
during the latter part of the second quarter of 2004. The upgrade was completed
under budget for approximately $13 million.
The Company's two-year program to expand the capabilities of its jack-up
fleet by significantly upgrading six of its 14 jack-up rigs is now complete.
Three of these upgrades were completed in 2002, two were completed in 2003 and
one was completed early in 2004. The installation of a cantilever package on the
Ocean Titan began in May 2003 and was completed in January 2004 for
approximately $22 million.
The Company expects to spend approximately $79 million in 2004 for capital
expenditures. These expenditures include approximately $65 million associated
with its continuing rig enhancement program (other than rig upgrades),
approximately $9 million related to customer contract requirements and
approximately $5 million for other corporate requirements including life
enhancement maintenance of one of the Company's semisubmersibles, the Ocean
Concord. During the nine months ended September 30, 2004, the Company spent
$56.3 million on its continuing rig enhancement program and to meet other
corporate capital expenditure requirements.
INTEGRATED SERVICES
The Company from time to time selectively engages in drilling services
pursuant to turnkey or modified-turnkey contracts under which it agrees to drill
a well to a specified depth for a fixed price. The Company had no such activity
during the nine months ended September 30, 2004. During the nine months ended
September 30, 2003, the Company had project income of $0.4 million from the
completion of one turnkey plug and abandonment project in the Gulf of Mexico
which was more than offset by operating overhead costs and insurance premiums.
It is the Company's intent not to pursue contracts for integrated services,
which includes turnkey contracts, except in very limited circumstances.
FORWARD-LOOKING STATEMENTS
Certain written and oral statements made or incorporated by reference from
time to time by the Company or its representatives are "forward-looking
statements" within the meaning of Section 27A of the Securities Act of 1933, as
amended (the "Securities Act"), and Section 21E of the Securities Exchange Act
of 1934, as amended (the "Exchange Act"). All statements other than statements
of historical fact are, or may be deemed to be, forward-looking statements.
Forward-looking statements include, without limitation, any statement that may
project, indicate or imply future results, events, performance or achievements,
and may contain or be identified by the words "expect," "intend," "plan,"
"predict," "anticipate," "estimate," "believe," "should," "could," "may,"
"might," "will," "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 " - Overview-Results of
Operations and Industry Conditions");
- future uses of and requirements for financial resources (see " -
Liquidity" and " - Capital Resources");
36
- interest rate and foreign exchange risk (see " -- Liquidity-Credit
Ratings" and "Quantitative and Qualitative Disclosures About Market
Risk");
- future contractual obligations (see " -- Overview -- Results of
Operations and Industry Conditions," "--Operations Outside the
United States" and " - Liquidity");
- future operations outside the United States including, without
limitation, the Company's operations in Mexico (see " -- Overview --
Results of Operations and Industry Conditions" and " -- Operations
Outside the United States");
- business strategy;
- growth opportunities;
- competitive position;
- expected financial position;
- future cash flows;
- future dividends;
- financing plans;
- tax planning (See " -- Overview -- General--Critical Accounting
Estimates -- Income Taxes," " -- Three Months Ended September 30,
2004 and 2003 -- Income Tax (Expense) Benefit" and " -- Nine Months
Ended September 30, 2004 and 2003 -- Income Tax Benefit");
- 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 " -- Overview -- Results of Operations and
Industry Conditions" and "--Capital Resources");
- plans and objectives of management;
- performance of contracts (see " -- Overview -- Results of Operations
and Industry Conditions," " -- Operations Outside the United States"
and " -- Integrated Services");
- outcomes of legal proceedings;
- compliance with applicable laws; and
- adequacy of insurance or indemnification.
Such statements inherently are subject to a variety of risks and
uncertainties that could cause actual results to differ materially from those
expected, projected or expressed in forward-looking statements. Such risks and
uncertainties include, among others, the following:
- general economic and business conditions;
- worldwide demand for oil and natural gas;
- changes in foreign and domestic oil and gas exploration, development
and production activity;
- oil and natural gas price fluctuations and related market
expectations;
- the ability of the Organization of Petroleum Exporting Countries,
commonly called OPEC, to set and maintain production levels and
pricing, and the level of production in non-OPEC countries;
- policies of the various governments regarding exploration and
development of oil and gas reserves;
- advances in exploration and development technology;
- the political environment of oil-producing regions;
- casualty losses;
- operating hazards inherent in drilling for oil and gas offshore;
- industry fleet capacity;
- market conditions in the offshore contract drilling industry,
including dayrates and utilization levels;
- competition;
- changes in foreign, political, social and economic conditions;
- risks of international operations, compliance with foreign laws and
taxation policies and expropriation or nationalization of equipment
and assets;
- risks of potential contractual liabilities pursuant to the Company's
various drilling contracts in effect from time to time;
- foreign exchange and currency fluctuations and regulations, and the
inability to repatriate income or capital;
- risks of war, military operations, other armed hostilities,
terrorist acts and embargoes;
- changes in offshore drilling technology, which could require
significant capital expenditures in order to maintain
competitiveness;
- regulatory initiatives and compliance with governmental regulations;
37
- compliance with environmental laws and regulations;
- customer preferences;
- effects of litigation;
- cost, availability and adequacy of insurance;
- adequacy of the Company's sources of liquidity;
- risks inherent in turnkey operations, including the risk of failure
to complete a well and cost overruns;
- the availability of qualified personnel to operate and service the
Company's drilling rigs; and
- various other matters, many of which are beyond the Company's
control.
The risks included here are not exhaustive. Other sections of this report
and the Company's other filings with the Securities and Exchange Commission
include additional factors that could adversely affect the Company's business,
results of operations and financial performance. Given these risks and
uncertainties, investors should not place undue reliance on forward-looking
statements. Forward-looking statements included in this report speak only as of
the date of this report. The Company expressly disclaims any obligation or
undertaking to release publicly any updates or revisions to any forward-looking
statement to reflect any change in the Company's expectations with regard
thereto or any change in events, conditions or circumstances on which any
forward-looking statement is based.
38
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The information included in this Item 3 is considered to constitute
"forward-looking statements" for purposes of the statutory safe harbor provided
in Section 27A of the Securities Act and Section 21E of the Exchange Act. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Forward-Looking Statements" in Item 2 of Part I of this report.
The Company's measure of market risk exposure represents an estimate of
the change in fair value of its financial instruments. Market risk exposure is
presented for each class of financial instrument held by the Company at
September 30, 2004 and December 31, 2003 assuming immediate adverse market
movements of the magnitude described below. The Company believes that the
various rates of adverse market movements represent a measure of exposure to
loss under hypothetically assumed adverse conditions. The estimated market risk
exposure represents the hypothetical loss to future earnings and does not
represent the maximum possible loss or any expected actual loss, even under
adverse conditions, because actual adverse fluctuations would likely differ. In
addition, since the Company's investment portfolio is subject to change based on
its portfolio management strategy as well as in response to changes in the
market, these estimates are not necessarily indicative of the actual results
which may occur.
Exposure to market risk is managed and monitored by senior management.
Senior management approves the overall investment strategy employed by the
Company and has responsibility to ensure that the investment positions are
consistent with that strategy and the level of risk acceptable to it. The
Company may manage risk by buying or selling instruments or entering into
offsetting positions.
Interest Rate Risk
The Company has exposure to interest rate risk arising from changes in the
level or volatility of interest rates. The Company's investments in marketable
securities are primarily in fixed maturity securities. The Company monitors its
sensitivity to interest rate risk by evaluating the change in the value of its
financial assets and liabilities due to fluctuations in interest rates. The
evaluation is performed by applying an instantaneous change in interest rates by
varying magnitudes on a static balance sheet to determine the effect such a
change in rates would have on the recorded market value of the Company's
investments and the resulting effect on stockholders' equity. The analysis
presents the sensitivity of the market value of the Company's financial
instruments to selected changes in market rates and prices which the Company
believes are reasonably possible over a one-year period.
The sensitivity analysis estimates the change in the market value of the
Company's interest sensitive assets and liabilities that were held on September
30, 2004 and December 31, 2003 due to instantaneous parallel shifts in the yield
curve of 100 basis points, with all other variables held constant.
The interest rates on certain types of assets and liabilities may
fluctuate in advance of changes in market interest rates, while interest rates
on other types may lag behind changes in market rates. Accordingly the analysis
may not be indicative of, is not intended to provide, and does not provide a
precise forecast of the effect of changes of market interest rates on the
Company's earnings or stockholders' equity. Further, the computations do not
contemplate any actions the Company could undertake in response to changes in
interest rates.
The Company's long-term debt as of September 30, 2004 and December 31,
2003 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 $173.8 million
and $150.5 million, respectively. A 100 basis point decrease would result in an
increase in market value of $212.5 million and $186.8 million, respectively.
Foreign Exchange Risk
Foreign exchange risk arises from the possibility that changes in foreign
currency exchange rates will impact the value of financial instruments. During
the quarter ended September 30, 2004, the Company invested in Australian dollar
time deposits and at September 30, 2004 30.0 million Australian dollars
(equivalent to $21.8 million) of time deposits were included in "Investments and
marketable securities" in the Consolidated Balance Sheet. The sensitivity
analysis assumes an instantaneous 20% change in foreign currency exchange rates
versus the U.S. dollar from their levels at September 30, 2004.
39
The following table presents the Company's market risk by category
(interest rates and foreign currency exchange rates):
FAIR VALUE ASSET (LIABILITY) MARKET RISK
-------------------------------------- -----------------------------
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30, DECEMBER 31,
CATEGORY OF RISK EXPOSURE: 2004 2003 2004 2003
- -------------------------------------------- ------------------ ---------------- ------------- ------------
(IN THOUSANDS)
Interest rate: ...........................
Marketable securities..................... $ 647,528 (a) $ 503,995 (a) $ 400 (c) $ 700 (c)
Long-term debt .......................... (1,199,509)(b) (909,100)(b) -- --
Foreign Exchange:
Australian dollar time deposits ......... 21,756 (d) -- 4,400 (d) --
- ----------
(a) The fair market value of the Company's investment in marketable
securities is based on the quoted closing market prices on September 30, 2004
and December 31, 2003.
(b) The fair values of the Company's 5.15% senior notes, 1.5% convertible
senior debentures due 2031 and zero coupon convertible debentures due 2020 are
based on the quoted closing market prices on September 30, 2004 and December 31,
2003. The fair value of the Company's Ocean Alliance lease-leaseback agreement
is based on the present value of estimated future cash flows using a discount
rate of 4.01% for September 30, 2004 and 2.08% for December 31, 2003.
(c) The calculation of estimated market risk exposure is based on assumed
adverse changes in the underlying reference price or index of an increase in
interest rates of 100 basis points at September 30, 2004 and December 31, 2003.
(d) The calculation of estimated foreign exchange risk is based on assumed
adverse changes in the underlying reference price or index of a decrease in
foreign exchange rates of 20% at September 30, 2004.
ITEM 4. CONTROLS AND PROCEDURES.
The Company's management formed a disclosure controls and procedures
committee (the "Disclosure Committee") in 2002. The purpose and responsibility
of the Disclosure Committee is to coordinate and review the process by which
information is recorded, processed, summarized and reported on a timely basis as
required to be disclosed by the Company in its reports filed, furnished or
submitted under the Exchange Act. In addition, the Disclosure Committee is
responsible for ensuring that this information is accumulated and communicated
to the Company's management, including its principal executive officer and
principal financial officer, as appropriate, to allow timely decisions regarding
required disclosure.
Evaluation of Disclosure Controls and Procedures
Based upon their evaluation, as of the end of the period covered by this
report, of the effectiveness of the Company's disclosure controls and procedures
(as defined in Exchange Act Rule 13a-15(e)), the Company's principal executive
officer and principal financial officer concluded that the Company's disclosure
controls and procedures were effective.
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.
40
PART II. OTHER INFORMATION
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
The following table sets forth information regarding the Company's
purchases of shares of its common stock on a monthly basis during the third
quarter of 2004:
ISSUER PURCHASES OF EQUITY SECURITIES
TOTAL NUMBER OF SHARES MAXIMUM NUMBER OF SHARES
TOTAL NUMBER AVERAGE PURCHASED AS PART OF THAT MAY YET BE PURCHASED
OF SHARES PRICE PAID PUBLICLY ANNOUNCED PLANS UNDER THE PLANS
PERIOD PURCHASED PER SHARE OR PROGRAMS OR PROGRAMS
- ------------------------- ------------- ---------- ------------------------ ---------------------------
July 1, 2004 through July
31, 2004 -- -- -- --
August 1, 2004 through
August 31, 2004 782,200 (a) $ 23.11 -- --
September 1, 2004 through
September 30, 2004 -- -- -- --
-------------------------------------------------------------------------------------
TOTAL 782,200 (a) $ 23.11 -- --
=====================================================================================
- ----------
(a) The Company purchased 782,200 shares of its common stock in open-market
transactions in August 2004. None of such shares were purchased pursuant to a
publicly announced share repurchase program. Depending on market conditions, the
Company may, from time to time, purchase shares of its common stock in the open
market or otherwise. Although the Board of Directors of the Company has approved
such purchases, it has not adopted any expiration date or other limitations
regarding such purchases.
ITEM 6. EXHIBITS.
See the Exhibit Index for a list of those exhibits filed or furnished
herewith.
41
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DIAMOND OFFSHORE DRILLING, INC.
(Registrant)
Date: November 8, 2004 By: /s/ Gary T. Krenek
-----------------------------
Gary T. Krenek
Vice President and Chief
Financial Officer
Date: November 8, 2004 /s/ Beth G. Gordon
-----------------------------
Beth G. Gordon
Controller (Chief Accounting
Officer)
42
EXHIBIT INDEX
Exhibit No. Description
- ----------- -----------
3.1 Amended and Restated Certificate of Incorporation of the Company (incorporated by reference to
Exhibit 3.1 to the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2003).
3.2 Amended and Restated By-laws of the Company (incorporated by reference to Exhibit 3.2 to the Company's Quarterly
Report on Form 10-Q for the quarterly period ended March 31, 2001).
4.1 Indenture, dated as of February 4, 1997, between the Company and The Chase Manhattan Bank, as Trustee
(incorporated by reference to Exhibit 4.1 to the Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 2001).
4.2 Fourth Supplemental Indenture, dated as of August 27, 2004, between the Company and JPMorgan Chase Bank, as Trustee
(incorporated by reference to Exhibit 4.2 to the Company's Current Report on Form 8-K dated August 27, 2004).
4.3 Exchange and Registration Rights Agreement, dated August 27, 2004, between the Company and Goldman,
Sachs & Co. (incorporated by reference to Exhibit 4.3 to the Company's Current Report on Form 8-K dated August 27,
2004).
31.1* Rule 13a-14(a) Certification of the Chief Executive Officer.
31.2* Rule 13a-14(a) Certification of the Chief Financial Officer.
32.1* Section 1350 Certification of the Chief Executive Officer.
32.2* Section 1350 Certification of the Chief Financial Officer.
* Filed or furnished herewith.
43