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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 March 31, 2005
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 April 25, 2005 Common stock, $0.01 par value per share 128,579,668
shares
DIAMOND OFFSHORE DRILLING, INC.
TABLE OF CONTENTS FOR FORM 10-Q
QUARTER ENDED MARCH 31, 2005
PAGE NO.
COVER PAGE....................................................................................... 1
TABLE OF CONTENTS................................................................................ 2
PART I. FINANCIAL INFORMATION................................................................... 3
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
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..................................................... 17
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK..................... 30
ITEM 4. CONTROLS AND PROCEDURES ....................................................... 31
PART II. OTHER INFORMATION...................................................................... 31
ITEM 6. EXHIBITS....................................................................... 31
SIGNATURES....................................................................................... 32
EXHIBIT INDEX.................................................................................... 33
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)
MARCH 31, DECEMBER 31,
2005 2004
----------- ------------
(UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents ..................................... $ 242,622 $ 266,007
Investments and marketable securities ......................... 702,262 661,849
Accounts receivable ........................................... 220,221 187,558
Rig inventory and supplies .................................... 47,636 47,590
Prepaid expenses and other .................................... 25,462 32,677
----------- -----------
Total current assets .................................. 1,238,203 1,195,681
DRILLING AND OTHER PROPERTY AND EQUIPMENT, NET OF
ACCUMULATED DEPRECIATION ...................................... 2,129,947 2,154,593
OTHER ASSETS .................................................... 29,420 29,112
----------- -----------
Total assets .......................................... $ 3,397,570 $ 3,379,386
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt ............................. $ 488,215 $ 484,102
Accounts payable .............................................. 30,099 27,530
Accrued liabilities ........................................... 74,226 87,614
Taxes payable ................................................. 8,261 14,661
----------- -----------
Total current liabilities ............................. 600,801 613,907
LONG-TERM DEBT .................................................. 709,425 709,413
DEFERRED TAX LIABILITY .......................................... 380,693 369,722
OTHER LIABILITIES ............................................... 58,788 60,516
----------- -----------
Total liabilities ..................................... 1,749,707 1,753,558
----------- -----------
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,
133,496,468 shares issued and 128,579,668 shares outstanding
at March 31, 2005; 133,483,820 shares issued and 128,567,020
shares outstanding at December 31, 2004) ..................... 1,335 1,335
Additional paid-in capital .................................... 1,264,945 1,264,512
Retained earnings ............................................. 498,465 476,382
Accumulated other comprehensive losses ........................ (2,469) (1,988)
Treasury stock, at cost (4,916,800 shares at March 31, 2005 and
December 31, 2004) ........................................... (114,413) (114,413)
----------- -----------
Total stockholders' equity ............................ 1,647,863 1,625,828
----------- -----------
Total liabilities and stockholders' equity ............ $ 3,397,570 $ 3,379,386
=========== ===========
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
MARCH 31,
---------
2005 2004
---- ----
REVENUES:
Contract drilling...................................... $ 250,022 $177,240
Revenues related to reimbursable expenses.............. 8,736 6,958
---------- --------
Total revenues.................................... 258,758 184,198
---------- --------
OPERATING EXPENSES:
Contract drilling...................................... 148,214 134,678
Reimbursable expenses.................................. 7,335 6,234
Depreciation........................................... 45,472 44,520
General and administrative............................. 9,473 8,789
Loss (gain) on sale of assets.......................... 258 (325)
---------- --------
Total operating expenses.......................... 210,752 193,896
---------- --------
OPERATING INCOME (LOSS)........................................ 48,006 (9,698)
OTHER INCOME (EXPENSE):
Interest income........................................ 5,768 1,568
Interest expense....................................... (9,567) (6,354)
Loss on sale of marketable securities.................. (1,274) (25)
Other, net............................................. 425 (154)
---------- --------
INCOME (LOSS) BEFORE INCOME TAX (EXPENSE) BENEFIT.............. 43,358 (14,663)
INCOME TAX (EXPENSE) BENEFIT................................... (13,240) 3,691
---------- --------
NET INCOME (LOSS).............................................. $ 30,118 $(10,972)
========== ========
INCOME (LOSS) PER SHARE:
BASIC.................................................. $ 0.23 $ (0.08)
========== ========
DILUTED................................................ $ 0.23 $ (0.08)
========== ========
WEIGHTED AVERAGE SHARES OUTSTANDING:
Shares of common stock................................. 128,573 129,322
Dilutive potential shares of common stock.............. 9,557 -
---------- --------
Total weighted average shares outstanding......... 138,130 129,322
========== ========
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)
THREE MONTHS ENDED
MARCH 31,
---------
2005 2004
---- ----
OPERATING ACTIVITIES:
Net income (loss)............................................. $ 30,118 $ (10,972)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation................................................ 45,472 44,520
Loss (gain) on sale and disposition of assets............... 258 (325)
Loss on sale of marketable securities, net.................. 1,274 25
Deferred tax provision...................................... 10,968 (1,731)
Accretion of discounts on marketable securities............. (2,676) (1,022)
Amortization of debt issuance costs......................... 284 267
Amortization of discount on zero coupon convertible
debentures................................................. 4,113 3,972
Changes in operating assets and liabilities:
Accounts receivable......................................... (33,270) 4,677
Rig inventory and supplies and other current assets......... 7,169 2,389
Other assets, non-current................................... (519) 352
Accounts payable and accrued liabilities.................... (10,863) 3,319
Taxes payable............................................... (6,400) (3,219)
Other liabilities, non-current.............................. (1,728) (3,742)
Other items, net............................................ (477) 149
------------ ---------
Net cash provided by operating activities............... 43,723 38,659
------------ ---------
INVESTING ACTIVITIES:
Capital expenditures.......................................... (21,674) (23,470)
Proceeds from sale of assets.................................. 590 576
Proceeds from sale and maturities of marketable securities.... 1,418,003 625,515
Purchases of marketable securities............................ (1,468,651) (623,461)
Proceeds from maturities of Australian dollar time deposits... 11,761 -
Proceeds from settlement of forward contracts................. 46 -
------------ ---------
Net cash used by investing activities................... (59,925) (20,840)
------------ ---------
FINANCING ACTIVITIES:
Payment of dividends.......................................... (8,035) (8,083)
Proceeds from stock options exercised......................... 1,084 -
Debt issue costs - 5.15% senior notes......................... (61) -
------------ ---------
Net cash used by financing activities................... (7,012) (8,083)
------------ ---------
EFFECT OF EXCHANGE RATE CHANGES ON CASH ............................ (171) (112)
------------ ---------
NET CHANGE IN CASH AND CASH EQUIVALENTS............................. (23,385) 9,624
Cash and cash equivalents, beginning of period................ 266,007 106,345
------------ ---------
Cash and cash equivalents, end of period...................... $ 242,622 $ 115,969
============ =========
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 unaudited consolidated financial statements of Diamond Offshore
Drilling, Inc. and subsidiaries, which we refer to as "Diamond Offshore," "we,"
"us" or "our," should be read in conjunction with our Annual Report on Form 10-K
for the year ended December 31, 2004 (File No. 1-13926).
As of April 25, 2005 Loews Corporation, or Loews, owned 54.5% of our
outstanding shares of common stock.
Interim Financial Information
The accompanying unaudited 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.
Our 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 our 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 our 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 our Consolidated Statements of
Operations in "Other income (expense)."
Derivative Financial Instruments
Our derivative financial instruments include forward currency exchange
contracts and a contingent interest provision that is embedded in the 1.5%
Convertible Senior Debentures Due 2031, or the 1.5% Debentures, issued on April
11, 2001. See Note 4.
Supplementary Cash Flow Information
We paid interest on long-term debt totaling $6.6 million for the three
months ended March 31, 2005. We did not make any interest payments on long-term
debt during the same period in 2004.
Our payments of foreign income taxes, net of foreign tax refunds, were
$2.7 million and $0.6 million during the three months ended March 31, 2005 and
2004, respectively. We received refunds of U.S. income taxes during the three
months ended March 31, 2005 and 2004 of $7.7 million and $0.4 million,
respectively.
Capitalized Interest
Interest cost for construction and upgrade of qualifying assets is
capitalized. We did not capitalize any interest cost during the three months
ended March 31, 2005 or 2004.
6
Debt Issuance Costs
Debt issuance costs are included in our Consolidated Balance Sheets in
"Other assets" and are amortized over the respective terms of the related debt.
Treasury Stock
Depending on market conditions, we may, from time to time, purchase shares
of our 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
our Consolidated Balance Sheets. We did not purchase any treasury stock during
the quarters ended March 31, 2005 or 2004.
Comprehensive Income (Loss)
A reconciliation of net income (loss) to comprehensive income (loss) is as
follows:
THREE MONTHS ENDED
MARCH 31,
---------
2005 2004
---- ----
(IN THOUSANDS)
Net income (loss) ............................. $ 30,118 $(10,972)
Other comprehensive gains (losses), net of tax:
Foreign currency translation (loss) gain ... (457) 286
Unrealized holding gain on investments ..... 21 460
Reclassification adjustment for gain
included in net income (loss) ............ (45) (28)
-------- --------
Comprehensive income (loss) ................... $ 29,637 $(10,254)
======== ========
Currency Translation
Our primary functional currency is the U.S. dollar. Certain of our
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
our Consolidated Balance Sheets in "Accumulated other comprehensive losses."
Currency transaction gains and losses are included in our 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.
7
Stock-Based Compensation
Our Amended and Restated 2000 Stock Option Plan is accounted for in
accordance with Accounting Principles Board, or APB, Opinion No. 25, "Accounting
for Stock Issued to Employees." Accordingly, no compensation expense has been
recognized for the options granted to our employees under the plan. If
compensation expense had been recognized for stock options granted to our
employees based on the fair value of the options at the grant dates, valued
using the Binomial Option pricing model, our net income (loss) and earnings
(loss) per share would have been as follows:
THREE MONTHS ENDED
MARCH 31,
---------
2005 2004
---- ----
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net income (loss) as reported ................................ $ 30,118 $ (10,972)
Add: Stock-based employee compensation expense
included in reported net income (loss), net of
related tax effects ....................................... - -
Deduct: Total stock-based employee compensation
expense determined under fair value based method,
net of related tax effects ................................ (311) (311)
---------- ----------
Pro forma net income (loss) .................................. $ 29,807 $ (11,283)
========== ==========
Earnings (loss) per share of common stock:
As reported ............................................... $ 0.23 $ (0.08)
Pro forma ................................................. $ 0.23 $ (0.09)
Earnings (loss) per share of common stock - assuming dilution:
As reported ............................................... $ 0.23 $ (0.08)
Pro forma ................................................. $ 0.22 $ (0.09)
Revenue Recognition
Revenue from our dayrate drilling contracts is recognized as services are
performed. In connection with such drilling contracts, we may receive lump-sum
fees for the mobilization of equipment. These fees are earned as services are
performed over the initial term of the related drilling contracts. We 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 we changed our 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 we 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.
We record reimbursements received for the purchase of supplies, equipment,
personnel services and other services provided at the request of our customers
in accordance with a contract or agreement, for the gross amount billed to the
customer, as "Revenues related to reimbursable expenses" in our Consolidated
Statements of Operations.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amount of revenues and
expenses during the reporting period. Actual results could differ from those
estimated.
8
Reclassifications
Certain amounts applicable to prior periods have been reclassified to
conform to the classifications currently followed. Such reclassifications do not
affect earnings.
Recent Accounting Pronouncements
In December 2004 the Financial Accounting Standards Board revised
Statement of Financial Accounting Standards, or SFAS, No. 123, "Accounting for
Stock-Based Compensation," or SFAS 123 (R). This statement supersedes APB
Opinion No. 25 and its related implementation guidance. This statement requires
that the compensation cost relating to share-based payment transactions be
recognized in financial statements. That cost will be measured based on the fair
value of the equity or liability instruments issued. SFAS 123 (R) was originally
effective as of the first interim or annual reporting period beginning after
June 15, 2005. In April 2005, however, the Securities and Exchange Commission
adopted a rule that defers the required effective date of SFAS 123 (R) for
registrants such as us until the beginning of the first fiscal year beginning
after June 15, 2005. This statement applies to all awards granted after the
required effective date and to awards modified, repurchased or cancelled after
that date, as well as the unvested portion of awards granted prior to the
effective date of SFAS 123 (R). We do not expect adoption of SFAS 123 (R) to
have a material impact on our consolidated results of operations, financial
position or cash flows.
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
MARCH 31,
---------
2005 2004
---- ----
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net income (loss) - basic (numerator): ........ $ 30,118 $ (10,972)
Effect of dilutive potential shares
1.5% Debentures ...................... 1,170 -
Zero Coupon Debentures ............... - -
--------- ---------
Net income (loss) including conversions - diluted
(numerator) ..................................... $ 31,288 $ (10,972)
========= =========
Weighted average shares - basic (denominator): 128,573 129,322
Effect of dilutive potential shares
1.5% Debentures ...................... 9,383 -
Zero Coupon Debentures .............. - -
Stock options ........................ 174 -
--------- ---------
Weighted average shares including conversions-
diluted (denominator) 138,130 129,322
========= =========
Earnings (losses) per share:
Basic ................................ $ 0.23 $ (0.08)
========= =========
Diluted .............................. $ 0.23 $ (0.08)
========= =========
The computation of diluted earnings per share, or EPS, for the quarters
ended March 31, 2005 and 2004 excludes approximately 6.9 million potentially
dilutive shares issuable upon conversion of our Zero Coupon Convertible
Debentures due 2020, or Zero Coupon Debentures. The computation of diluted EPS
for the quarter ended March 31, 2004 also excludes approximately 9.4 million
potentially dilutive shares issuable upon conversion of our 1.5% Debentures. The
inclusion of such shares from the Zero Coupon Debentures in the EPS computations
for the quarters ended March 31, 2005 and 2004 would be antidilutive. The shares
from our 1.5% Debentures were not included in the EPS computation for the
quarter ended March 31, 2004 because there was a net loss for the period.
9
For the quarter ended March 31, 2004, we excluded stock options
representing 338,150 shares of common stock from the computation of diluted EPS
because the options' exercise prices were higher than the average market price
per share of our common stock. We also excluded stock options representing
256,250 shares of our common stock with an average market price in excess of
their exercise prices from the computation of diluted EPS for the quarter ended
March 31, 2004 because potential shares of common stock are not included when a
loss from continuing operations exists.
For the quarter ended March 31, 2005, we did not have any antidilutive
stock options which were excluded from the computation of diluted EPS for the
period.
3. INVESTMENTS AND MARKETABLE SECURITIES
We report investments as current assets in our Consolidated Balance Sheets
in "Investments and marketable securities," representing our investment of cash
available for current operations. At December 31, 2004, "Investments and
marketable securities" also included $11.6 million of time deposits (converted
from 15.0 million Australian dollars) which matured through March 2005. These
securities did not meet the definition of debt securities under SFAS No. 115,
"Accounting for Certain Investments in Debt and Equity Securities," and were
therefore carried at cost, which we determined to approximate fair value.
Our investments in marketable securities are classified as available for
sale and are summarized as follows:
MARCH 31, 2005
--------------
AMORTIZED UNREALIZED MARKET
COST GAIN (LOSS) VALUE
---- ----------- ------
(IN THOUSANDS)
Debt securities issued by the U.S. Treasury
and other U.S. government agencies:
Due within one year .................. $699,387 $ 64 $699,451
Mortgage-backed securities ........... 2,773 38 2,811
-------- -------- --------
Total ................................ $702,160 $ 102 $702,262
======== ======== ========
DECEMBER 31,2004
----------------
AMORTIZED UNREALIZED MARKET
COST GAIN (LOSS) VALUE
---- ----------- ------
(IN THOUSANDS)
Debt securities issued by the U.S. Treasury
and other U.S. government agencies:
Due within one year .................. $498,011 $ 189 $498,200
Due within one year through
five years ......................... 148,877 (119) 148,758
Mortgage-backed securities ........... 3,221 68 3,289
-------- -------- --------
Total ................................ $650,109 $ 138 $650,247
======== ======== ========
At December 31, 2004, we held one investment in marketable securities, a
treasury note purchased on December 15, 2004 ($150 million face value), that was
in an unrealized loss position as a result of interest rate changes. Based on
our ability and intent to hold this investment for a reasonable period of time
sufficient for a recovery of fair value, we did not consider this investment to
be other-than-temporarily impaired at December 31, 2004. We subsequently sold
this treasury note during the quarter ended March 31, 2005 at a $0.5 million
loss.
10
Proceeds from sales and maturities of marketable securities and gross
realized gains and losses are summarized as follows:
THREE MONTHS ENDED
MARCH 31,
---------
2005 2004
---- ----
(IN THOUSANDS)
Proceeds from sales................ $ 1,368,003 $ 515
Proceeds from maturities .......... 50,000 625,000
Gross realized gains .............. 77 -
Gross realized losses ............. (1,351) (25)
4. DERIVATIVE FINANCIAL INSTRUMENTS
Forward Currency Exchange Contracts
Our international operations expose us to foreign exchange risk, primarily
associated with our costs payable in foreign currencies for employee
compensation and for purchases from foreign suppliers. When possible, we utilize
a technique for minimizing our foreign exchange risk by 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
our 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, we may use a foreign exchange
forward contract to minimize the forward exchange risk. A forward currency
exchange contract obligates a contract holder to exchange predetermined amounts
of specified foreign currencies at specified foreign exchange rates on specified
dates.
In February 2005, we entered into forward currency exchange contracts
requiring us to purchase the equivalent of approximately $3.0 million in Mexican
pesos monthly, beginning in March 2005 through May 2005. Our first forward
exchange contract was settled in February 2005, resulting in approximately a
$46,000 gain. These forward contracts are derivatives as defined by SFAS No.
133, "Accounting for Derivatives and Hedging Activities," or SFAS 133. SFAS 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 133 further provides specific criteria
necessary for a derivative to qualify for hedge accounting. The forward
contracts entered into in 2005 did not qualify for hedge accounting. We recorded
a pre-tax gain of $0.1 million in our Consolidated Statement of Operations for
the quarter ended March 31, 2005 in "Other income (expense)" to adjust the
carrying value of these derivative financial instruments to their fair value.
Contingent Interest
Our 1.5% Debentures, of which an aggregate principal amount of $460.0
million are outstanding, contain a contingent interest provision. The contingent
interest component is an embedded derivative as defined by SFAS 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, 2004 or at March 31, 2005.
11
5. DRILLING AND OTHER PROPERTY AND EQUIPMENT
Cost and accumulated depreciation of drilling and other property and
equipment are summarized as follows:
MARCH 31, DECEMBER 31,
2005 2004
---- ----
(IN THOUSANDS)
Drilling rigs and equipment ........................ $ 3,545,648 $ 3,529,593
Construction work-in-progress ...................... 4,045 -
Land and buildings ................................. 15,978 15,770
Office equipment and other ......................... 23,413 22,895
----------- -----------
Cost ........................................... 3,589,084 3,568,258
Less: accumulated depreciation ..................... (1,459,137) (1,413,665)
----------- -----------
Drilling and other property and equipment,
net ......................................... $ 2,129,947 $ 2,154,593
=========== ===========
Construction work-in-progress at March 31, 2005 consisted of costs related
to the major upgrade of the Ocean Endeavor to ultra-deepwater service, which we
expect to be completed in approximately two years.
6. GOODWILL
Goodwill from the merger with Arethusa (Off-Shore) Limited, or Arethusa,
in 1996 was generated from an excess of the purchase price over the net assets
acquired.
During the quarter ended March 31, 2004, an adjustment of $3.4 million was
recorded to reduce goodwill for tax benefits not previously recognized for the
excess of tax deductible goodwill over book goodwill. Our goodwill balance was
zero at March 31, 2005 and December 31, 2004.
7. ACCRUED LIABILITIES
Accrued liabilities consist of the following:
MARCH 31, DECEMBER 31,
2005 2004
---- ----
(IN THOUSANDS)
Payroll and benefits .............. $27,990 $26,221
Personal injury and other claims... 8,400 8,076
Interest payable .................. 4,530 5,938
Deferred revenue .................. 3,954 6,514
Accrued project expenses .......... 5,264 14,920
Other ............................. 24,088 25,945
------- -------
Total ................... $74,226 $87,614
======= =======
12
8. LONG-TERM DEBT
The holders of our Zero Coupon Debentures have the right to require us to
repurchase the debentures on June 6, 2005, June 6, 2010 and June 6, 2015 at
their accreted value through the date of repurchase. We may pay such repurchase
price with either cash or shares of our common stock or a combination thereof.
As of March 31, 2005 the aggregate accreted value of the outstanding Zero Coupon
Debentures was $475.4 million. Because the holders of these debentures have the
right to require us to repurchase the debentures in 2005, the aggregate accreted
value is classified as a current liability in our Consolidated Balance Sheet at
March 31, 2005.
On June 6, 2005, the aggregate accreted value of the Zero Coupon Debentures
currently outstanding will be approximately $478 million.
9. COMMITMENTS AND CONTINGENCIES
Various claims have been filed against us in the ordinary course of
business, including claims by offshore workers alleging personal injuries.
Management believes that we have established adequate reserves for any
liabilities that may reasonably be expected to result from these claims. In the
opinion of our management, no pending or threatened claims, actions or
proceedings against us are expected to have a material adverse effect on our
consolidated financial position, results of operations or cash flows.
Litigation. In January 2005, we were notified that we had been named as a
defendant in a lawsuit filed in the U.S. District Court for the Eastern District
of Louisiana on behalf of Total E&P USA, Inc. and several oil companies alleging
that the Ocean America had damaged a natural gas pipeline in the Gulf of Mexico
during Hurricane Ivan in September 2004. The lawsuit alleges that on or about
September 15, 2004 the Ocean America broke free from its moorings and, as the
rig drifted, its anchor, wire cable and other parts struck and damaged various
components of the Canyon Express Common System curtailing its supply of natural
gas to, and preventing production from, several fields. The plaintiffs seek
damages from us including, but not limited to, loss of revenue, that are
currently estimated to be in excess of $100 million, together with interest,
attorneys fees and costs. The lawsuit has been filed but has not been formally
served on us. We do not believe that ultimate liability, if any, resulting from
this litigation will have a material adverse effect on our financial condition,
results of operations or cash flows. In addition, we have given notice to our
insurance underwriters that a potential loss may exist with respect to this
incident. Our deductible for this type of loss is $2 million.
During the third quarter of 2004, we were notified that some of our
subsidiaries had been named, along with other defendants, in several complaints
that had 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 named as
defendants over 25 other companies that are not affiliated with us. The
complaints alleged that the defendants manufactured, distributed or utilized
drilling mud containing asbestos and, in our case 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. To date, we have been served with 29 complaints, of which 13
complaints were filed against Arethusa Off-Shore Company and 16 complaints were
filed against Diamond Offshore (USA), Inc. (now known as Diamond Offshore (USA)
L.L.C. and formerly known as Odeco Drilling, Inc.). We recently filed motions to
dismiss each of these cases based upon a number of legal grounds, including
naming improper parties. In April 2005 the plaintiffs agreed to dismiss, with
prejudice, all 13 complaints filed against Arethusa Off-Shore Company after we
demonstrated that the claims could not be maintained against us or any of our
subsidiaries. In addition, we expect to receive complete defense and indemnity
for the remaining 16 complaints from Murphy Exploration & Production Company
pursuant to the terms of our 1992 asset purchase agreement with them.
Accordingly, we are unable to estimate our potential exposure, if any, to these
lawsuits at this time but do not believe that ultimate liability, if any,
resulting from this litigation will have a material adverse effect on our
financial condition, results of operations or cash flows.
Various other claims have been filed against us in the ordinary course of
business. In the opinion of our management, no pending or known threatened
claims, actions or proceedings against us are expected to have a material
adverse effect on our consolidated financial position, results of operations or
cash flows.
Other. Our operations in Brazil have exposed us to various claims and
assessments related to our personnel, customs duties and municipal taxes, among
other things, that have arisen in the ordinary course of business. In accordance
with SFAS No. 5, "Accounting for Contingencies," we have assessed each claim or
exposure to
13
determine the likelihood that the resolution of the matter might ultimately
result in an adverse effect on our financial condition, results of operations or
cash flows. When we determine that an unfavorable resolution of a matter is
probable and such amount of loss can be determined, we record a reserve for the
estimated loss at the time that both of these criteria are met. At March 31,
2005, our loss reserves related to our Brazilian operations aggregated $13.0
million, of which $0.7 million and $12.3 million were recorded in "Accrued
liabilities" and "Other liabilities," respectively, in our Consolidated Balance
Sheets. Loss reserves related to our Brazilian operations totaled $13.0 million
at December 31, 2004, of which $0.9 million was recorded in "Accrued
liabilities" and $12.1 million was recorded in "Other liabilities" in our
Consolidated Balance Sheets.
We intend to defend these matters vigorously; however, we cannot predict
with certainty the outcome or effect of any litigation matters specifically
described above or any other pending litigation or claims. There can be no
assurance as to the ultimate outcome of these lawsuits.
Personal Injury Claims. Our 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. Our in-house claims department estimates the amount of our
liability for our retention. This department establishes a reserve for each of
our 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. Our claims department also
estimates our liability for claims that are incurred but not reported by using
historical data. Historically, our ultimate liability for personal injury claims
has not differed materially from our recorded estimates. At March 31, 2005, our
estimated liability for personal injury claims was $34.6 million, of which $8.4
million and $26.2 million were recorded in "Accrued liabilities" and "Other
liabilities," respectively, in our Consolidated Balance Sheets. At December 31,
2004, we had recorded loss reserves for personal injury claims aggregating $33.4
million, of which $8.0 million and $25.4 million were recorded in "Accrued
liabilities" and "Other liabilities," respectively, in our Consolidated Balance
Sheets. The eventual settlement or adjudication of these claims could differ
materially from our estimated amounts due to uncertainties such as:
- the severity of personal injuries claimed,
- significant changes in the volume of personal injury claims,
- the unpredictability of legal jurisdictions where the claims will
ultimately be litigated,
- inconsistent court decisions and
- the risks and lack of predictability inherent in personal injury
litigation.
14
10. SEGMENTS AND GEOGRAPHIC AREA ANALYSIS
We report our operations as one reportable segment, contract drilling of
offshore oil and gas wells. Although we provide 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 for such services.
Contract Drilling Services
Revenues from customers for contract drilling and similar services by
equipment-type are listed below:
THREE MONTHS ENDED
MARCH 31,
------------------------
2005 2004
--------- ----------
(IN THOUSANDS)
High Specification Floaters....................... $ 94,111 $ 64,752
Other Semisubmersibles............................ 94,981 71,135
Jack-ups.......................................... 60,704 40,819
Other............................................. 226 534
--------- ----------
Total Contract Drilling Revenues............... 250,022 177,240
Revenues Related to Reimbursable Expenses......... 8,736 6,958
--------- ----------
Total revenues............................ $ 258,758 $ 184,198
========= ==========
Geographic Areas
At March 31, 2005 our drilling rigs were located offshore 11 countries
other than the United States. As a result, we are exposed to the risk of changes
in social, political, economic and other conditions inherent in foreign
operations and our results of operations and the value of our 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
MARCH 31,
------------------------
2005 2004
--------- ----------
(IN THOUSANDS)
United States..................... $ 131,291 $ 77,710
Foreign:
South America.................. 27,569 31,480
Europe/Africa.................. 18,274 13,899
Australia/Asia................. 60,570 39,736
Mexico......................... 21,054 21,373
--------- ----------
Total revenues............ $ 258,758 $ 184,198
========= ==========
11. INCOME TAXES
Income tax (expense) benefit is a function of the mix between our domestic
and international pre-tax earnings (losses), as well as the mix of international
tax jurisdictions in which we operate. Income tax expense of $13.2 million was
recognized on pre-tax income of $43.4 million for the three months ended March
31, 2005 compared to an income tax benefit of $3.7 million on a pre-tax loss of
$14.7 million for the comparable period in 2004.
Certain of our international rigs are owned and operated, directly or
indirectly, by Diamond Offshore International Limited, a Cayman Island
corporation which is one of our wholly owned subsidiaries. Earnings from this
subsidiary are reinvested internationally and remittance to the U.S. is
indefinitely postponed. Consequently, no
15
U.S tax expense or benefit was recognized on these earnings or losses during
2005 and 2004. Our estimated annual effective rate was 28.0% as of March 31,
2005 and 25.2% as of March 31, 2004.
Tax expense for the three months ended March 31, 2005 also included $0.2
million related to a settlement of a tax dispute in East Timor and a $0.9
million adjustment related to finalizing prior year tax returns in the U.K. This
additional expense is not included in the current year estimated annual
effective tax rate of 28.0%.
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:
MARCH 31,
--------------
2005 2004
----- -----
(IN THOUSANDS)
Interest cost............................. $ 260 $ 255
Expected return on plan assets............ (316) (297)
Amortization of unrecognized loss......... 76 77
----- -----
Net periodic pension expense.............. $ 20 $ 35
===== =====
During 2004 we made a voluntary contribution to the plan of $0.2 million.
We do not expect to make a contribution to our pension plan in 2005.
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following discussion should be read in conjunction with our unaudited
Consolidated Financial Statements (including the Notes thereto) included
elsewhere in this report. References to "Diamond Offshore," "we," "us" or "our"
mean Diamond Offshore Drilling, Inc., a Delaware corporation, and its
subsidiaries.
We are a leader in deep water drilling with a fleet of 45 offshore
drilling rigs. Our fleet consists of 30 semisubmersibles, 14 jack-ups and one
drillship.
OVERVIEW
RESULTS OF OPERATIONS AND INDUSTRY CONDITIONS
The overall market for our mid and deepwater semisubmersible rigs
continues to reflect the steady improvement that began in the third quarter of
2004. Solid demand for all classes of offshore drilling rigs in the face of
tight supply is continuing to lift dayrates around the world.
Gulf of Mexico. In the U.S. Gulf of Mexico, or GOM, the most recent
commitments for our deepwater (high-specification) floaters have reached as high
as $172,500 per day for the Ocean Star for work beginning in the third quarter
of 2005 and extending into the third quarter of 2006. This contrasts with an
average dayrate of $60,000 that the Ocean Star was earning in the third quarter
of 2004. All six of our deepwater semisubmersible rigs are currently contracted
with backlog extending at least until the third quarter of 2005 at improving
dayrates. In addition, the most recent commitments for our four mid-water
semisubmersibles operating in the U.S. GOM have reached as high as $125,000 per
day for both the Ocean Voyager and the Ocean Concord for work beginning in the
third quarter of 2005. The Ocean Voyager was cold-stacked during most of the
third quarter of 2004, while the Ocean Concord was in a shipyard for inspections
and related repairs. Backlog is also building in this market at improving
dayrates. In addition, in February 2005 we signed an agreement under which the
Ocean Baroness, one of our deepwater rigs, will begin mobilizing to the U.S.
GOM from Indonesia for a term of one year at a dayrate of $200,000. The term of
work is expected to begin early in the fourth quarter of 2005. We continue to
view the deepwater and mid-water markets in the U.S. GOM as under-supplied, and
believe that additional improvement in utilization, backlog and dayrates is
likely in these market segments during 2005.
Our jack-up fleet in the U.S. GOM also continued to experience high
utilization and improving dayrates during the first quarter of 2005. We view the
jack-up market in the U.S. GOM as under-supplied, with effective utilization
near 100 percent and demand exceeding supply. As a result, we believe the market
and dayrates for this class of equipment could improve further during 2005.
In the Mexican GOM, our four semisubmersible rigs remain under long-term
contracts that extend into late 2006 and early 2007. We view the market for the
Mexican GOM as in balance and expect it to remain so this year.
Brazil. All four of our rigs operating in Brazil have contracts that
expire late in 2005 or early in 2006. These units were contracted prior to the
mid-year 2004 market improvement, and we are currently involved in negotiations
to obtain new contracts for all four rigs that reflect current market
conditions. We view the Brazilian semisubmersible market as improving and expect
that trend to continue during 2005.
North Sea. Drilling activity in both the U.K. and Norwegian sectors of the
North Sea has mirrored that in the U.S. GOM since mid-2004. Effective
utilization remains near 100 percent. All four of our rigs operating in the
North Sea have term contracts extending at least through 2005. We believe this
market will remain firm throughout the balance of 2005 with higher dayrates
likely.
Australia/Asia. We currently have seven semisubmersible rigs and one
jack-up rig operating in the Australian/Asian market under contracts or
commitments for work extending at least into mid-2005 at favorable and
increasing dayrates. One of our jack-up units, Ocean Heritage, is mobilizing
from India to Qatar where the unit will operate under an approximately
seven-month agreement at a dayrate of $71,000. We view demand in the
Australian/Asian market as increasing, which we expect to result in higher
utilization and dayrates.
17
GENERAL
Revenues. Our 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, we may mobilize our rigs from one market to another. However, during
periods of mobilization, revenues may be adversely affected. As a response to
changes in demand, we 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 our control
and are difficult to predict with any degree of specificity beyond broad market
trends.
Revenue from dayrate drilling contracts is recognized as services are
performed. In connection with such drilling contracts, we may receive lump-sum
fees for the mobilization of equipment. These fees are earned as services are
performed over the initial term of the related drilling contracts. We 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 we changed our 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 we 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.
We record reimbursements received for the purchase of supplies, equipment,
personnel services and other services provided at the request of our customers
in accordance with a contract or agreement, for the gross amount billed to the
customer, as "Revenues related to reimbursable expenses" in our Consolidated
Statements of Operations.
Operating Income. Operating income is primarily affected by revenue
factors, but is also a function of varying levels of operating expenses.
Operating expenses generally are not affected by changes in dayrates and may not
be significantly affected by fluctuations in utilization. For instance, if a rig
is to be idle for a short period of time, 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, we are
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, we 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. We recognize, as
incurred, operating expenses such as inspections, painting projects and routine
overhauls that meet certain criteria and which maintain rather than upgrade our
rigs. These expenses vary from period to period. Costs of rig enhancements are
capitalized and depreciated over the expected useful lives of the enhancements.
Higher depreciation expense decreases operating income in periods subsequent to
capital upgrades.
Operating income is negatively impacted when we perform certain regulatory
inspections, which we refer to as a 5-year survey, that are due every five years
for all of our 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
Our significant accounting policies are included in Note 1 of our Notes to
Unaudited Consolidated Financial Statements in Item 1 of this report.
Management's judgments, assumptions and estimates are inherent in the
preparation of our financial statements and the application of its significant
accounting policies. We believe that our most critical accounting estimates are
as follows:
18
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. Our
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.
We evaluate our property and equipment for impairment whenever changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. We utilize a probability-weighted cash flow analysis in testing an
asset for potential impairment. The assumptions and estimates underlying this
analysis include:
- dayrate by rig,
- utilization rate by rig (expressed as the actual percentage of time
per year that the rig would be used),
- the per day operating cost for each rig if active, ready stacked or
cold stacked and
- salvage value for each rig.
Based on these assumptions and estimates a matrix is developed assigning
probabilities to various combinations of assumed utilization rates and dayrates.
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) is also considered as
part of this analysis.
At March 31, 2005, there were no changes in circumstances that indicated
that the carrying value of our property and equipment, primarily drilling
equipment, may not be recoverable.
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. Our 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. Our in-house claims department estimates the amount of our
liability for our retention. This department establishes a reserve for each
personal injury claim by evaluating the existing facts and circumstances and
comparing the circumstances of each claim to historical experiences with similar
past personal injury claims. Our claims department also estimates our liability
for claims which are incurred but not reported by using historical data.
Historically, our ultimate liability for personal injury claims has not differed
materially from our recorded estimates. At March 31, 2005, our estimated
liability for personal injury claims was $34.6 million. The eventual settlement
or adjudication of these claims could differ materially from the estimated
amounts due to uncertainties such as:
- the severity of personal injuries claimed,
- significant changes in the volume of personal injury claims,
- the unpredictability of legal jurisdictions where the claims will
ultimately be litigated,
- inconsistent court decisions and
- the risks and lack of predictability inherent in personal injury
litigation.
Income Taxes. We account for income taxes in accordance with Statement of
Financial Accounting Standards, or SFAS, 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 our financial statements or tax returns.
In each of our tax jurisdictions we recognize 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, we
estimate our annual effective tax rate by forecasting our annual income before
income tax, taxable income and tax expense in each of our tax jurisdictions. We
make judgments regarding future events and related estimates especially as they
pertain to forecasting of our 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.
19
Certain of our foreign tax credit carryforwards are scheduled to expire in
2011. Although we intend 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 we determined that
a valuation allowance was necessary. At March 31, 2005, our valuation allowance
related to the potential realization of deferred tax assets was $10.3 million.
THREE MONTHS ENDED MARCH 31, 2005 AND 2004
Comparative data relating to our revenues and operating expenses by
equipment type are listed below. Certain amounts applicable to the prior period
have been reclassified to conform to the classifications currently followed.
Such reclassifications do not affect earnings.
THREE MONTHS ENDED
MARCH 31,
----------------------- FAVORABLE/
2005 2004 (UNFAVORABLE)
--------- --------- -------------
(In thousands)
CONTRACT DRILLING REVENUE
High Specification Floaters................. $ 94,111 $ 64,752 $ 29,359
Other Semisubmersibles...................... 94,981 71,135 23,846
Jack-ups.................................... 60,704 40,819 19,885
Other....................................... 226 534 (308)
--------- --------- -------------
TOTAL CONTRACT DRILLING REVENUE............. $ 250,022 $ 177,240 $ 72,782
========= ========= =============
REVENUES RELATED TO REIMBURSABLE EXPENSES... $ 8,736 $ 6,958 $ 1,778
CONTRACT DRILLING EXPENSE
High Specification Floaters................. $ 44,034 $ 42,470 $ (1,564)
Other Semisubmersibles...................... 75,093 62,992 (12,101)
Jack-ups.................................... 27,906 27,937 31
Other....................................... 1,181 1,279 98
--------- --------- -------------
TOTAL CONTRACT DRILLING EXPENSE............. $ 148,214 $ 134,678 $ (13,536)
========= ========= =============
REIMBURSABLE EXPENSES....................... $ 7,335 $ 6,234 $ (1,101)
OPERATING INCOME (LOSS)
High Specification Floaters................. $ 50,077 $ 22,282 $ 27,795
Other Semisubmersibles...................... 19,888 8,143 11,745
Jack-ups.................................... 32,798 12,882 19,916
Other....................................... (955) (745) (210)
Reimbursable expenses, net.................. 1,401 724 677
Depreciation................................ (45,472) (44,520) (952)
General and administrative expense.......... (9,473) (8,789) (684)
(Loss) gain on sale of assets............... (258) 325 (583)
--------- --------- -------------
TOTAL OPERATING INCOME (LOSS)............... $ 48,006 $ (9,698) $ 57,704
========= ========= =============
High Specification Floaters.
Revenues. Revenues from our high specification floaters (deepwater
semisubmersibles) increased $29.4 million during the quarter ended March 31,
2005 compared to the same period in 2004.
The average operating dayrate for our rigs in this category rose to
$108,500 during the first quarter of 2005 from $92,600 during the first quarter
of 2004, which generated an additional $14.3 million in revenue in the first
three months of 2005 compared to the same period in 2004. All but two of our
higher specification floaters operated under contracts with higher average
dayrates during the first quarter of 2005, as compared to the first quarter of
2004, as a result of the improving deepwater market. Average dayrates for four
of these rigs in 2005 increased 30% or more over average dayrates earned during
the first quarter of 2004.
20
In addition, utilization for our deepwater fleet improved to 96% during
the first quarter of 2005 from 77% during the same period in 2004, which
generated $15.1 million in additional revenues in the first quarter of 2005.
Utilization improved in the first quarter of 2005 compared to the same quarter
of 2004 for:
- the Ocean Star, which was ready-stacked on location for nearly all
of the first quarter of 2004;
- the Ocean Confidence, which had approximately three weeks of unpaid
downtime for repairs during the first quarter of 2004;
- the Ocean America, which entered a shipyard in March 2004 to begin a
5-year survey and upgrade;
- the Ocean Alliance, which was in a shipyard for approximately one
month during the first quarter of 2004 for a 5-year survey; and
- the Ocean Quest, which was ready-stacked approximately one month
during the first quarter of 2004.
All of these rigs operated under contract for all or most of the first
quarter of 2005.
Contract Drilling Expense. Contract drilling expense for deepwater
semisubmersibles increased $1.6 million for the quarter ended March 31, 2005
compared to the same period in 2004 primarily due to:
- rental of anchor chain for the Ocean America to replace owned
equipment that was lost during Hurricane Ivan in the third quarter
of 2004;
- higher normal operating expenses for the Ocean Alliance, which was
working the majority of the first quarter of 2005 compared to being
in a shipyard during the same period of 2004; and
- higher routine maintenance and repair costs for the Ocean Clipper
and the Ocean Quest during the first quarter of 2005.
Partially offsetting the higher contract drilling expenses were lower
inspection and other related expenses for the Ocean Alliance and the Ocean
America and lower non-reimbursable fuel charges for the Ocean Alliance during
the first three months of 2005.
Other Semisubmersibles.
Revenues. Revenues generated by our other (or mid-water) semisubmersibles
for the quarter ended March 31, 2005 increased $23.8 million compared to the
same period in 2004.
Utilization for our rigs in the mid-water market improved for the first
quarter of 2005, compared to the same period in 2004, resulting in an additional
$11.7 million in revenue. Average utilization increased from 73% for the first
quarter of 2004 to 83% (excluding the Ocean Liberator, which is being marketed
for sale, and the Ocean Endeavor, which is undergoing a major upgrade) for the
first quarter of 2005. Utilization improved for:
- the Ocean Voyager, which was cold-stacked the entire first quarter
of 2004;
- the Ocean Patriot, which worked only one month during the first
quarter of 2004;
- the Ocean Concord and the Ocean Winner, each of which spent part of
the first quarter of 2004 in a shipyard for 5-year surveys; and
- the Ocean Vanguard, which was ready-stacked the entire first quarter
of 2004.
Excluding the Ocean Vanguard, each of these rigs worked all or most of the
first quarter of 2005. The Ocean Vanguard was undergoing repairs for all but 12
days in the first quarter of 2005.
The overall improvement in utilization was partially offset by the Ocean
Epoch, which mobilized to a shipyard in Singapore for inspections and to prepare
for an upcoming contract during the first quarter of 2005. This drilling unit
operated throughout the same period in 2004.
21
Average dayrates for our fleet of mid-water semisubmersibles increased
from $55,200 in the first quarter of 2004 to $64,900 in the first quarter of
2005, in response to the improving mid-water market. Contracts in 2005 for many
of our rigs operating in both the first quarter of 2005 and 2004 were
renegotiated or initiated at higher rates than those previously contracted for
in 2004. This favorable trend in average dayrates resulted in $11.2 million in
additional revenues in the first three months of 2005, as compared to the same
period in 2004.
Additionally, in the first quarter of 2005 we amortized $2.1 million in
deferred mobilization fees received for the Ocean Patriot's 2004 mobilization
from South Africa to New Zealand and the Bass Strait.
Contract Drilling Expense. Contract drilling expense for our mid-water
semisubmersibles increased $12.1 million during the first quarter of 2005
compared to the same period in 2004 primarily due to:
- normal operating costs for the Ocean Vanguard and the Ocean Voyager
during the first quarter of 2005, as compared to reduced costs
during the comparable period of 2004 when the Ocean Vanguard was
ready-stacked in the U.K. and the Ocean Voyager was cold-stacked in
the U.S. GOM until the fourth quarter of 2004;
- amortization of $2.1 million in deferred mobilization costs for the
Ocean Patriot during the first quarter of 2005;
- inspection costs for the Ocean Epoch during the first three months
of 2005 in addition to normal operating expenses; and
- higher labor costs for the Ocean Nomad, the Ocean Guardian and the
Ocean Princess associated with mandated labor benefits legislated in
the U.K. and the effect of the U.S. dollar weakening against the
British pound sterling during the first quarter of 2005, as compared
to the same period in 2004.
Partially offsetting these higher expenses were lower comparative expenses
during the first quarter of 2005 for:
- additional mobilization and 5-year survey costs for the Ocean
Concord during the first quarter of 2004, compared to normal
operating costs incurred during the first quarter of 2005; and
- the Ocean Nomad, which incurred additional costs to mobilize from
the U.K. to South Africa in mid-January 2004, as compared to normal
operating costs during the same period of 2005.
Jack-Ups.
Revenues. Revenues for our jack-up fleet increased $19.9 million during
the first quarter of 2005 compared to the same quarter in 2004.
Improvements in average operating dayrates contributed $12.1 million to
the overall revenue increase as average operating dayrates rose from $36,000
during the first quarter of 2004 to $47,900 during the same period of 2005. All
of our operating jack-up rigs experienced an increase in average operating
dayrate reflecting the continuing improvement in the jack-up market.
Additionally, we recognized $2.6 million in deferred mobilization revenue
during the first quarter of 2005 related to the mobilizations of:
- the Ocean Sovereign from Singapore to Bangladesh and
- the Ocean Heritage to India in the latter part of 2004.
In response to the improvement in the jack-up market, utilization for our
jack-up fleet rose to 96% for the first quarter of 2005, as compared to 85% for
the comparable period in 2004, generating an additional $5.6 million in revenue
in the first quarter of 2005 compared to the first quarter of 2004. The
improvement in utilization for the first quarter of 2005 is primarily the result
of the reactivation from cold-stack status of the Ocean Champion in the third
quarter of 2004 and operation of the Ocean Columbia, Ocean Nugget and Ocean
Titan, which were in shipyards for all or part of the first quarter of 2004 for
inspections and related repairs and a cantilever upgrade in the case of the
Ocean Titan. These favorable utilization trends in 2005 were partly offset by
lower utilization for the Ocean Warwick, which was in a shipyard for hurricane
repairs during January 2005.
22
Contract Drilling Expense. Contract drilling expense for our jack-up fleet
for the first quarter of 2005 was consistent with operating costs incurred
during the same period in 2004. Lower reactivation and inspection costs in the
first quarter of 2005, as compared to the same period in 2004, were mostly
offset by higher labor costs as a result of the reactivation of the Ocean
Champion in the third quarter of 2004 and, to a lesser extent, a December 2004
wage increase for all rig-based personnel, as well as higher supply and
maintenance costs resulting from the continued high utilization of our fleet in
this market. We also incurred mobilization costs in the first quarter of 2004 to
relocate the Ocean Heritage from a shipyard in Singapore to Ecuador where it
operated under contract until late August 2004.
Reimbursable expenses, net.
Revenues related to reimbursable items, offset by the related expenditures
for these items, were $1.4 million and $0.7 million for the quarters ended March
31, 2005 and 2004, respectively. Reimbursable expenses include items that we
purchase, and/or services we perform, at the request of our customers. We charge
our customers for purchases and/or services performed on their behalf at cost,
plus a mark-up where applicable. Therefore, net reimbursables fluctuate based on
customer requirements, which vary.
Depreciation.
Depreciation expense increased $1.0 million to $45.5 million in the first
quarter of 2005 compared to $44.5 million in the first quarter of 2004 primarily
due to depreciation associated with capital additions in 2004 and the first
quarter of 2005, partially offset by lower depreciation for the Ocean Liberator,
which we removed from our actively-marketed fleet in December of 2004 and are
marketing for sale.
General and Administrative Expense.
General and administrative expense for the quarter ended March 31, 2005 of
$9.5 million increased from $8.8 million for the same period in 2004. This
increase was primarily due to higher payroll costs, engineering consulting fees,
higher external audit fees and other costs related to compliance with the
Sarbanes-Oxley Act of 2002.
Interest Income.
We earned interest income of $5.8 million during the first quarter of 2005
compared to interest income of $1.6 million in the same period of 2004. The $4.2
million increase in interest income is primarily the result of higher interest
rates earned on cash and marketable securities in the first three months of 2005
compared to the same period in 2004, as well as the inclusion of interest earned
on higher cash and investment balances in 2005, as compared to 2004, reflecting
an increase in cash available for investments related to the issuance of $250
million principal amount of our 5.15% Senior Notes Due September 1, 2014, or the
5.15% Senior Notes, in August 2004.
Interest Expense.
Interest expense of $9.6 million during the first quarter of 2005 was $3.2
million higher than interest expense of $6.4 million in the same period in 2004
primarily from interest expense on our 5.15% Senior Notes.
Loss on Sale of Marketable Securities.
Sales of marketable securities in the first quarter of 2005 resulted in
net losses of $1.3 million compared to a loss of $25,000 for the same period in
2004. See Note 3, "Marketable Securities," in Item 1 of this report.
Income Tax (Expense) Benefit.
Income tax (expense) benefit is a function of the mix between our domestic
and international pre-tax earnings (losses), as well as the mix of international
tax jurisdictions in which we operate. Income tax expense of $13.2 million was
recognized on pre-tax income of $43.4 million for the three months ended March
31, 2005 compared to an income tax benefit of $3.7 million on a pre-tax loss of
$14.7 million for the comparable period in 2004.
Certain of our international rigs are owned and operated, directly or
indirectly, by Diamond Offshore International Limited, a Cayman Island
corporation which is one of our wholly owned subsidiaries. Earnings from this
subsidiary are reinvested internationally and remittance to the U.S. is
indefinitely postponed. Consequently, no
23
U.S. tax expense or benefits were recognized on these earnings or losses during
2005 and 2004. Our estimated annual effective rate was 28.0% as of March 31,
2005 and 25.2% as of March 31, 2004.
Tax expense for the three months ended March 31, 2005 also included $0.2
million related to a settlement of a tax dispute in East Timor and a $0.9
million adjustment related to finalizing prior year tax returns in the U.K. This
additional expense is not included in the current year estimated annual
effective tax rate of 28.0%.
OPERATIONS OUTSIDE THE UNITED STATES
Our 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 our non-U.S. operations or the international
offshore contract drilling industry. Our 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.
We operate four of our semisubmersible rigs offshore Mexico for
Pemex-Exploracion y Produccion, the national oil company of Mexico. The terms of
these contracts expose us to greater risks than we normally assume, such as
exposure to greater environmental liability. While we believe that the financial
terms of the contracts and our operating safeguards in place mitigate these
risks, there can be no assurance that our increased risk exposure will not have
a negative impact on our future operations or financial results.
SOURCES OF LIQUIDITY AND CAPITAL RESOURCES
Our principal sources of liquidity and capital resources are our cash
flows from operations, proceeds from the issuance of debt securities and other
borrowings and our cash reserves. At March 31, 2005 we had $242.6 million in
"Cash and cash equivalents" and $702.3 million in "Investments and marketable
securities," representing our investment of cash available for current
operations.
Cash Flows from Operations. We operate in an industry that has been, and
is expected to continue to be, extremely competitive and highly cyclical. Our
cash flows from operations are a function of the dayrates we receive for our
drilling rigs, as well as the utilization of these rigs. These factors are not
within our control and are difficult to predict with any degree of specificity.
For a description of other factors that could affect our cash flows from
operations, see "- Overview - Results of Operations and Industry Conditions" and
" - Forward-Looking Statements."
Shelf Registration. We have the ability to issue an aggregate of
approximately $117.5 million in debt, equity and other securities under a shelf
registration statement. In addition, we may issue, from time to time, up to
eight million shares of common stock, shares which are registered under an
acquisition shelf registration statement (upon effectiveness of an amendment
thereto reflecting the effect of the two-for-one stock split declared in July
1997), in connection with one or more acquisitions by us of securities or assets
of other businesses.
LIQUIDITY AND CAPITAL REQUIREMENTS
Our liquidity and capital requirements are primarily a function of our
working capital needs, capital expenditures and debt service requirements. Cash
required to meet our capital commitments is determined by evaluating the need to
upgrade rigs to meet specific customer requirements and by evaluating our
ongoing rig equipment replacement and enhancement programs, including water
depth and drilling capability upgrades. It is the opinion of our management that
our operating cash flows and cash reserves will be sufficient to meet these
capital commitments; however, we will continue to make periodic assessments
based on industry conditions. In addition, we 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. Our
ability to effect any such issuance will be dependent on the results of our
operations, our current financial condition, current market conditions and other
factors which are beyond our control.
We believe that we have the financial resources needed to meet our
business requirements in the foreseeable future, including capital expenditures
for rig upgrades and continuing rig enhancements, and working capital
requirements.
24
Contractual Cash Obligations.
As of March 31, 2005, we had purchase obligations aggregating
approximately $169 million related to the major upgrade of the Ocean Endeavor.
We had no other purchase obligations for major rig upgrades or any other
significant obligations at March 31, 2005, except for those related to our
direct rig operations, which arise during the normal course of business.
Payments on certain of our long-term debt, including interest, could be
accelerated due to certain rights that holders of our debentures have to put the
securities to us. The holders of our Zero Coupon Debentures due 2020, or Zero
Coupon Debentures, have the right to require us to repurchase the debentures on
June 6, 2005, June 6, 2010 and June 6, 2015 at the accreted value through the
date of repurchase. We may pay such repurchase price with either cash or shares
of our common stock or a combination of cash and shares of common stock. Based
on the redemption price of $594.25 per debenture on June 6, 2005, as of that
date the Zero Coupon Debentures may be converted into shares of our common stock
at $69.04 per share using the fixed conversion rate of 8.6075 shares per
debenture.
As of March 31, 2005, the aggregate accreted value of the outstanding Zero
Coupon Debentures was $475.4 million and is classified as a current liability in
our Consolidated Balance Sheet at March 31, 2005 because the holders of our
debentures have the right to require us to repurchase the debentures within one
year.
On June 6, 2005, the aggregate accreted value of the Zero Coupon
Debentures outstanding as of the date of this report 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.
Dividends
In April 2005, we declared a cash dividend of $0.0625 per share of our
common stock payable on June 1, 2005 to stockholders of record on May 2, 2005.
Any future determination as to the payment of dividends will be made at the
discretion of our Board of Directors and will depend upon our operating results,
financial condition, capital requirements, general business conditions and such
other factors that our Board of Directors deems relevant.
Letters of Credit.
We are contingently liable as of March 31, 2005 in the amount of $77.5
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 $4.2 million currently have
the option to require cash collateral due to the lowering of our credit rating
on April 27, 2004. As of March 31, 2005 we have not been required to make any
cash collateral deposits with respect to these agreements. The remaining
agreements cannot require cash collateral except in events of default. On our
behalf, banks have issued letters of credit securing certain of these bonds.
Capital Expenditures.
In January 2005, we announced the initiation of a major upgrade of our
Victory-class semisubmersible, the Ocean Endeavor, for ultra-deepwater service.
The modernized rig will be designed to operate in up to 10,000 feet of water at
an estimated upgrade cost of approximately $250 million. We expect to spend
approximately $110 million on the upgrade in 2005, of which approximately $4
million had been spent as of March 31, 2005. The rig is currently enroute to a
shipyard in Singapore where work is scheduled to commence in mid-May 2005. We
expect delivery of the upgraded rig in approximately two years.
We have budgeted an additional $115 million of capital expenditures in
2005 associated with our ongoing rig equipment replacement and enhancement
programs, and other corporate requirements. As of March 31, 2005, we had spent
approximately $18 million for capital additions, excluding upgrade costs for the
Ocean Endeavor. We expect to finance our 2005 capital expenditures through the
use of existing cash balances or internally generated funds.
In addition, in the first quarter of 2005, we signed a definitive
agreement to purchase the Enserch Garden Banks, a Victory-class semi-submersible
drilling rig, and related equipment for $20.0 million. We expect to close this
transaction in September 2005.
25
Off-Balance Sheet Arrangements.
At March 31, 2005 and December 31, 2004, we had no off-balance sheet debt.
HISTORICAL CASH FLOWS
The following is a discussion of our historical cash flows from operating,
investing and financing activities for the three months ended March 31, 2005
compared to the same period in 2004.
Net Cash Provided by Operating Activities.
THREE MONTHS ENDED MARCH 31,
-------------------------------
2005 2004 CHANGE
------------ ------------- -----------
(IN THOUSANDS)
Net income (loss).................................. $ 30,118 $ (10,972) $ 41,090
Net changes in operating assets and liabilities.... (46,088) 3,925 (50,013)
Loss on sale of marketable securities.............. 1,274 25 1,249
Depreciation and other non-cash items, net......... 58,419 45,681 12,738
------------ ------------- -----------
$ 43,723 $ 38,659 $ 5,064
============ ============= ===========
Cash flow from our operations in the first quarter of 2005 increased $5.1
million or 13% as compared to the same period in 2004. The increase in cash flow
from our operations in the first quarter of 2005 is the result of higher
utilization and higher average dayrates earned by our offshore drilling units as
a result of an increase in overall demand for offshore contract drilling
services, as compared to early 2004. These favorable trends were negatively
impacted by an increase in cash required to satisfy our working capital
requirements, as well as a temporary increase in our trade receivables account,
which will generate cash as the billing cycle is completed.
Net Cash Used in Investing Activities.
THREE MONTHS ENDED MARCH 31,
-------------------------------
2005 2004 CHANGE
------------ ------------- -----------
(IN THOUSANDS)
Purchase of marketable securities.................. $ (1,468,651) $ (623,461) $ (845,190)
Proceeds from sale of marketable securities....... 1,418,003 625,515 792,488
Capital expenditures............................... (21,674) (23,470) 1,796
Proceeds from maturities of Australian dollar
time deposits..................................... 11,761 -- 11,761
Other.............................................. 636 576 60
------------ ------------- -----------
$ (59,925) $ (20,840) $ (39,085)
============ ============= ===========
We used $59.9 million for investing activities in the first quarter of
2005 compared to $20.8 million in the same period in 2004. In the first three
months of 2005, we made net purchases of marketable securities of $50.6 million
compared to net sales of marketable securities of $2.1 million in the same
period of 2004. This increase in activity is the result of an increase in cash
available for investment in the first quarter of 2005, as compared to the same
period in 2004, primarily as a result of our favorable results of operations and
proceeds from our issuance of 5.15% Senior Notes in August 2004. Additionally,
in the first quarter of 2005 we realized $11.8 million (equivalent of 15.0
million Australian dollars) in cash from the maturity of our Australian time
deposits, which we entered into in the second quarter of 2004.
26
We may utilize forward exchange contracts from time to time to hedge our
exposure to changes in exchange rates between U.S. dollars and the local
currencies of the countries in which we operate. In February 2005, we entered
into forward exchange contracts requiring us to purchase the equivalent of
approximately $3.0 million in Mexican pesos monthly beginning in March 2005
through May 2005. Our first forward exchange contract was settled in March 2005,
resulting in a $0.1 million gain.
In April 2005, we entered into three additional forward exchange contracts
to purchase Mexican pesos in the second and third quarters of 2005. These
contracts, each requiring us to purchase the equivalent of $3.0 million in
Mexican pesos, will settle on the first day of June 2005, July 2005 and August
2005.
Net Cash Used in Financing Activities.
THREE MONTHS ENDED MARCH 31,
----------------------------
2005 2004 CHANGE
-------- -------- ----------
(IN THOUSANDS)
Payment of dividends........................... $ (8,035) $ (8,083) $ 48
Proceeds from stock options exercised.......... 1,084 -- 1,084
Other.......................................... (61) -- (61)
-------- -------- -----------
$ (7,012) $ (8,083) $ 1,071
======== ======== ===========
On January 25, 2005, we declared a dividend of $0.0625 per share of our
common stock payable March 1, 2005 to stockholders of record on February 1,
2005.
Depending on market conditions, we may, from time to time, purchase shares
of our common stock or issue put options in the open market or otherwise.
However, during the three months ended March 31, 2005 and 2004, we did not
repurchase any shares of our outstanding common stock or issue any put options.
During the first quarter of 2005, we received $1.1 million in proceeds
from the exercise of stock options to purchase shares of our common stock.
OTHER
Currency Risk. Certain of our subsidiaries use the local currency in the
country where they conduct operations as their functional currency. Currency
environments in which we have material business operations include Mexico,
Brazil, the U.K., Australia, Indonesia and Malaysia. When possible, we attempt
to minimize our currency exchange risk by seeking international contracts
payable in local currency in amounts equal to our estimated operating costs
payable in local currency with the balance of the contract payable in U.S.
dollars. At present, however, only a limited number of our contracts are payable
both in U.S. dollars and the local currency.
Currency translation adjustments are generally accumulated in a separate
section of stockholders' equity. If we were to cease our operations in a
currency environment, the accumulated adjustments would be recognized currently
in our results of operations. The effect on our results of operations from these
translation gains and losses has not been material and we do not expect them to
have a significant effect in the future.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004 the Financial Accounting Standards Board revised SFAS
123, "Accounting for Stock-Based Compensation," or SFAS 123 (R). This statement
supersedes Accounting Principles Board Opinion No. 25 and its related
implementation guidance. This statement requires that the compensation cost
relating to share-based payment transactions be recognized in financial
statements. That cost will be measured based on the fair value of the equity or
liability instruments issued. SFAS 123 (R) was originally effective as of the
first interim or annual reporting period beginning after June 15, 2005. In April
2005, however, the Securities and Exchange Commission adopted a rule that defers
the required effective date of SFAS 123 (R) for registrants such as us until the
beginning of the first fiscal year beginning after June 15, 2005. This statement
applies to all awards granted after the required effective date and to awards
modified, repurchased or cancelled after that date, as well as the unvested
portion of awards granted prior to the effective date of SFAS 123(R). We do not
expect our adoption of SFAS 123 (R) to have a material impact on our
consolidated results of operations, financial position or cash flows.
27
FORWARD-LOOKING STATEMENTS
We or our representatives may, from time to time, make or incorporate by
reference certain written or oral statements that are "forward-looking
statements" within the meaning of Section 27A of the Securities Act of 1933, as
amended, or the Securities Act, and Section 21E of the Securities Exchange Act
of 1934, as amended, or 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 made by us in this
report that contain forward-looking statements include, but are not limited to,
information concerning our possible or assumed future results of operations and
statements about the following subjects:
- future market conditions and the effect of such conditions on our
future results of operations (see " - Overview-Results of Operations
and Industry Conditions");
- future uses of and requirements for financial resources (see " -
Liquidity and Capital Requirements" and " - Sources of Liquidity and
Capital Resources");
- interest rate and foreign exchange risk (see "Quantitative and
Qualitative Disclosures About Market Risk");
- future contractual obligations (see " -- Overview -- Results of
Operations and Industry Conditions" and " - Liquidity and Capital
Requirements");
- future operations outside the United States including, without
limitation, our operations in Mexico (see " -- Overview -- Results
of Operations and Industry Conditions");
- 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," and " -- Three Months Ended March 31,
2005 and 2004");
- budgets for capital and other expenditures (see " - Liquidity and
Capital Requirements");
- timing and cost of completion of rig upgrades and other capital
projects (see " - Liquidity and Capital Requirements");
- delivery dates and drilling contracts related to rig conversion and
upgrade projects (see " -- Liquidity and Capital Requirements");
- plans and objectives of management;
- performance of contracts (see " -- Overview -- Results of Operations
and Industry Conditions");
- outcomes of legal proceedings;
- compliance with applicable laws; and
- adequacy of insurance or indemnification.
These types of 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. These 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;
28
- 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 our various
drilling contracts in effect from time to time;
- foreign exchange and currency fluctuations and regulations, and the
inability to repatriate income or capital;
- risks of war, military operations, other armed hostilities,
terrorist acts and embargoes;
- changes in offshore drilling technology, which could require
significant capital expenditures in order to maintain
competitiveness;
- regulatory initiatives and compliance with governmental regulations;
- compliance with environmental laws and regulations;
- customer preferences;
- effects of litigation;
- cost, availability and adequacy of insurance;
- adequacy of our sources of liquidity;
- the availability of qualified personnel to operate and service our
drilling rigs; and
- various other matters, many of which are beyond our control.
The risks included here are not exhaustive. Other sections of this report
and our other filings with the Securities and Exchange Commission include
additional factors that could adversely affect our 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. We expressly disclaim any obligation or undertaking to release
publicly any updates or revisions to any forward-looking statement to reflect
any change in our expectations with regard to the statement or any change in
events, conditions or circumstances on which any forward-looking statement is
based.
29
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.
Our measure of market risk exposure represents an estimate of the change
in fair value of our financial instruments. Market risk exposure is presented
for each class of financial instrument held by us at March 31, 2005 and December
31, 2004 assuming immediate adverse market movements of the magnitude described
below. We believe 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 our investment portfolio is subject to change
based on our 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 that we employ and
has responsibility to ensure that the investment positions are consistent with
that strategy and the level of risk acceptable to us. We may manage risk by
buying or selling instruments or entering into offsetting positions.
Interest Rate Risk
We have exposure to interest rate risks arising from changes in the level
or volatility of interest rates. Our investments in marketable securities are
primarily in fixed maturity securities. We monitor our sensitivity to interest
rate risk by evaluating the change in the value of our 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 our investments and the resulting effect on
stockholders' equity. The analysis presents the sensitivity of the market value
of our financial instruments to selected changes in market rates and prices
which we believe are reasonably possible over a one-year period.
The sensitivity analysis estimates the change in the market value of our
interest sensitive assets and liabilities that were held on March 31, 2005 and
December 31, 2004, 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 our
earnings or stockholders' equity. Further, the computations do not contemplate
any actions we could undertake in response to changes in interest rates.
Our long-term debt as of March 31, 2005 and December 31, 2004 is
denominated in U.S. dollars. Our 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 $182.2 million and $177.8 million,
respectively. A 100 basis point decrease would result in an increase in market
value of $222.7 million and $217.3 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
2004, we invested in Australian dollar time deposits and at December 31, 2004,
15.0 million Australian dollars (equivalent to $11.6 million) of time deposits
were included in "Investments and marketable securities" in our Consolidated
Balance Sheet at December 31, 2004. These time deposits matured during the first
quarter of 2005.
Additionally, in February 2005, we entered into forward exchange contracts
requiring us to purchase the equivalent of approximately $3.0 million in Mexican
pesos monthly beginning in March 2005 through May 2005.
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As of March 31, 2005, two forward exchange contracts remain outstanding and were
included in "Other assets" in our Consolidated Balance Sheet at March 31, 2005
at fair value in accordance with SFAS No. 133, "Accounting for Derivatives and
Hedging Activities."
The sensitivity analysis below assumes an instantaneous 20% change in
foreign currency exchange rates versus the U.S. dollar from their levels at
March 31, 2005 and December 31, 2004.
The following table presents our market risk by category (interest rates
and foreign currency exchange rates):
FAIR VALUE ASSET (LIABILITY) MARKET RISK
------------------------------------ ------------------------------
MARCH 31, DECEMBER 31, MARCH 31, DECEMBER 31,
CATEGORY OF RISK EXPOSURE: 2005 2004 2005 2004
- ------------------------------------- ---------------- ------------- ----------- ------------
(IN THOUSANDS)
Interest rate:
Marketable securities............ $ 702,262 (a) $ 650,247 (a) $ 500 (c) $ 2,100 (c)
Long-term debt................... (1,247,474) (b) (1,213,820)(b) -- --
Foreign Exchange:
Australian dollar time deposits.. -- 11,602 (c) -- 2,300 (d)
Forward exchange contracts....... 51 (d) -- 1,100 (d) --
(a) The fair market value of our investment in marketable securities is
based on the quoted closing market prices on March 31, 2005 and December 31,
2004.
(b) The fair values of our 5.15% Senior Notes, 1.5% convertible senior
debentures due 2031 and Zero Coupon Debentures are based on the quoted closing
market prices on March 31, 2005 and December 31, 2004. The fair value of our
Ocean Alliance lease-leaseback agreement is based on the present value of
estimated future cash flows using a discount rate of 4.80% for March 31, 2005
and 4.27% for December 31, 2004.
(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 March 31, 2005 and December 31, 2004.
(d) The calculation of estimated foreign exchange risk is based on assumed
adverse changes in the underlying reference price or index of an increase in
foreign exchange rates of 20% at March 31, 2005 and a decrease in foreign
exchange rates of 20% at December 31, 2004.
ITEM 4. CONTROLS AND PROCEDURES.
Our Chief Executive Officer, or CEO, and Chief Financial Officer, or CFO,
participated in an evaluation by our management of the effectiveness of our
disclosure controls and procedures as of the end of our last fiscal quarter that
ended on March 31, 2005. Based on their participation in that evaluation, our
CEO and CFO concluded that our disclosure controls and procedures were effective
as of March 31, 2005 to ensure that required information is disclosed on a
timely basis in our reports filed or furnished under the Exchange Act.
There was no change in our internal control over financial reporting that
occurred during the first fiscal quarter of 2005 that has materially affected,
or is reasonably likely to materially affect, our internal control over
financial reporting.
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS.
See the Exhibit Index for a list of those exhibits filed or furnished herewith.
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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 29-April-2005 By: \s\ Gary T. Krenek
-------------------------------------------
Gary T. Krenek
Vice President and Chief Financial Officer
Date 29-April-2005 \s\ Beth G. Gordon
-------------------------------------------
Beth G. Gordon
Controller (Chief Accounting Officer)
32
EXHIBIT INDEX
Exhibit No Description
3.1 Amended and Restated Certificate of Incorporation of the
Company (incorporated by reference to Exhibit 3.1 to the
Company's Quarterly Report on Form 10-Q for the quarterly
period ended June 30, 2003).
3.2 Amended and Restated By-laws of the Company (incorporated by
reference to Exhibit 3.2 to the Company's Quarterly Report on
Form 10-Q for the quarterly period ended March 31, 2001).
31.1* Rule 13a-14(a) Certification of the Chief Executive Officer.
31.2* Rule 13a-14(a) Certification of the Chief Financial Officer.
32.1* Section 1350 Certification of the Chief Executive Officer and
Chief Financial Officer.
* Filed or furnished herewith.
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