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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997
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
(State or other jurisdiction of incorporation 76-0321760
or organization) (I.R.S. Employer Identification No.)
15415 KATY FREEWAY
HOUSTON, TEXAS 77094
(Address and zip code of principal executive offices)
(281) 492-5300
(Registrant's telephone number, including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
Common Stock, $0.01 par value per share New York Stock Exchange
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
State the aggregate market value of the voting and non-voting common equity
held by non-affiliates of the registrant.
As of January 30, 1998 $3,089,306,640
Indicate the number of shares of each of the issuer's classes of common
stock, as of the latest practicable date.
As of January 30, 1998 Common Stock, $0.01 par value per share 139,328,160 shares
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive proxy statement relating to the 1998 Annual
Meeting of Stockholders of Diamond Offshore Drilling, Inc., which will be filed
within 120 days of December 31, 1997, are incorporated by reference in Part III
of this form.
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DIAMOND OFFSHORE DRILLING, INC. AND SUBSIDIARIES
FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1997
TABLE OF CONTENTS
PAGE NO.
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Cover Page.............................................................. 1
Document Table of Contents.............................................. 2
PART I
Item 1. Business.................................................... 3
Item 2. Properties.................................................. 11
Item 3. Legal Proceedings........................................... 11
Item 4. Submission of Matters to a Vote of Security Holders......... 11
Part II
Item 5. Market for the Registrant's Common Equity and Related 13
Stockholder Matters.........................................
Item 6. Selected Financial Data..................................... 14
Item 7. Management's Discussion and Analysis of Financial Condition 15
and Results of Operations...................................
Item 7A. Quantitative and Qualitative Disclosures About Market 25
Risk........................................................
Item 8. Financial Statements and Supplementary Data................. 26
Consolidated Financial Statements........................... 27
Notes to Consolidated Financial Statements.................. 31
Item 9. Changes in and Disagreements with Accountants on Accounting 46
and Financial Disclosure....................................
Part III
Information called for by Part III has been omitted as the Registrant
intends to file with the Securities and Exchange Commission not later
than 120 days after the close of its fiscal year a definitive Proxy
Statement pursuant to Regulation 14A.
Part IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 46
8-K.........................................................
Signatures ............................................................ 49
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PART I
ITEM 1. BUSINESS.
GENERAL
Diamond Offshore Drilling, Inc., incorporated in Delaware in 1989, engages
principally in the contract drilling of offshore oil and gas wells. Unless the
context otherwise requires, references herein to the "Company" shall mean
Diamond Offshore Drilling, Inc. and its consolidated subsidiaries. The Company
is a leader in deep water drilling with a fleet of 46 offshore rigs. The fleet
consists of 30 semisubmersibles (including an accommodation vessel), 15 jack-ups
and one drillship and operates in the waters of six of the world's seven
continents.
STOCK DIVIDEND
In July 1997, the Board of Directors declared a two-for-one stock split in
the form of a stock dividend which was distributed on August 14, 1997 to
stockholders of record on July 24, 1997. The dividend was charged to retained
earnings in the amount of $0.7 million. Weighted average shares outstanding and
all per share amounts included herein are based on the increased number of
shares, giving retroactive effect to the stock dividend.
ISSUANCE OF CONVERTIBLE SUBORDINATED NOTES
In February 1997, the Company issued $400.0 million, including $50.0
million from an over-allotment option, of 3.75 percent convertible subordinated
notes (the "Notes") due February 15, 2007. The Notes are convertible, in whole
or in part, at the option of the holder at any time following the date of
original issuance thereof and prior to the close of business on the business day
immediately preceding the maturity date, unless previously redeemed, into shares
of the Company's common stock, par value $0.01 per share ("Common Stock"), at a
conversion price of $40.50 per share (equivalent to a conversion rate of 24.691
shares per $1,000 principal amount of Notes), subject to adjustment in certain
circumstances. The Notes are redeemable, in whole or from time to time in part,
at the option of the Company, at any time on or after February 22, 2001 at
specified redemption prices, plus accrued and unpaid interest to the date of
redemption. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Liquidity" in Item 7 of this Report.
MERGER WITH ARETHUSA
On April 29, 1996, the Company acquired 100 percent of the common stock of
Arethusa (Off-Shore) Limited ("Arethusa"), a Bermuda corporation, (the "Arethusa
Merger") in exchange for shares of Common Stock. Arethusa owned a fleet of 11
mobile offshore drilling rigs, operated two additional mobile offshore drilling
rigs pursuant to bareboat charters and provided drilling services worldwide to
international and government-controlled oil and gas companies. The fleet was
comprised of eight semisubmersible rigs and five jack-up rigs. The Company
issued 35.8 million shares of Common Stock based on an exchange ratio of 1.76
shares for each share of Arethusa's issued and outstanding common stock. See
Note 2 to the Company's Consolidated Financial Statements in Item 8 of this
Report.
INDUSTRY CONDITIONS
The offshore contract drilling business is influenced by a number of
factors, including the current and anticipated prices of oil and natural gas,
the expenditures by oil and gas companies for exploration and development and
the availability of drilling rigs. In addition, demand for drilling services
remains dependent on a variety of political and economic factors beyond the
Company's control, including worldwide demand for oil and natural gas, the
ability of the Organization of Petroleum Exporting Countries ("OPEC") to set and
maintain production levels and pricing, the level of production of non-OPEC
countries and the policies of the various governments regarding exploration and
development of their oil and natural gas reserves.
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Historically, the offshore contract drilling industry has been highly
competitive and cyclical, with periods of low demand, excess rig supply and low
dayrates followed by periods of high demand, short rig supply and high dayrates.
For a number of years, depressed oil and natural gas prices and an oversupply of
rigs adversely affected the offshore drilling market. In particular, the
prolonged weakness and uncertainty in the demand for and price of natural gas
resulted in a significant decline in exploration and production activities in
the Gulf of Mexico. Subsequently, the offshore drilling industry has benefited
from increased demand and from a tight supply of major offshore drilling rigs
worldwide. These conditions are due, in part, to technological advances that
have broadened opportunities for offshore exploration and development.
All of the Company's markets have experienced high utilization levels and
improved dayrates in 1997 and early 1998 and, in many cases, customers seek to
contract rigs for term commitments (as opposed to contracts for the drilling of
a single well or a group of wells) and often will pay for upgrades and
modifications necessary for more challenging drilling locations in order to
assure rig availability. Although not currently a material factor in the
Company's markets, weak commodity prices, economic problems in countries outside
the United States, or a number of other influencing factors could curtail
spending by oil and gas companies and possibly depress the offshore drilling
industry. Therefore, the Company cannot predict whether and, if so, to what
extent current market conditions will continue. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Outlook" in Item 7
of this Report.
THE FLEET
The Company's large, diverse fleet, which includes some of the most
technologically advanced rigs in the world, enables it to offer a broad range of
services worldwide in various markets, including the deep water market, the
harsh environment market (such as the North Sea), the conventional
semisubmersible market and the jack-up market.
Semisubmersibles. The Company owns and operates 30 semisubmersibles
(including an accommodation vessel). Semisubmersible rigs consist of an upper
working and living deck resting on vertical columns connected to lower hull
members. Such rigs operate in a "semi-submerged" position, remaining afloat, off
bottom, in a position in which the lower hull is approximately 55 to 90 feet
below the water line and the upper deck protrudes well above the surface. The
rig is typically anchored in position and remains stable for drilling in the
semi-submerged floating position due in part to its wave transparency
characteristics at the water line.
The Company owns and operates three fourth-generation semisubmersibles and
three fourth-generation deep water conversions. Fourth-generation
semisubmersibles are larger than other semisubmersibles, are capable of working
in deep water or harsh environments and have other advanced features. Currently
the Ocean America, the Ocean Quest, the Ocean Star, and the Ocean Victory are
located in deep water areas of the Gulf of Mexico; the Ocean Alliance is located
in the harsh environment of the North Sea offshore Norway; and the Ocean Valiant
is located offshore West Africa.
In addition, the Company owns and operates 24 other semisubmersibles, which
operate in maximum water depths of up to 3,500 feet. The diverse capabilities of
most of these semisubmersibles enable them to work in both shallow and deep
water environments in the U.S. and in most markets outside the U.S. Currently,
12 of these semisubmersibles are contracted in the Gulf of Mexico; four are
contracted offshore Brazil; three are contracted in the North Sea; three are
contracted offshore Australia; and one is contracted offshore West Africa.
In May 1997, the Company purchased a semisubmersible accommodation vessel,
the Polyconfidence, equipped with dynamic-positioning capabilities. The
Polyconfidence (soon to be renamed Ocean Confidence) will be converted to a
drilling unit with fourth-generation capabilities, including harsh environment
and ultra-deep water capabilities. The rig is anticipated to be delivered in
late 1999. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Capital Resources" in Item 7 of this Report.
Jack-ups. The Company owns 15 jack-ups. Jack-up rigs are mobile,
self-elevating drilling platforms equipped with legs that are lowered to the
ocean floor until a foundation is established to support the drilling platform.
The rig hull includes the drilling rig, jacking system, crew quarters, loading
and unloading facilities,
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storage areas for bulk and liquid materials, heliport and other related
equipment. Jack-ups are used extensively for drilling in water depths from 20
feet to 350 feet. The water depth limit of a particular rig is principally
determined by the length of the rig's legs. A jack-up rig is towed by tugboats
to the drillsite with its hull riding in the sea, as a vessel, with its legs
retracted. Once over a drillsite, the legs are lowered until they rest on the
seabed and jacking continues until the hull is elevated above the surface of the
water. After completion of drilling operations, the hull is lowered until it
rests in the water and then the legs are retracted for relocation to another
drillsite.
The principal market for the Company's jack-up rigs is currently the Gulf
of Mexico, where 12 of the Company's jack-up rigs are located. Of the Company's
jack-up rigs in the Gulf of Mexico, seven are independent-leg cantilevered rigs,
two are mat-supported cantilevered rigs, two are independent-leg slot rigs, and
one is a mat-supported slot rig. All three of the Company's internationally
based jack-ups are independent-leg cantilevered rigs.
Drillship. Drillships, which are typically self-propelled, are positioned
over a drillsite through the use of either an anchoring system or a computer
controlled thruster system (dynamic-positioning) similar to those used on
certain semisubmersible rigs. Deep water drillships compete in many of the same
markets as do fourth-generation semisubmersible rigs. The Company's drillship,
the Ocean Clipper I, was upgraded in 1997 with dynamic-positioning capabilities
and other enhancements and is operating in the deep water market of the Gulf of
Mexico.
Fleet Enhancements. The Company's strategy is to maximize dayrates and
utilization by adapting to trends in its markets, including enhancing its fleet
to meet customer demand for diverse drilling capabilities. The average age of
the Company's fleet of offshore drilling rigs (calculated as of December 31,
1997 and measured from the year built) is 19.6 years. Many of the Company's rigs
have been upgraded during the last five years with enhancements such as
top-drive drilling systems, additional water depth capability, mud pump
additions or increases in deck load capacity, and the Company believes that it
will be feasible to continue to upgrade its rigs notwithstanding the average age
of its fleet. However, there can be no assurance as to if, when or to what
extent upgrades will continue to be made to rigs in the Company's fleet,
particularly in view of current dayrates that would be forgone by removing a rig
from service for upgrade. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Capital Resources" in Item 7 of this
Report.
The design of the Company's Victory-class semisubmersible rigs, including
their cruciform hull configurations, long fatigue-life and advantageous stress
characteristics, makes this class of rig particularly well-suited for
significant upgrade projects. Since 1995, the Company has upgraded five of its
eight Victory-class rigs with enhancements such as increased efficiency in the
handling of subsea completion equipment, stability enhancements that allow
increased variable deck load, and increased water depth capabilities. Currently,
the Company's Victory-class rigs are outfitted for service in maximum water
depths of 1,200 to 5,000 feet.
The Ocean Quest, one of the Company's Victory-class rigs, was upgraded to
conduct drilling operations in the Gulf of Mexico in water depths of up to 3,500
feet and was placed into service in September 1996. In March 1997, the Company
completed the major upgrade of the Ocean Star, including stability and other
enhancements such as water depth capabilities of up to 4,500 feet, increased
variable deck load to approximately 6,000 tons, a top-drive drilling system, a
15,000 psi blow-out prevention system, increased deck area, and additional mud
pit and tensioner capacity. The Company completed the upgrade of the Ocean
Victory in November 1997, which enabled the rig to conduct drilling operations
in water depths of up to 5,000 feet with enhancements similar to the Ocean Star.
These rigs are now able to compete effectively in the fourth-generation deep
water market.
The upgrade of the Company's drillship, the Ocean Clipper I, was completed
in July 1997. The drillship is now equipped with dynamic-positioning
capabilities, a 15,000 psi blow-out prevention system, three mud pumps, and
other enhancements. Since completion of its upgrade, however, the Ocean Clipper
I has experienced certain subsea system equipment difficulties primarily
associated with new technology for operations in deep water. While the drillship
is operating under its drilling contract in the Gulf of Mexico, the
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Company continues to participate in developing design revisions that will
benefit the affected systems long-term.
The Company is scheduled to upgrade the Polyconfidence from an
accommodation vessel to a semisubmersible drilling unit capable of operating in
harsh environments and ultra-deep waters. The conversion will include
enhancements such as increased capability for operations in up to 7,500 foot
water depths, approximately 6,000 tons variable deck load, a 15,000 psi blow-out
prevention system, and four mud pumps. The upgrade is anticipated to be
completed in late 1999, when the rig will commence a five-year commitment in the
Gulf of Mexico.
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More detailed information concerning the Company's fleet of mobile offshore
drilling rigs, as of January 31, 1998, is set forth in the table below.
WATER YEAR
DEPTH BUILT/LATEST CURRENT
TYPE AND NAME CAPABILITY(FT.) ATTRIBUTES ENHANCEMENT (A) LOCATION CUSTOMER (B)
- ----------------------------- --------------- ---------------------------- --------------- -------------- --------------
FOURTH-GENERATION EQUIPMENT
ORIGINAL CONSTRUCTION (3):
Ocean Alliance............. 5,000 TDS; DP; 15K; 3M 1988/1995 North Sea Shell
Ocean America.............. 5,000 TDS; SP; 15K; 3M 1988/1992 Gulf of Mexico BP
Ocean Valiant.............. 5,000 TDS; SP; 15K; 3M 1988/1995 Angola Exxon
CONVERSIONS (3):
Ocean Victory.............. 5,000 TDS; VC; 15K; 3M 1972/1997 Gulf of Mexico Vastar
Ocean Star................. 4,500 TDS; VC; 15K; 3M 1974/1997 Gulf of Mexico Texaco
Ocean Quest................ 3,500 TDS; VC; 15K; 3M 1973/1996 Gulf of Mexico Chevron
DRILLSHIP (1):
Ocean Clipper I............ 7,500 TDS; DP; 15K; 3M 1976/1997 Gulf of Mexico BP
OTHER
SEMISUBMERSIBLES (24):
Polyconfidence (c)......... 5,000 DP 1987 Enroute BP
Ocean Worker (d)........... 3,500 TDS; 3M 1982/1992 Gulf of Mexico Shell
Ocean Voyager.............. 3,200 TDS; VC 1973/1995 Gulf of Mexico EEX
Ocean Winner (d)........... 3,000 TDS; 3M 1977/1996 Gulf of Mexico Chevron
Ocean Yatzy (d)............ 3,000 TDS; DP; 15K 1989 Brazil Petrobras
Ocean Yorktown (d)......... 2,850 TDS 1976/1996 Brazil Petrobras
Ocean Concord (d).......... 2,200 TDS; 3M 1975/1995 Gulf of Mexico Shell
Ocean Lexington (d)........ 2,200 TDS; 3M 1976/1995 Gulf of Mexico Marathon
Ocean Saratoga (d)......... 2,200 TDS; 3M 1976/1995 Gulf of Mexico Shell
Ocean Endeavor............. 2,000 TDS; VC 1975/1994 Gulf of Mexico British-Borneo
Ocean Rover................ 2,000 TDS; VC; 15K 1973/1992 Gulf of Mexico Amerada Hess
Ocean Prospector........... 1,700 VC 1971/1981 Gulf of Mexico Mariner (e)
Ocean Bounty............... 1,500 TDS; VC; 3M 1977/1992 Australia BHPP
Ocean Guardian............. 1,500 TDS; SP; 3M 1985 North Sea Enterprise
Ocean New Era.............. 1,500 TDS 1974/1990 Gulf of Mexico Amerada Hess
Ocean Princess............. 1,500 TDS; 15K 1977/1996 North Sea Mobil
Ocean Whittington (d)(f)... 1,500 TDS; 3M 1974/1995 Gulf of Mexico Petrobras
Ocean Epoch................ 1,200 TDS 1977/1990 Australia Woodside
Ocean General.............. 1,200 TDS 1976/1990 Australia Shell
Ocean Nomad................ 1,200 TDS 1975/1995 North Sea Shell
Ocean Baroness............. 1,200 TDS; VC 1973/1995 Brazil Petrobras
Ocean Ambassador........... 1,100 TDS; 3M 1975/1995 Gulf of Mexico Coastal
Ocean Century.............. 800 1973 Gulf of Mexico Murphy
Ocean Liberator............ 600 1974 Congo AGIP
JACK-UPS (15):
Ocean Titan................ 350 TDS; IS; 15K; 3M 1974/1989 Gulf of Mexico CNG
Ocean Tower (g)............ 350 TDS; IS; 3M 1972/1998 Gulf of Mexico Seneca
Ocean King................. 300 TDS; IC 1973/1989 Gulf of Mexico Chevron
Ocean Nugget............... 300 TDS; IC 1976/1995 Gulf of Mexico ADTI
Ocean Summit............... 300 SDS; IC 1972/1991 Gulf of Mexico Coastal
Ocean Warwick.............. 300 TDS; IC 1971/1998 Gulf of Mexico Upgrade (h)
Ocean Champion............. 250 MS 1975/1985 Gulf of Mexico Vastar
Ocean Columbia............. 250 TDS; IC 1978/1990 Gulf of Mexico Coastal
Ocean Heritage (d)......... 250 TDS; IC 1981/1995 Indonesia Maxus
Ocean Sovereign (d)........ 250 TDS; IC 1981/1994 Indonesia Maxus
Ocean Spartan.............. 250 TDS; IC 1980/1994 Gulf of Mexico Vastar
Ocean Spur................. 250 TDS; IC 1981/1994 Gulf of Mexico ADTI
Ocean Crusader............. 200 TDS; MC 1982/1992 Gulf of Mexico Chevron
Ocean Drake................ 200 TDS; MC 1983/1986 Gulf of Mexico Chevron
Ocean Scotian (d).......... 200 TDS; IC; 15K 1981/1988 Netherlands Elf
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ATTRIBUTES
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DP = Dynamically-Positioned/Self-Propelled MS = Mat-Supported Slot Rig TDS = Top-Drive Drilling System
IC = Independent-Leg Cantilevered Rig SDS = Side-Drive Drilling System 3M = Three Mud Pumps
IS = Independent-Leg Slot Rig VC = Victory-Class 15K = 15,000 psi Blow-Out Preventer
MC = Mat-Supported Cantilevered Rig SP = Self-Propelled
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(a) Such enhancements include the installation of top-drive drilling systems,
water depth upgrades, mud pump additions and increases in deck load
capacity.
(b) For ease of presentation in this table, customer names have been shortened
or abbreviated.
(c) Committed under a five-year term contract with BP in the Gulf of Mexico upon
completion of relocation from the North Sea and conversion to a drilling
unit.
(d) Formerly an Arethusa rig.
(e) Managed daywork project operated by Diamond Offshore Team Solutions, Inc.
(f) Committed under a three-year term contract with Petrobras offshore Brazil
upon completion of repairs and relocation from the Gulf of Mexico.
(g) Committed under a nine-month term contract with Seneca in the Gulf of Mexico
after completion of a leg reinforcement upgrade.
(h) Subsequent to January 31, 1998, committed under a three-well contract with
Apache in the Gulf of Mexico upon completion of cantilever conversion.
MARKETS
The Company's principal markets for its offshore contract drilling services
are the Gulf of Mexico, Europe, including principally the U.K. sector of the
North Sea, South America, Africa, and Australia/Southeast Asia. The Company
actively markets its rigs worldwide. In the past, rigs in the Company's fleet
have also operated in various other markets throughout the world. See Note 14 to
the Company's Consolidated Financial Statements in Item 8 of this Report.
The Company believes that its presence in multiple markets is valuable in
many respects. For example, the Company believes that its experience with safety
and other regulatory matters in the U. K. has been beneficial in Australia and
in the Gulf of Mexico and that production experience gained through Brazilian
and North Sea operations has potential application worldwide. Additionally, the
Company believes that its performance for a customer in one market segment or
area enables it to better understand that customer's needs and serve that
customer in different market segments or other geographic locations.
OFFSHORE CONTRACT DRILLING SERVICES
The Company's contracts to provide offshore drilling services vary in their
terms and provisions. The Company often obtains its contracts through
competitive bidding, although it is not unusual for the Company to be awarded
drilling contracts without competitive bidding. Drilling contracts generally
provide for a basic drilling rate on a fixed dayrate basis regardless of whether
such drilling results in a productive well. Drilling contracts may also provide
for lower rates during periods when the rig is being moved or when drilling
operations are interrupted or restricted by equipment breakdowns, adverse
weather or water conditions or other conditions beyond the control of the
Company. Under dayrate contracts, the Company generally pays the operating
expenses of the rig, including wages and the cost of incidental supplies.
Dayrate contracts have historically accounted for a substantial portion of the
Company's revenues. In addition, the Company has worked some of its rigs under
dayrate contracts pursuant to which the customer also agrees to pay the Company
an incentive bonus based upon performance.
A dayrate drilling contract generally extends over a period of time
covering either the drilling of a single well, a group of wells (a "well-to-well
contract") or a stated term (a "term contract") and may be terminated by the
customer in the event the drilling unit is destroyed or lost or if drilling
operations are suspended for a specified period of time as a result of a
breakdown of major equipment or, in some cases, due to other events beyond the
control of either party. In addition, certain of the Company's contracts permit
the customer to terminate the contract early by giving notice and in some
circumstances may require the payment of an early termination fee by the
customer. The contract term in many instances may be extended by the customer
exercising options for the drilling of additional wells at fixed or mutually
agreed terms, including dayrates.
The duration of offshore drilling contracts is generally determined by
market demand and the respective management strategy of the offshore drilling
contractor and its customers. In periods of rising demand for offshore rigs,
contractors typically prefer well-to-well contracts that allow contractors to
profit from increasing dayrates. In contrast, during these periods customers
with reasonably definite drilling programs typically prefer longer term
contracts to maintain dayrate prices at the lowest level possible. Conversely,
in periods of
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decreasing demand for offshore rigs, contractors generally prefer longer term
contracts to preserve dayrates at existing levels and ensure utilization, while
the customers prefer well-to-well contracts that allow them to obtain the
benefit of lower dayrates. Under current conditions, the Company seeks to have a
foundation of long-term contracts with a reasonable balance of single well,
well-to-well and short-term contracts to minimize the downside impact of a
decline in the market while still participating in the benefit of increasing
dayrates in a rising market.
The Company, through its wholly owned subsidiary, Diamond Offshore Team
Solutions, Inc. ("DOTS"), offers a portfolio of drilling services to complement
the Company's offshore contract drilling business. These services include
overall project management, extended well tests, and drilling and completion
operations. During 1997 and 1996, DOTS primarily provided project management
services on a dayrate basis and contributed operating income of $1.9 million and
$2.5 million, respectively, to the Company's consolidated results of operations.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Results of Operations" in Item 7 of this Report.
DISPOSITION OF ASSETS
During 1997, the Company's bareboat charter of a jack-up drilling rig
acquired in the Arethusa Merger terminated and the Company no longer operates
this rig. In addition, in 1997, the Company sold a semisubmersible drilling rig
located offshore Brazil for approximately $5.4 million, resulting in an
after-tax gain for the year ended December 31, 1997 of $0.6 million. In December
1996, the Company exited the land drilling business with the sale of its land
rigs and associated equipment for approximately $26.0 million, resulting in an
after-tax gain for the year ended December 31, 1996 of $15.6 million. See
"Management's Discussion and Analysis of Financial Condition -- Results of
Operations" in Item 7 and Note 5 to the Company's Consolidated Financial
Statements in Item 8 of this Report.
Certain other assets, including drilling rigs, have been sold in previous
years. These assets have generally been inactive or did not fit the overall
strategic direction of the Company. Although the Company does not, as of the
date hereof, have any commitment with respect to a material disposition, it
could enter into such agreement in the future.
CUSTOMERS
The Company provides offshore drilling services to a customer base that
includes major and independent oil and gas companies and government-owned oil
companies. Occasionally, several customers have accounted for 10.0 percent or
more of the Company's annual consolidated revenues, although the specific
customers may vary from year to year. During 1997, the Company performed
services for approximately 50 different customers with Shell companies
(including domestic and foreign affiliates) ("Shell") accounting for 14.3
percent of the Company's annual total consolidated revenues. During 1996, the
Company performed services for approximately 80 different customers with Shell
and British Petroleum companies (including domestic and foreign affiliates)
("BP") accounting for 13.8 percent and 13.5 percent of the Company's annual
total consolidated revenues, respectively. During 1995, the Company performed
services for approximately 90 different customers with BP accounting for 16.5
percent of the Company's annual total consolidated revenues. Management believes
that at current levels of activity the Company has alternative customers for its
services such that the loss of a single customer would not have a material
adverse effect on the Company.
The Company's services are marketed principally through its Houston office,
with support from its regional offices in New Orleans, Louisiana; Aberdeen,
Scotland; and Perth, Western Australia. Technical and administrative support
functions for the Company's operations are provided by its Houston office.
COMPETITION
The contract drilling industry is highly competitive. Customers often award
contracts on a competitive bid basis, and although a customer selecting a rig
may consider, among other things, a contractor's safety record, crew quality and
quality of service and equipment, the historical oversupply of rigs has created
an intensely competitive market in which price is the primary factor in
determining the selection of a drilling
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contractor. However, due to the escalation of drilling activity, rig
availability has, in some cases, also become a consideration, particularly with
respect to fourth-generation and other technologically advanced units. The
Company believes that competition for drilling contracts will continue to be
intense in the foreseeable future. Contractors are also able to adjust localized
supply and demand imbalances by moving rigs from areas of low utilization and
dayrates to areas of greater activity and relatively higher dayrates. Such
movements or reactivations or a decrease in drilling activity in any major
market could depress dayrates and could adversely affect utilization of the
Company's rigs. See "-- Offshore Contract Drilling Services."
In addition, the recent improvement in the current results of operations
and prospects for the offshore contract drilling industry as a whole has led to
increased rig construction and enhancement programs by the Company's
competitors. A significant increase in the supply of technologically advanced
rigs capable of drilling in deep water may have an adverse effect on the average
operating dayrates for the Company's rigs, particularly its more advanced
semisubmersible units, and on the overall utilization level of the Company's
fleet. In such case, the Company's results of operations would be adversely
affected.
GOVERNMENTAL REGULATION
The Company's operations are subject to numerous federal, state and local
laws and regulations that relate directly or indirectly to its operations,
including certain regulations controlling the discharge of materials into the
environment, requiring removal and clean-up under certain circumstances, or
otherwise relating to the protection of the environment. For example, the
Company may be liable for damages and costs incurred in connection with oil
spills for which it is held responsible. Laws and regulations protecting the
environment have become increasingly stringent in recent years and may in
certain circumstances impose "strict liability" rendering a company liable for
environmental damage without regard to negligence or fault on the part of such
company. Liability under such laws and regulations may result from either
governmental or citizen prosecution. Such laws and regulations may expose the
Company to liability for the conduct of or conditions caused by others, or for
acts of the Company that were in compliance with all applicable laws at the time
such acts were performed. The application of these requirements or the adoption
of new requirements could have a material adverse effect on the Company.
The United States Oil Pollution Act of 1990 ("OPA '90") and similar
legislation enacted in Texas, Louisiana and other coastal states address oil
spill prevention and control and significantly expand liability exposure across
all segments of the oil and gas industry. OPA '90, such similar legislation and
related regulations impose a variety of obligations on the Company related to
the prevention of oil spills and liability for damages resulting from such
spills. OPA '90 imposes strict and, with limited exceptions, joint and several
liability upon each responsible party for oil removal costs and a variety of
public and private damages.
INDEMNIFICATION AND INSURANCE
The Company's operations are subject to hazards inherent in the drilling of
oil and gas wells such as blowouts, reservoir damage, loss of production, loss
of well control, cratering or fires, the occurrence of which could result in the
suspension of drilling operations, injury to or death of rig and other personnel
and damage to or destruction of the Company's, the Company's customer's or a
third party's property or equipment. Damage to the environment could also result
from the Company's operations, particularly through oil spillage or uncontrolled
fires. In addition, offshore drilling operations are subject to perils peculiar
to marine operations, including capsizing, grounding, collision and loss or
damage from severe weather. The Company has insurance coverage and contractual
indemnification for certain risks, but there can be no assurance that such
coverage or indemnification will adequately cover the Company's loss or
liability in many circumstances or that the Company will continue to carry such
insurance or receive such indemnification.
OPERATIONS OUTSIDE THE UNITED STATES
Operations outside the United States accounted for approximately 36.3
percent, 37.1 percent and 36.4 percent of the Company's total consolidated
revenues for the years ended December 31, 1997, 1996 and 1995, respectively. The
Company's non-U.S. operations are subject to certain political, economic and
other
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uncertainties not encountered in U.S. operations, including risks of war and
civil disturbances (or other risks that may limit or disrupt markets),
expropriation and the general hazards associated with the assertion of national
sovereignty over certain areas in which operations are conducted. The Company's
operations outside the United States may face the additional risk of fluctuating
currency values, hard currency shortages, controls of currency exchange and
repatriation of income or capital. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Other -- Currency Risk" in Item
7 and Note 14 to the Company's Consolidated Financial Statements in Item 8 of
this Report. No prediction can be made as to what governmental regulations may
be enacted in the future that could adversely affect the international drilling
industry.
EMPLOYEES
As of December 31, 1997, the Company had approximately 4,020 employees
(including international crews furnished through labor contractors),
approximately 80 of whom were union members. The Company has experienced
satisfactory labor relations and provides comprehensive benefit plans for its
employees. The improved opportunities for the offshore contract drilling
industry worldwide have resulted in increased demand for and a shortage of
experienced personnel necessary on offshore drilling rigs. As a result,
employment and retention of qualified personnel is likely to become more
difficult without significant increases in compensation.
ITEM 2. PROPERTIES.
The Company owns an eight-story office building containing approximately
182,000 net rentable square feet on approximately 6.2 acres of land located in
Houston, Texas, where the Company has its corporate headquarters, an 18,000
square foot building and 20 acres of land in New Iberia, Louisiana for its
offshore drilling warehouse and storage facility, and a 13,000 square foot
building and five acres of land in Aberdeen, Scotland for its North Sea
operations. Additionally, the Company currently leases various office, warehouse
and storage facilities in Louisiana, Africa, Australia, Brazil, India,
Indonesia, Scotland, Singapore, and The Netherlands to support its offshore
drilling operations.
ITEM 3. LEGAL PROCEEDINGS.
Brown Services, Inc. and KOS Industries, Inc. v. Michael D. Brown, BSI
International, Inc., Robert Brown, Robert Furlough, Power House International,
Inc., Zapata Off-Shore Company and Zapata Corporation; No. 92-05691 in the 334th
Judicial District Court of Harris County, Texas, filed February 7, 1992.
Plaintiffs sued Zapata Off-Shore Company and Zapata Corporation (the "Zapata
Defendants") for tortious interference with contract and conspiracy to
tortiously interfere with contract seeking $14.0 million in actual damages and
unspecified punitive damages, plus costs of court, interest and attorneys' fees.
A former subsidiary of Arethusa, which is now a subsidiary of the Company,
defended and indemnified the Zapata Defendants pursuant to a contractual defense
and indemnification agreement. In November 1997, the jury awarded a take nothing
judgment in favor of the Zapata Defendants. It is not yet known whether the
plaintiffs will appeal the judgment.
The Company and its subsidiaries are named defendants in certain other
lawsuits and are involved from time to time as parties to governmental
proceedings, all arising in the ordinary course of business. Although the
outcome of lawsuits or other proceedings involving the Company and its
subsidiaries cannot be predicted with certainty and the amount of any liability
that could arise with respect to such lawsuits or other proceedings cannot be
predicted accurately, management does not expect these matters to have a
material adverse effect on the financial position, results of operations, or
cash flows of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
There were no matters submitted to a vote of security holders of the
Company during the fourth quarter of 1997.
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EXECUTIVE OFFICERS OF THE REGISTRANT
In reliance on General Instruction G(3) to Form 10-K, information on
executive officers of the Registrant is included in this Part I. The executive
officers of the Company are elected annually by the Board of Directors to serve
until the next annual meeting of the Board of Directors, or until their
successors are duly elected and qualified, or until their earlier death,
resignation, disqualification or removal from office. Information with respect
to the executive officers of the Company is set forth below.
AGE AS OF
NAME JANUARY 31, 1998 POSITION
---- ---------------- --------
James S. Tisch......................... 45 Chairman of the Board and Chief
Executive Officer(1)(2)
Lawrence R. Dickerson.................. 45 President and Chief Operating Officer
and Director(1)(2)
Robert E. Rose......................... 59 President and Chief Executive Officer
and Director(2)
David W. Williams...................... 40 Executive Vice President(1)
Rodney W. Eads......................... 46 Senior Vice President -- Worldwide
Operations
Denis J. Graham........................ 48 Senior Vice President -- Technical
Services
Gary T. Krenek......................... 39 Vice President and Chief Financial
Officer(1)
Richard L. Lionberger.................. 47 Vice President, General Counsel and
Secretary
Leslie C. Knowlton..................... 30 Controller(1)
- ---------------
(1) Effective March 31, 1998.
(2) Robert E. Rose resigned as President and Chief Executive Officer and a
Director of the Company effective March 31, 1998.
James S. Tisch was elected to become Chief Executive Officer of the Company
effective March 31, 1998. Mr. Tisch has served as Chairman of the Board since
1995 and as a director of the Company since June 1989. Mr. Tisch has served as
President and Chief Operating Officer of Loews Corporation ("Loews"), a
diversified holding company and the Company's controlling stockholder, since
1994 and prior thereto served as Executive Vice President of Loews for more than
five years. Mr. Tisch, a director of Loews since 1986, also serves as a director
of CNA Financial Corporation, an 84 percent owned subsidiary of Loews, and
serves as a director of Vail Resort, Inc.
Lawrence R. Dickerson was elected President and Chief Operating Officer and
a Director of the Company effective March 31, 1998. Prior to such date, Mr.
Dickerson serves as Senior Vice President and Chief Financial Officer of the
Company. Mr. Dickerson has served as Chief Financial Officer of the Company
since June 1989. Mr. Dickerson has also served as Senior Vice President of the
Company since April 1993 and as Vice President of the Company from June 1989
through April 1993.
Robert E. Rose has served as President and Chief Executive Officer of the
Company and as a director since June 1989. Mr. Rose resigned as President and
Chief Executive Officer and a director of the Company effective March 31, 1998.
David W. Williams was elected Executive Vice President of the Company
effective March 31, 1998. Prior to such date, Mr. Williams serves as Senior Vice
President of the Company, which position he has held since December 1994. He was
a Marketing Vice President between February 1992 and May 1994. Mr. Williams was
employed by Noble Drilling Corporation, a contract drilling company, from May
1994 through December 1994 as Vice President of Marketing.
Rodney W. Eads has served as Senior Vice President of the Company since May
1997. Mr. Eads was employed by Exxon Company, International from August 1994
through May 1997 as Field Drilling Manager. From February 1991 through August
1994, Mr. Eads served as Drilling Manager for Esso Exploration & Production UK.
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Denis J. Graham has served as Senior Vice President of the Company since
July 1997 and from September 1993 through June 1997 as Vice President of the
Company. Previously, Mr. Graham served as Manager of Design Services for the
Company.
Gary T. Krenek was elected Vice President and Chief Financial Officer of
the Company effective March 31, 1998. Prior to such date, Mr. Krenek serves as
Controller of the Company, which position he has held since February 1992.
Richard L. Lionberger has served as Vice President, General Counsel and
Secretary of the Company since February 1992.
Leslie C. Knowlton was elected Controller of the Company effective March
31, 1998. Prior to such date, Ms. Knowlton serves as Assistant Controller of the
Company, which position she has held since August 1995. From February 1992
through July 1995, Ms. Knowlton served as Accounting Manager of the Company.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
PRICE RANGE OF COMMON STOCK
The Company's Common Stock is listed on the New York Stock Exchange
("NYSE") under the symbol "DO." The following table sets forth, for the calendar
quarters indicated, the high and low closing prices of Common Stock as reported
by the NYSE. Periods prior to the July 1997 two-for-one stock split in the form
of a stock dividend have been restated, giving retroactive effect to the stock
dividend. See Note 3 to the Company's Consolidated Financial Statements in Item
8 of this Report.
COMMON STOCK
-------------
HIGH LOW
---- ---
1997
First Quarter............................................... $36 1/2 $27 11/16
Second Quarter.............................................. 38 15/16 31 1/8
Third Quarter............................................... 59 1/8 39 1/4
Fourth Quarter.............................................. 66 3/4 42 5/8
1996
First Quarter............................................... $21 11/16 $16 11/16
Second Quarter.............................................. 28 1/2 21 3/4
Third Quarter............................................... 29 1/16 23 1/2
Fourth Quarter.............................................. 32 3/16 27 1/8
On January 30, 1998, the closing price of the Common Stock, as reported by
the NYSE, was $44 5/8 per share. As of January 30, 1998, there were
approximately 234 holders of record of Common Stock. This number does not
include the stockholders for whom shares are held in a "nominee" or "street"
name.
DIVIDEND POLICY
The Company paid cash dividends of $0.07 per share on August 7, 1997 and
December 1, 1997 and has declared a dividend of $0.125 per share payable March
2, 1998 to stockholders of record on February 6, 1998. In connection with the
Company's initial public offering in October 1995, the Company paid a special
dividend of $2.1 million to Loews Corporation ("Loews"), the Company's
controlling stockholder, with a portion of the proceeds. Any future
determination as to payment of dividends will be made at the discretion of the
Board of Directors of the Company and will depend upon the Company's operating
results, financial condition, capital requirements, general business conditions
and such other factors that the Board of Directors deems relevant.
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ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth certain historical consolidated financial
data relating to the Company. The selected consolidated financial data are
derived from the financial statements of the Company as of and for the periods
presented. The selected consolidated financial data below should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" in Item 7 and the Company's Consolidated Financial
Statements (including the Notes thereto) in Item 8 of this Report.
1997 1996(1) 1995 1994 1993
---------- ---------- ---------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
INCOME STATEMENT DATA:
Total revenues...................... $ 956,093 $ 611,430 $ 336,584 $ 307,918 $ 288,069
Operating income (loss)............. 419,873 213,491 11,651 (14,624) 4,455
Net income (loss)................... 278,605 146,388 (7,026) (34,804) (16,629)
Net income per share(2):
Basic............................. 2.01 1.18 -- -- --
Diluted........................... 1.93 1.18 -- -- --
Pro forma net income per
share(2)(3)....................... -- -- 0.10 -- --
BALANCE SHEET DATA:
Drilling and other property and
equipment, net.................... 1,451,741 1,198,160 502,278 488,664 498,740
Total assets........................ 2,298,561 1,574,500 618,052 588,158 592,162
Long-term debt...................... 400,000 63,000 -- 394,777 353,483
OTHER FINANCIAL DATA:
Capital expenditures................ 281,572 267,000 66,646 21,146 14,345
Cash dividends declared per
share(4).......................... 0.14 -- -- -- --
Ratio of earnings to fixed
charges(5)........................ 28.94x 31.56x -- -- --
- ---------------
(1) The Company acquired all of the common stock of Arethusa in consideration of
35.8 million shares of Common Stock effective April 29, 1996. See Note 2 to
the Company's Consolidated Financial Statements in Item 8 of this Report.
(2) All per share amounts give retroactive effect to the Company's July 1997
two-for-one stock split in the form of a stock dividend. See Note 3 to the
Company's Consolidated Financial Statements in Item 8 of this Report.
(3) Pro forma net income per share gives effect to the Company's initial public
offering and the after-tax effects of a reduction in interest expense.
Assuming the offering had occurred at January 1, 1995, the Company would
have recognized net income of $10.0 million, or $0.10 per share of Common
Stock, after adjusting for the after-tax effects of a reduction in interest
expense. See Note 1 to the Company's Consolidated Financial Statements in
Item 8 of this Report.
(4) The Company paid dividends of $0.07 per share on August 7, 1997 and on
December 1, 1997 and has declared a dividend of $0.125 per share payable
March 2, 1998 to stockholders of record on February 6, 1998. In connection
with the Company's initial public offering in 1995, the Company paid a
special dividend of $2.1 million to Loews with a portion of the proceeds. No
other dividends were declared or paid during the periods presented.
(5) The deficiency in the Company's earnings available for fixed charges for the
years ended December 31, 1995, 1994, and 1993 was approximately $13.8
million, $46.4 million, and $21.7 million, respectively. Fixed charges for
the years ended December 31, 1993 through December 31, 1995 consisted
primarily of interest expense on notes payable to Loews. For all periods
presented, the ratio of earnings to fixed charges has been computed on a
total enterprise basis. Earnings represent income (loss) from continuing
operations plus income taxes and fixed charges. Fixed charges include (i)
interest, whether expensed or
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capitalized, (ii) amortization of debt issuance costs, whether expensed or
capitalized, and (iii) one-third of rent expense, which the Company believes
represents the interest factor attributable to rent.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the Company's
Consolidated Financial Statements (including the Notes thereto) in Item 8 of
this Report.
RECENT EVENTS
On March 5, 1998, the Company announced several changes in its executive
management structure which will be effective March 31, 1998. Robert E. Rose
resigned as President and Chief Executive Officer and a Director of the Company
to pursue another opportunity. James S. Tisch, Chairman of the Board of
Directors, will assume the additional title of Chief Executive Officer. Lawrence
R. Dickerson, formerly Senior Vice President and Chief Financial Officer, was
elected President and Chief Operating Officer and Director. Mr. Dickerson will
serve on the Board's Executive Committee. David W. Williams, formerly Senior
Vice President -- Contracts and Marketing, was elected Executive Vice President.
Gary T. Krenek, formerly Controller, was elected Vice President and Chief
Financial Officer. Leslie C. Knowlton, formerly Assistant Controller, was
elected Controller for the Company.
RESULTS OF OPERATIONS
General
Revenues. The Company's revenues vary based upon demand, which affects the
number of days the fleet is utilized and the dayrates earned. Revenues can also
increase or decrease as a result of the acquisition or disposal of rigs. In
order to improve utilization or realize higher dayrates, the Company may
mobilize its rigs from one market to another. During periods of mobilization,
however, revenues may be adversely affected. As a response to changes in demand,
the Company may withdraw a rig from the market by stacking it or may reactivate
a rig which was previously stacked, which may decrease or increase revenues,
respectively.
Revenues from dayrate drilling contracts are recognized currently. The
Company may receive lump-sum payments in connection with specific contracts.
Such payments are recognized as revenues over the term of the related drilling
contract. Mobilization revenues less costs incurred to mobilize an offshore rig
from one market to another are recognized over the term of the related drilling
contract.
Operating Income. Operating income is primarily affected by revenue
factors, but is also a function of varying levels of operating expenses.
Operating expenses are not affected by changes in dayrates, nor are they
necessarily significantly affected by fluctuations in utilization. For instance,
if a rig is to be idle for a short period of time, the Company realizes few
decreases in operating expenses since the rig is typically maintained in a
prepared state with a full crew. However, if the rig is to be idle for an
extended period of time, the Company may reduce the size of a rig's crew and
take steps to "cold stack" the rig, which lowers expenses and partially offsets
the impact on operating income associated with loss of revenues. The Company
recognizes as an operating expense activities such as painting, inspections and
routine overhauls that maintain rather than upgrade its rigs. These expenses
vary from period to period. Costs of rig enhancements are capitalized and
depreciated over the expected useful lives of the enhancements. Increased
depreciation expense decreases operating income in periods subsequent to capital
upgrades. From time to time, the Company sells assets in the ordinary course of
its business and gains or losses associated with such sales are included in
operating income.
Merger with Arethusa. Effective April 29, 1996, the Arethusa Merger was
completed. Arethusa owned a fleet of 11 mobile offshore drilling rigs, operated
two additional mobile offshore drilling rigs pursuant to bareboat charters, and
provided drilling services worldwide to international and government-controlled
oil and gas companies. Because the Arethusa Merger was accounted for as a
purchase for financial reporting purposes, results of operations include those
of Arethusa from the effective date of the Arethusa Merger. See Note 2 to the
Company's Consolidated Financial Statements in Item 8 of this Report.
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YEARS ENDED DECEMBER 31, 1997 AND 1996
Comparative data relating to the Company's revenues and operating expenses
by equipment type are listed below (eliminations offset dayrate revenues earned
when the Company's rigs are utilized in its integrated services and intercompany
expenses charged to rig operations). Certain amounts applicable to the prior
periods have been reclassified to conform to the classifications currently
followed. Such reclassifications do not affect earnings.
During November 1997, July 1997, March 1997, and September 1996, the
Company completed its major upgrades of the Ocean Victory, the Ocean Clipper I,
the Ocean Star, and the Ocean Quest, respectively, expanding these rigs to have
fourth-generation capabilities. Upon completion, these rigs are included in
Fourth-Generation Semisubmersibles for discussion purposes (prior period
information will continue to include these rigs in Other Semisubmersibles).
YEAR ENDED
DECEMBER 31,
-------------------- INCREASE/
1997 1996 (DECREASE)
-------- -------- ----------
(IN THOUSANDS)
REVENUES
Fourth-Generation Semisubmersibles............... $206,708 $112,022 $ 94,686
Other Semisubmersibles........................... 545,701 341,163 204,538
Jack-ups......................................... 192,169 122,503 69,666
Integrated Services.............................. 36,342 32,798 3,544
Land............................................. -- 22,675 (22,675)
Other............................................ 3,257 -- 3,257
Eliminations..................................... (28,084) (19,731) (8,353)
-------- -------- --------
Total Revenues........................... $956,093 $611,430 $344,663
======== ======== ========
CONTRACT DRILLING EXPENSE
Fourth-Generation Semisubmersibles............... $ 64,314 $ 37,512 $ 26,802
Other Semisubmersibles........................... 234,578 191,937 42,641
Jack-ups......................................... 96,246 85,149 11,097
Integrated Services.............................. 34,464 30,344 4,120
Land............................................. -- 19,631 (19,631)
Other............................................ 6,119 (865) 6,984
Eliminations..................................... (29,378) (22,054) (7,324)
-------- -------- --------
Total Contract Drilling Expense.......... $406,343 $341,654 $ 64,689
======== ======== ========
OPERATING INCOME
Fourth-Generation Semisubmersibles............... $142,394 $ 74,510 $ 67,884
Other Semisubmersibles........................... 311,123 149,226 161,897
Jack-ups......................................... 95,923 37,354 58,569
Integrated Services.............................. 1,878 2,454 (576)
Land............................................. -- 3,044 (3,044)
Other............................................ (2,862) 865 (3,727)
Eliminations..................................... 1,294 2,323 (1,029)
Depreciation and Amortization Expense............ (108,335) (75,767) (32,568)
General and Administrative Expense............... (22,556) (15,640) (6,916)
Gain on Sale of Assets........................... 1,014 35,122 (34,108)
-------- -------- --------
Total Operating Income................... $419,873 $213,491 $206,382
======== ======== ========
Revenues. The $94.7 million increase in revenues from fourth-generation
semisubmersibles resulted, in part, from a $61.4 million increase in revenues
generated by the Ocean Victory, the Ocean Clipper I, the Ocean Star, and the
Ocean Quest upon completion of their upgrade projects in November 1997, July
1997, March 1997, and September 1996, respectively. However, utilization of the
Ocean Clipper I was less than
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expected due to subsea system equipment difficulties. Also, improvements in
dayrates in the Gulf of Mexico and the North Sea contributed $30.0 million of
additional revenue and increased utilization in the North Sea contributed $3.3
million of additional revenue during the year ended December 31, 1997. The
$204.5 million increase in revenues from other semisubmersibles resulted
primarily from $123.0 million of additional revenue for improvements in dayrates
in 1997. The average operating dayrate for other semisubmersibles was $67,400
per day in 1997, as compared to $50,100 per day in 1996. Also, $69.4 million of
additional revenue was generated primarily by the inclusion of operating results
for the eight semisubmersibles acquired in the Arethusa Merger for twelve months
in 1997 as compared to the inclusion of only eight months in 1996. In addition,
an increase of $12.1 million in revenue resulted primarily from improved
utilization in 1997 for several rigs that were either relocating or undergoing
repairs necessary for new contracts or locations in early 1996. The $69.7
million increase in revenues from jack-ups resulted primarily from improvements
in dayrates, which contributed $59.6 million of additional revenue. The average
operating dayrate for jack-ups was $37,000 per day in 1997 as compared to
$24,700 per day in 1996. In addition, the inclusion of operating results for the
jack-up rigs acquired in the Arethusa Merger for twelve months in 1997 as
compared to the inclusion of only eight months in 1996 resulted in $14.0 million
of additional revenue. Partially offsetting these increases was a decrease of
$3.9 million due to downtime incurred in late 1997 for a regulatory inspection
and leg reinforcement upgrade on the Ocean Tower and leg reinforcements and
other modifications on the Ocean Titan. The $3.5 million increase in revenues
from integrated services resulted from an increase in project management service
revenue during 1997 as compared to the prior year. The $22.7 million decrease in
land revenues resulted from the sale of the Company's land drilling assets in
December 1996. Other revenues of $3.3 million were generated by the
Polyconfidence, a semisubmersible accommodation vessel purchased in May 1997.
See "-- Capital Resources."
Contract Drilling Expense. The $26.8 million increase in contract drilling
expense for fourth-generation semisubmersibles resulted primarily from
additional operating expense of $23.3 million from the Ocean Victory, the Ocean
Clipper I, the Ocean Star, and the Ocean Quest, which was generated upon
completion of their major upgrades. Also, the Ocean Valiant recognized increased
expenses in late 1997 in preparation for its relocation from the Gulf of Mexico
to West Africa. The $42.6 million increase for other semisubmersibles resulted
primarily from $42.7 million of additional costs generated by the
semisubmersibles acquired in the Arethusa Merger. These additional costs were
primarily due to the inclusion of operating results for these rigs for twelve
months in 1997 as compared to the inclusion of only eight months in 1996. Also,
higher operating costs incurred in connection with the reactivation of the Ocean
Century to work in the Gulf of Mexico and regulatory inspections and associated
repairs on the Ocean Saratoga in early 1997 and the Ocean General in late 1997
resulted in increased contract drilling expense as compared to the prior year.
Partially offsetting these increases was a decrease of approximately $4.5
million due to the reclassification of operations for the Ocean Clipper I to
fourth-generation semisubmersibles upon completion of its upgrade in July 1997.
The sale of the Ocean Zephyr, a semisubmersible located offshore Brazil, in 1997
also reduced expenses by $3.1 million as compared to 1996. The $11.1 million
increase in jack-up expense resulted primarily from the rigs acquired in the
Arethusa Merger, regulatory inspections and associated repairs on the Ocean
Scotian, the Ocean Crusader, and the Ocean King, and leg reinforcement and other
modifications on the Ocean Titan. Partially offsetting these increases was a
decrease of $2.0 million resulting from the termination of the bareboat charter
agreement in 1996 for the Bonito II, a jack-up rig previously operated by the
Company. The $4.1 million increase in expenses for integrated services resulted
primarily from increased intercompany rates charged for rigs utilized in project
management services (offset in eliminations) during 1997 as compared to 1996.
The $19.6 million decrease in land expense resulted from the sale of the
Company's land drilling assets in December 1996. Other contract drilling expense
increased $7.0 million primarily due to expenses associated with crew training
programs for new employees and certain non-recurring charges in 1997 and
non-recurring credits recognized in the prior year.
Depreciation and Amortization Expense. Depreciation and amortization
expense of $108.3 million for the year ended December 31, 1997 increased
primarily due to additional expense for (i) the eight semisubmersibles and three
jack-up drilling rigs acquired in the Arethusa Merger, (ii) goodwill
amortization expense associated with the Arethusa Merger, (iii) rig upgrades
completed in 1997 and 1996, (iv) capital
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expenditures associated with the Company's continuing rig enhancement program,
and (v) the Polyconfidence, which was acquired in May 1997. See "-- Capital
Resources."
General and Administrative Expense. General and administrative expense of
$22.6 million for the year ended December 31, 1997 increased from $15.6 million
for the year ended December 31, 1996 primarily due to (i) additional overhead
resulting from the Arethusa Merger, (ii) increased accruals for the Company's
employee bonus and retention plan, and (iii) increased legal fees associated
with various legal matters. See Note 9 to the Company's Consolidated Financial
Statements in Item 8 of this Report. The increased accruals for the employee
bonus and retention plan resulted from a higher bonus pool for the 1997
performance year and from additional participants in the plan.
Gain on Sale of Assets. Gain on sale of assets for the year ended December
31, 1997 consisted primarily of the gain associated with the sale of the Ocean
Zephyr, a semisubmersible drilling rig located offshore Brazil. Gain on sale of
assets for the year ended December 31, 1996 resulted primarily from the sale of
all of the operational assets of Diamond M Onshore, Inc., the Company's wholly
owned land drilling subsidiary, resulting in a gain of $24.0 million. Also
during 1996, the Company sold two shallow water jack-up drilling rigs, the Ocean
Magallanes and the Ocean Conquest, and one semisubmersible, the Ocean Zephyr II,
resulting in gains totaling $10.8 million.
Interest Income. Interest income of $19.4 million for the year ended
December 31, 1997 consisted primarily of the accretion of discounts and interest
earned on investments of excess cash primarily generated by the issuance of the
Notes. See " -- Liquidity."
Interest Expense. Interest expense of $10.3 million for the year ended
December 31, 1997 consisted primarily of $14.7 million interest on the Notes,
partially offset by $4.4 million interest capitalized to major upgrades.
Interest expense for the year ended December 31, 1996 included $2.2 million of
origination costs, including costs previously capitalized, which were expensed
in connection with the restructuring of a revolving credit facility during
December 1996. See Note 8 to the Company's Consolidated Financial Statements in
Item 8 of this Report.
Income Tax Expense. Income tax expense for the year ended December 31, 1997
was $151.5 million as compared to $66.3 million for the prior year. This change
resulted primarily from the increase of $217.4 million in the Company's income
before income tax expense and a reduction in income tax expense during the prior
year. In 1996, benefits for utilization of previously unrecorded net operating
losses in a foreign jurisdiction were recognized, which contributed to the
reduction in income tax expense. See Note 12 to the Company's Consolidated
Financial Statements in Item 8 of this Report.
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YEARS ENDED DECEMBER 31, 1996 AND 1995
Comparative data relating to the Company's revenues and operating expenses
by equipment type are listed below (eliminations offset dayrate revenues earned
when the Company's rigs are utilized in its integrated services and intercompany
expenses charged to rig operations). Certain amounts applicable to the prior
periods have been reclassified to conform to the classifications currently
followed. Such reclassifications do not affect earnings.
During September 1996, the Company completed its major upgrade of the Ocean
Quest, expanding the rig to have fourth-generation capabilities. Upon
completion, the Ocean Quest is included in Fourth-Generation Semisubmersibles
for discussion purposes (prior period information will continue to include the
rig in Other Semisubmersibles). The Company's drillship, Ocean Clipper I, is
included in Other Semisubmersibles for discussion purposes.
YEAR ENDED
DECEMBER 31,
-------------------- INCREASE/
1996 1995 (DECREASE)
-------- -------- ----------
(IN THOUSANDS)
REVENUES
Fourth-Generation Semisubmersibles............... $112,022 $ 67,393 $ 44,629
Other Semisubmersibles........................... 341,163 168,582 172,581
Jack-ups......................................... 122,503 68,829 53,674
Integrated Services.............................. 32,798 27,121 5,677
Land............................................. 22,675 19,926 2,749
Other............................................ -- 4 (4)
Eliminations..................................... (19,731) (15,271) (4,460)
-------- -------- --------
Total Revenues........................... $611,430 $336,584 $274,846
======== ======== ========
CONTRACT DRILLING EXPENSE
Fourth-Generation Semisubmersibles............... $ 37,512 $ 34,717 $ 2,795
Other Semisubmersibles........................... 191,937 129,795 62,142
Jack-ups......................................... 85,149 60,798 24,351
Integrated Services.............................. 30,344 30,297 47
Land............................................. 19,631 17,899 1,732
Other............................................ (865) 3,011 (3,876)
Eliminations..................................... (22,054) (16,957) (5,097)
-------- -------- --------
Total Contract Drilling Expense.......... $341,654 $259,560 $ 82,094
======== ======== ========
OPERATING INCOME
Fourth-Generation Semisubmersibles............... $ 74,510 $ 32,676 $ 41,834
Other Semisubmersibles........................... 149,226 38,787 110,439
Jack-ups......................................... 37,354 8,031 29,323
Integrated Services.............................. 2,454 (3,176) 5,630
Land............................................. 3,044 2,027 1,017
Other............................................ 865 (3,007) 3,872
Eliminations..................................... 2,323 1,686 637
Depreciation and Amortization Expense............ (75,767) (52,865) (22,902)
General and Administrative Expense............... (15,640) (13,857) (1,783)
Gain on Sale of Assets........................... 35,122 1,349 33,773
-------- -------- --------
Total Operating Income................... $213,491 $ 11,651 $201,840
======== ======== ========
Revenues. The $44.6 million increase in revenues from fourth-generation
semisubmersibles resulted from improvements in dayrates ($26.5 million) and
increases in utilization ($18.1 million). The improvement in utilization for
1996 was partially attributable to the relocation of two fourth-generation rigs
during the prior year, reducing the days worked for these rigs during that
period. The $172.6 million increase in revenues from other semisubmersibles was
primarily attributable to $90.9 million of revenues from the eight
semisubmersibles acquired in the Arethusa Merger and increases in dayrates in
both the North Sea and the Gulf of
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20
Mexico. The $53.7 million increase in revenues from jack-ups resulted primarily
from revenues associated with rigs acquired in the Arethusa Merger and
improvements in dayrates in the Gulf of Mexico. The $5.7 million increase in
revenues from integrated services resulted from an increase in project
management service revenue during 1996 as compared to the prior year.
Contract Drilling Expense. Contract drilling expense for fourth-generation
semisubmersibles increased $2.8 million primarily due to the completion of the
major upgrade of the Ocean Quest which, beginning in September 1996, was
included as a fourth-generation semisubmersible as compared to the prior year.
The $62.1 million increase for other semisubmersibles resulted from the
additional rigs acquired in the Arethusa Merger, increased expenses for shipyard
repairs on three rigs, and increased expenses attributable to improved
utilization during 1996. These increases were partially offset by a reduction in
local payroll expenses resulting from the relocation of a rig and decreased
expenses for a rig undergoing a major upgrade during 1996. The $24.4 million
increase in jack-up expense resulted primarily from the rigs acquired in the
Arethusa Merger, partially offset by decreased operating expenses for two rigs
which were cold stacked during 1996 (one of which was sold in July 1996).
Integrated services expense was relatively unchanged from the prior year. Other
contract drilling expense decreased $3.9 million primarily due to collections
from a settlement in connection with a lawsuit and collections on accounts
receivable written off in the prior year.
Depreciation and Amortization Expense. Depreciation and amortization
expense of $75.8 million for the year ended December 31, 1996 increased
primarily due to additional expense for (i) the eight semisubmersibles and three
jack-up drilling rigs acquired in the Arethusa Merger, (ii) goodwill
amortization expense associated with the Arethusa Merger, (iii) three rig
upgrades completed in 1995, and (iv) capital expenditures associated with the
Company's continuing rig enhancement program. Partially offsetting these
increases was a change in accounting estimate to increase the estimated useful
lives for certain classes of rigs. This change reduced depreciation expense by
approximately $8.5 million, as compared to the year ended December 31, 1995.
General and Administrative Expense. General and administrative expense of
$15.6 million for the year ended December 31, 1996 increased due to the Arethusa
Merger; however, these increases were partially offset by cost savings in rent
due to the February 1996 purchase of the building in which the Company has its
corporate headquarters. In addition, approximately $0.8 million of general and
administrative expense associated with the major upgrades of the Ocean Quest,
the Ocean Star, the Ocean Victory and the Ocean Clipper I was capitalized to
these projects during 1996.
Gain on Sale of Assets. Gain on sale of assets for the year ended December
31, 1996 consisted primarily of the sale of all of the operational assets of
Diamond M Onshore, Inc., the Company's wholly owned land drilling subsidiary,
resulting in a gain of $24.0 million. In addition, the Company sold two shallow
water jack-up drilling rigs, the Ocean Magallanes and the Ocean Conquest, and
one semisubmersible, the Ocean Zephyr II, resulting in gains totaling $10.8
million.
Interest Expense. Interest expense of $2.3 million for the year ended
December 31, 1996 primarily consisted of $2.2 million to expense origination
costs, including costs previously capitalized, in connection with the
restructuring of a revolving credit facility during December 1996. The decrease
from $27.1 million for the prior year was attributable to a reduction in
outstanding indebtedness resulting from the repayment of the Company's loan from
Loews in connection with the Company's initial public offering. In addition,
interest costs associated with the Company's financing arrangements were
capitalized with respect to qualified construction projects during 1996.
Income Tax (Expense) Benefit. Income tax (expense) benefit for the year
ended December 31, 1996 was $(66.3) million as compared to $6.8 million for the
prior year. This change resulted primarily from the increase of $226.5 million
in the Company's income before income tax expense, partially offset by the
recognition of benefits for utilization of previously unrecorded net operating
losses in a foreign jurisdiction in 1996. In addition, during the year ended
December 31, 1995, the Company's tax benefit reflected the effects of profits in
foreign jurisdictions where the Company's tax liability was minimal. See Note 12
to the Company's Consolidated Financial Statements in Item 8 of this Report.
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OUTLOOK
The Company continues to benefit from increased demand and from the recent
tight supply of major offshore drilling rigs worldwide. These conditions are
due, in part, to the increasing impact of technological advances, including 3-D
seismic, horizontal drilling, and subsea completion procedures, on oil and gas
exploration and development economics. To address the current tight supply
situation, customers seek to contract rigs for term commitments (as opposed to
contracts for the drilling of a single well or a group of wells) in many cases,
and often will pay for upgrades and modifications necessary for more challenging
drilling locations in order to assure rig availability. The Company seeks to
have a foundation of long-term contracts with a reasonable balance of short-term
or well-to-well contracts to minimize risk while participating in the benefit of
increasing dayrates in a rising market.
The Company continues to enhance its fleet to meet customer demand for
diverse drilling capabilities, including those required for deep water and harsh
environment operations. In March 1997, the Company completed the major upgrade
of the Ocean Star to fourth-generation capabilities and the rig began a three-
year commitment in the deep water market of the Gulf of Mexico. In July 1997,
the Ocean Clipper I began a four-year contract in the deep water market of the
Gulf of Mexico following its upgrade project. The Ocean Victory, previously
stacked in the North Sea, completed modifications in connection with its
three-year deep water drilling program in the Gulf of Mexico which began in
November 1997. In addition, the Company began the conversion of the
Polyconfidence, a semisubmersible accommodation vessel, in connection with a
five-year commitment in the Gulf of Mexico anticipated to begin in late 1999.
In February 1998, a fire was detected in the engine room of the Ocean
Victory, which was operating in the Gulf of Mexico. Although the fire was
contained and extinguished, damage was done to the power and electrical systems
aboard the rig. In March 1998, the rig was dockside in Mobile, Alabama for
further damage evaluation. Until that process is completed, the Company is
unable to determine how long the rig will be under repair. It is possible that
the repair period could remove the rig from service for a significant portion of
1998. The Company expects that its insurance will cover the repairs, but the
loss of revenue during the repair period is not covered by insurance. As a
result, the loss of such revenues will reduce the Company's results of
operations for 1998.
The ability to minimize costs and downtime is critical to the Company's
results of operations. The improved opportunities for the offshore contract
drilling industry worldwide have resulted in increased demand for and a shortage
of experienced personnel and equipment, including drill pipe and riser,
necessary on offshore drilling rigs. The Company does not consider the shortage
of such personnel and equipment currently to be a material factor in its
business. However, because of the increased demand for oil field services, a
significant increase in costs, including compensation and training, is likely to
occur if present trends continue for an extended period. In addition, because of
periodic inspections required by certain regulatory agencies, 15 of the
Company's rigs will be in the shipyard for a portion of 1998. The Company
intends to focus on returning these rigs to operations as soon as reasonably
possible, in order to minimize the downtime and associated loss of revenues.
In addition, the recent improvement in the current results of operations
and prospects for the offshore contract drilling industry as a whole has led to
increased rig construction and enhancement programs by the Company's
competitors. A significant increase in the supply of technologically advanced
rigs capable of drilling in deep water may have an adverse effect on the average
operating dayrates for the Company's rigs, particularly its more advanced
semisubmersible units, and on the overall utilization level of the Company's
fleet. In such case, the Company's results of operations would be adversely
affected.
The offshore contract drilling industry historically has been highly
competitive and cyclical and, although not currently a material factor in the
Company's markets, weak commodity prices, economic problems in countries outside
the United States, or a number of other influencing factors could curtail
spending by oil and gas companies and possibly depress the offshore drilling
industry. Therefore, the Company cannot predict whether and, if so, to what
extent current market conditions will continue.
21
22
LIQUIDITY
At December 31, 1997, cash and short-term investments totaled $466.1
million, up from $28.2 million at December 31, 1996. Cash provided by operating
activities for the year ended December 31, 1997 increased by $186.2 million to
$396.4 million, as compared to $210.2 million for the prior year. This increase
was primarily attributable to a $132.2 million increase in net income and a
$32.6 million increase in depreciation and amortization expense primarily
resulting from the Arethusa Merger and completion of upgrade projects.
Investing activities used $706.0 million in cash during the year ended
December 31, 1997, as compared to $200.3 million during the prior year. In May
1997, the Company purchased the Polyconfidence, a semisubmersible accommodation
vessel, for approximately $81.0 million in cash. See "-- Capital Resources." In
addition, the Company purchased U.S. Treasury securities, equity securities, and
also invested excess cash under repurchase agreements with third parties,
primarily major brokerage firms, for a set rate of return. Capital expenditures
also increased substantially during 1997 as the Company continued to invest in
major upgrades of its existing fleet.
Cash provided by financing activities for 1997 increased $376.4 million to
$384.4 million, as compared to $8.0 million of cash provided by financing
activities for 1996. Sources of financing during the year ended December 31,
1997 consisted primarily of the Company's issuance of the Notes, which resulted
in net proceeds of approximately $393.9 million. Also, in April 1997, the
Company completed a public offering of 2.5 million shares of common stock
generating net proceeds of approximately $82.3 million. The proceeds of the
offering were used to finance the acquisition of the Polyconfidence. See
"-- Capital Resources." Financing applications of cash during 1997 included
repayment of amounts outstanding under the Company's short and long-term credit
arrangements and the payment of cash dividends to stockholders.
The Notes, issued in February 1997, have a stated and effective interest
rate of 3.75 percent and 3.93 percent, respectively, and are due February 15,
2007. The Notes are convertible, in whole or in part, at the option of the
holder at any time prior to the close of business on the business day
immediately preceding the maturity date into shares of Common Stock, at a
conversion price of $40.50 per share (equivalent to a conversion rate of 24.691
shares per $1,000 principal amount of Notes), subject to adjustment in certain
circumstances. Interest on the Notes is payable in cash semi-annually on each
February 15 and August 15. The Notes are redeemable, in whole or from time to
time in part, at the option of the Company, at any time on or after February 22,
2001 at specified redemption prices, plus accrued and unpaid interest to the
date of redemption. The Notes are general unsecured obligations of the Company,
subordinated in right of payment to the prior payment in full of the principal
and premium, if any, and interest on all indebtedness of the Company for
borrowed money, other than the Notes, with certain exceptions, and effectively
subordinated in right of payment to the prior payment in full of all
indebtedness of the Company's subsidiaries. The Notes do not restrict the
Company's ability to incur other indebtedness or additional indebtedness of the
Company's subsidiaries.
In August 1997, the Company terminated its revolving credit facility which
had provided a maximum credit commitment of $200.0 million until December 2001.
However, the Company has the ability to issue an aggregate of approximately
$117.5 million in debt, equity and other securities under a "shelf" registration
statement. In addition, the Company may issue, from time to time, up to eight
million shares of Common Stock, which shares are registered under an
"acquisition shelf" registration statement (upon effectiveness of an amendment
thereto reflecting the effect of the two-for-one stock split declared in July
1997), in connection with one or more acquisitions by the Company of securities
or assets of other businesses.
The Company believes that it has the financial resources needed to meet its
business requirements in the foreseeable future, including capital expenditures
for major upgrades and continuing rig enhancements, and working capital
requirements.
CAPITAL RESOURCES
Cash requirements for capital commitments result from rig upgrades to meet
specific customer requirements and from the Company's continuing rig enhancement
program, including top-drive drilling
22
23
system installations and water depth and drilling capability upgrades. It is
management's opinion that operating cash flow resulting from current conditions
of improved dayrates and high utilization, in conjunction with proceeds from the
Notes, will be sufficient to meet these capital commitments. In addition, the
Company may, from time to time, issue debt or equity securities, or a
combination thereof, to finance capital expenditures, the acquisition of assets
and businesses, or for general corporate purposes. The Company's ability to
effect any such issuance will be dependent on the Company's results of
operations, its current financial condition and other factors beyond its
control.
During the year ended December 31, 1997, the Company expended $203.7
million, including capitalized interest expense, for significant rig upgrades in
connection with contract requirements. Such upgrades included completion of
modifications to the Ocean Star, the Ocean Clipper I, and the Ocean Victory. In
addition, a cantilever conversion project on the Ocean Warwick, a jack-up
drilling rig located in the Gulf of Mexico, began in early 1997. Also, leg
strengthening and other modifications began in late 1997 on the Ocean Tower, a
jack-up drilling rig operating in the Gulf of Mexico. Both upgrades are
anticipated to be completed in the first half of 1998.
The Company has budgeted $108.5 million for rig upgrade capital
expenditures during 1998. Included in this amount is approximately $93.5 million
for 1998 expenditures associated with the conversion of the Polyconfidence (soon
to be renamed Ocean Confidence) from an accommodation vessel to a
semisubmersible drilling unit capable of operating in harsh environments and
ultra-deep waters. The conversion includes enhancements which will provide
capabilities greater than existing fourth-generation equipment: capability for
operation in 7,500 foot water depths, approximately 6,000 tons variable deck
load, a 15,000 psi blow-out prevention system and four mud pumps to complement
the existing Class III dynamic-positioning system. Upon completion of the
conversion, the rig will begin a five-year drilling program in the Gulf of
Mexico, which is anticipated to commence in late 1999.
The Company generally seeks to mitigate financial risk associated with its
upgrade projects by deferring commencement of an upgrade until a term drilling
contract is secured with major integrated or large independent oil companies
with projected contract revenues substantially covering the upgrade costs. The
Company expects to evaluate other projects as opportunities arise.
During the year ended December 31, 1997, the Company expended $77.9 million
associated with its continuing rig enhancement program and other corporate
requirements, including $21.5 million to reactivate the Ocean Century to work in
the Gulf of Mexico. In addition to rig upgrade capital expenditures, the Company
has budgeted $126.7 million for 1998 capital expenditures associated with its
continuing rig enhancement program, spare equipment and other corporate
requirements. The increase in budgeted expenditures for 1998 is primarily
attributable to anticipated purchases of anchor chain, drill pipe, riser, and
other drilling equipment.
The Company is continually considering potential transactions including,
but not limited to, enhancement of existing rigs, the purchase of existing rigs,
construction of new rigs and the acquisition of other companies engaged in
contract drilling. Certain of the potential transactions reviewed by the Company
would, if completed, result in its entering new lines of business, although, in
general, these opportunities have been related in some manner to the Company's
existing operations. For example, the Company has explored the possibility of
acquiring certain floating production systems, crew accommodation units similar
to the Polyconfidence, oil service companies providing subsea products,
technology and services, oil and gas exploration companies, and shipping assets
such as oil tankers, through the acquisition of existing businesses or assets or
new construction. Although the Company does not, as of the date hereof, have any
commitment with respect to a material acquisition, it could enter into such
agreement in the future and such acquisition could result in a material
expansion of its existing operations or result in its entering a new line of
business. Some of the potential acquisitions considered by the Company could, if
completed, result in the expenditure of a material amount of funds or the
issuance of a material amount of debt or equity securities.
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RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 131, "Disclosure About
Segments of an Enterprise and Related Information." The statement provides
standards for reporting information about operating segments in annual financial
statements and requires selected information about operating segments to be
reported in interim financial statements. SFAS No. 131 is effective for fiscal
years beginning after December 15, 1997, with restatements of prior years'
comparative information required.
Also in June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income." This statement establishes standards for reporting comprehensive income
and its components and requires that an enterprise (i) classify items of other
comprehensive income by their nature in a financial statement and (ii) display
the accumulated balance of other comprehensive income separately from retained
earnings and additional paid-in capital in the equity section of a statement of
financial position. The statement is effective for fiscal years beginning after
December 15, 1997, with reclassification of prior years' comparative information
required.
The Company does not expect the adoption of these statements to have a
material effect on its financial position or results of operations.
FORWARD-LOOKING STATEMENTS
Certain written and oral statements made or incorporated by reference from
time to time by the Company or its representatives are "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. Forward-looking statements include, without limitation, any statement
that may project, indicate or imply future results, performance or achievements,
and may contain the words "expect," "intend," "plan," "anticipate," "estimate,"
"believe," "will be," "will continue," "will likely result," and similar
expressions. Such statements inherently are subject to a variety of risks and
uncertainties that could cause actual results to differ materially from those
projected. Such risks and uncertainties include, among others, general economic
and business conditions, operating difficulties arising from shortages of
equipment or qualified personnel or as a result of other causes, casualty
losses, industry fleet capacity, changes in foreign and domestic oil and gas
exploration and production activity, competition, changes in foreign, political,
social and economic conditions, regulatory initiatives and compliance with
governmental regulations, the ability to attract and retain qualified personnel,
customer preferences and various other matters, many of which are beyond the
Company's control. The risks included here are not exhaustive. Other sections of
this Report and the Company's other filings with the Securities and Exchange
Commission include additional factors that could adversely impact the Company's
business and financial performance. Given these risks and uncertainties,
investors should not place undue reliance on forward-looking statements. The
Company expressly disclaims any obligation or undertaking to release publicly
any updates or revisions to any forward-looking statement to reflect any change
in the Company's expectations with regard thereto or any change in events,
conditions or circumstances on which any forward-looking statement is based.
OTHER
Year 2000 Issues. The Company has addressed the impact of the upcoming
change in the century on the Company's business, operations, and financial
condition. However, the impact is dependent upon many factors, including the
Company's software and hardware, as well as that of the Company's suppliers,
customers, creditors, and financial service organizations. While the cost of
addressing Year 2000 issues is not anticipated to be material, the Company is
continuing to monitor, on an ongoing basis, the problems and uncertainties
associated with these issues and their consequences.
Currency Risk. Certain of the Company's subsidiaries use the local currency
in the country where they conduct operations as their functional currency.
Currency environments in which the Company has material business operations
include the U.K., Australia, Brazil, Indonesia and Africa. The Company generally
attempts to minimize its currency exchange risk by seeking international
contracts payable in local currency in amounts equal to the Company's estimated
operating costs payable in local currency and in U.S. dollars for
24
25
the balance of the contract. Because of this strategy, the Company has minimized
its unhedged net asset or liability positions denominated in local currencies
and has not experienced significant gains or losses associated with changes in
currency exchange rates. However, at present, contracts covering three of the
Company's four rigs operating in the U.K. sector of the North Sea are payable in
U.S. dollars. The Company has not hedged its exposure to changes in the exchange
rate between U.S. dollars and pounds sterling for operating costs payable in
pounds sterling, although it may seek to do so in the future.
Currency translation adjustments are accumulated in a separate section of
stockholders' equity. When the Company ceases its operations in a currency
environment, the accumulated adjustments are recognized currently in results of
operations. Additionally, translation gains and losses for the Company's
operations in areas which have experienced cumulative inflation of approximately
100 percent or more over a three-year period are recognized currently. The
effect on results of operations from these translation gains and losses has not
been material and is not expected to have a significant effect in the future.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information included in this Item is considered to constitute "forward
looking statements" for purposes of the statutory safe harbor provided in
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Forward-Looking
Statements" in Item 7 of this Report.
INTEREST RATE AND EQUITY PRICE SENSITIVITY
The Company's financial instruments that are potentially sensitive to
changes in interest rates include the Notes and investments through repurchase
agreements. In addition, the Company's investment in equity securities is
sensitive to equity price risk. The Notes, which are due February 15, 2007, have
a stated interest rate of 3.75 percent and an effective interest rate of 3.93
percent. At December 31, 1997, the fair value of the Notes, based on quoted
market prices, was approximately $527.0 million, as compared to a carrying
amount of $400.0 million. The Company's investments through repurchase
agreements bear interest at rates ranging from 5.00 to 6.00 percent. However,
these instruments are callable by the Company at any time or have original
maturities generally less than three months. At December 31, 1997, the
contracted amounts of such investments totaled $350.0 million, which
approximates fair value because of the nature and short maturity of these
instruments. At December 31, 1997, the fair value of the Company's investment in
equity securities was approximately $13.1 million, which includes an unrealized
holding loss of $0.2 million. Based on consideration of past market movements
and reasonably possible, near-term market movements, the Company does not
believe that potential, near-term losses in future earnings, fair values, or
cash flows are likely to be material.
EXCHANGE RATE SENSITIVITY
Other than trade accounts receivable and trade accounts payable, the
Company does not currently have financial instruments that are sensitive to
foreign currency exchange rates.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders
Diamond Offshore Drilling, Inc. and subsidiaries
Houston, Texas
We have audited the accompanying consolidated balance sheets of Diamond
Offshore Drilling, Inc. and subsidiaries as of December 31, 1997 and 1996, and
the related consolidated statements of operations, stockholders' equity and cash
flows for each of the three years in the period ended December 31, 1997. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of Diamond Offshore Drilling, Inc.
and subsidiaries as of December 31, 1997 and 1996, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1997, in conformity with generally accepted accounting principles.
DELOITTE & TOUCHE LLP
Houston, Texas
January 22, 1998
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27
DIAMOND OFFSHORE DRILLING, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
ASSETS
DECEMBER 31,
------------------------
1997 1996
---------- ----------
Current assets:
Cash and cash equivalents................................. $ 102,958 $ 28,180
Short-term investments.................................... 363,137 --
Accounts receivable....................................... 205,589 172,214
Rig inventory and supplies................................ 33,714 30,407
Prepaid expenses and other................................ 13,377 12,166
---------- ----------
Total current assets.............................. 718,775 242,967
Drilling and other property and equipment, net of
accumulated depreciation.................................. 1,451,741 1,198,160
Goodwill, net of accumulated amortization................... 118,623 129,825
Other assets................................................ 9,422 3,548
---------- ----------
Total assets...................................... $2,298,561 $1,574,500
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 57,557 $ 63,172
Accrued liabilities....................................... 48,935 28,451
Taxes payable............................................. 24,653 26,377
Short-term borrowings..................................... -- 10,000
---------- ----------
Total current liabilities......................... 131,145 128,000
Long-term debt.............................................. 400,000 63,000
Deferred tax liability...................................... 209,513 176,296
Other liabilities........................................... 22,376 12,472
---------- ----------
Total liabilities................................. 763,034 379,768
---------- ----------
Commitments and contingencies
Stockholders' equity:
Preferred stock (par value $0.01, 25,000,000 shares
authorized, none issued and outstanding)............... -- --
Common stock (par value $0.01, 200,000,000 shares
authorized, 139,309,948 and 68,353,409 shares issued
and outstanding at December 31, 1997 and 1996,
respectively).......................................... 1,393 684
Additional paid-in capital................................ 1,302,712 1,220,032
Retained earnings (accumulated deficit)................... 233,350 (25,056)
Cumulative translation adjustment......................... (1,822) (928)
Unrealized loss on investment securities.................. (106) --
---------- ----------
Total stockholders' equity........................ 1,535,527 1,194,732
---------- ----------
Total liabilities and stockholders' equity........ $2,298,561 $1,574,500
========== ==========
The accompanying notes are an integral part of the consolidated financial
statements.
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DIAMOND OFFSHORE DRILLING, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31,
---------------------------------
1997 1996 1995
--------- -------- --------
Revenues.................................................. $ 956,093 $611,430 $336,584
Operating expenses:
Contract drilling....................................... 406,343 341,654 259,560
Depreciation and amortization........................... 108,335 75,767 52,865
General and administrative.............................. 22,556 15,640 13,857
Gain on sale of assets.................................. (1,014) (35,122) (1,349)
--------- -------- --------
Total operating expenses........................ 536,220 397,939 324,933
--------- -------- --------
Operating income.......................................... 419,873 213,491 11,651
Other income (expense):
Interest income......................................... 19,379 879 1,226
Interest expense........................................ (10,270) (2,326) (27,052)
Other, net.............................................. 1,079 661 372
--------- -------- --------
Income (loss) before income tax (expense) benefit......... 430,061 212,705 (13,803)
Income tax (expense) benefit.............................. (151,456) (66,317) 6,777
--------- -------- --------
Net income (loss)......................................... $ 278,605 $146,388 $ (7,026)
========= ======== ========
Net income per share:
Basic................................................... $ 2.01 $ 1.18 $ --
========= ======== ========
Diluted................................................. $ 1.93 $ 1.18 $ --
========= ======== ========
Pro forma (Note 1)...................................... $ -- $ -- $ 0.10
========= ======== ========
Weighted average shares outstanding:
Common shares........................................... 138,560 124,462
Dilutive potential common shares........................ 8,929 --
--------- --------
Total weighted average shares outstanding....... 147,489 124,462
========= ========
The accompanying notes are an integral part of the consolidated financial
statements.
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29
DIAMOND OFFSHORE DRILLING, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT NUMBER OF SHARES)
RETAINED
COMMON STOCK ADDITIONAL EARNINGS CUMULATIVE LOSS ON TOTAL
-------------------- PAID-IN (ACCUMULATED TRANSLATION INVESTMENT STOCKHOLDERS'
SHARES AMOUNT CAPITAL DEFICIT) ADJUSTMENT SECURITIES EQUITY
----------- ------ ---------- ------------ ----------- ---------- -------------
December 31, 1994................ 100 $ 1 $ 289,685 $(164,418) $(1,202) $ -- $ 124,066
Net loss....................... -- -- -- (7,026) -- -- (7,026)
Capital contribution........... -- -- 39,676 -- -- -- 39,676
350,500-for-one stock split.... 35,049,900 350 (350) -- -- -- --
Issuance of common stock....... 14,950,000 149 338,214 -- -- -- 338,363
Dividend to Loews.............. -- -- (2,118) -- -- -- (2,118)
Exchange rate changes, net..... -- -- -- -- (67) -- (67)
----------- ------ ---------- --------- ------- ----- ----------
December 31, 1995................ 50,000,000 500 665,107 (171,444) (1,269) -- 492,894
----------- ------ ---------- --------- ------- ----- ----------
Net income..................... -- -- -- 146,388 -- -- 146,388
Merger with Arethusa........... 17,893,344 179 550,507 -- -- -- 550,686
Stock options exercised........ 460,065 5 4,418 -- -- -- 4,423
Exchange rate changes, net..... -- -- -- -- 341 -- 341
----------- ------ ---------- --------- ------- ----- ----------
December 31, 1996................ 68,353,409 684 1,220,032 (25,056) (928) -- 1,194,732
----------- ------ ---------- --------- ------- ----- ----------
Net income..................... -- -- -- 278,605 -- -- 278,605
Issuance of common stock....... 1,250,000 12 82,270 -- -- -- 82,282
Two-for-one stock split........ 69,649,474 696 -- (696) -- -- --
Dividends to stockholders...... -- -- -- (19,503) -- -- (19,503)
Stock options exercised........ 57,065 1 410 -- -- -- 411
Exchange rate changes, net..... -- -- -- -- (894) -- (894)
Loss on investments, net....... -- -- -- -- -- (106) (106)
----------- ------ ---------- --------- ------- ----- ----------
December 31, 1997................ 139,309,948 $1,393 $1,302,712 $ 233,350 $(1,822) $(106) $1,535,527
=========== ====== ========== ========= ======= ===== ==========
The accompanying notes are an integral part of the consolidated financial
statements.
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30
DIAMOND OFFSHORE DRILLING, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEAR ENDED DECEMBER 31,
-----------------------------------
1997 1996 1995
--------- --------- ---------
Operating activities:
Net income (loss)..................................... $ 278,605 $ 146,388 $ (7,026)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization...................... 108,335 75,767 52,865
Gain on sale of assets............................. (1,014) (35,122) (1,349)
Gain on sale of investment securities.............. (1,529) -- --
Accrued interest converted to notes payable to
Loews............................................ -- -- 27,044
Deferred tax provision (benefit)................... 34,650 17,278 (7,472)
Accretion of discount on investment securities..... (10,505) (159) (115)
Amortization of debt issuance costs................ 456 2,570 --
Changes in operating assets and liabilities:
Accounts receivable................................ (32,959) (64,715) (16,692)
Rig inventory and supplies and other current
assets........................................... (3,319) (2,789) (4,896)
Other assets, non-current.......................... 949 (1,747) --
Accounts payable and accrued liabilities........... 15,256 22,155 10,984
Taxes payable...................................... 3,893 46,149 (706)
Other liabilities, non-current..................... 3,885 4,093 --
Other, net............................................ (335) 365 29
--------- --------- ---------
Net cash provided by operating activities..... 396,368 210,233 52,666
--------- --------- ---------
Investing activities:
Cash acquired in the merger with Arethusa............. -- 20,883 --
Capital expenditures.................................. (281,572) (267,000) (66,646)
Acquisition of drilling rigs and related equipment.... (80,990) -- --
Proceeds from sale of assets.......................... 8,277 40,589 1,516
Net change in short-term investment securities........ (2,522) 5,200 --
Purchases of long-term investment securities.......... (124,242) -- --
Proceeds from sales of long-term investment
securities......................................... 125,082 -- --
Net change in investments through repurchase
agreements......................................... (350,000) -- --
--------- --------- ---------
Net cash used in investing activities......... (705,967) (200,328) (65,130)
--------- --------- ---------
Financing activities:
Payment of dividends.................................. (19,503) -- (2,118)
Issuance of common stock.............................. 82,282 -- 338,363
Debt (repayments) borrowings, net..................... (73,000) 5,523 (331,245)
Issuance of convertible subordinated notes............ 400,000 -- --
Debt issuance costs................................... (6,062) (2,570) --
Proceeds from stock options exercised................. 660 5,016 --
--------- --------- ---------
Net cash provided by financing activities..... 384,377 7,969 5,000
--------- --------- ---------
Net change in cash and cash equivalents................. 74,778 17,874 (7,464)
Cash and cash equivalents, beginning of year.......... 28,180 10,306 17,770
--------- --------- ---------
Cash and cash equivalents, end of year................ $ 102,958 $ 28,180 $ 10,306
========= ========= =========
The accompanying notes are an integral part of the consolidated financial
statements.
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31
DIAMOND OFFSHORE DRILLING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization and Business
Diamond Offshore Drilling, Inc. (the "Company") was incorporated in
Delaware on April 13, 1989. Loews Corporation ("Loews"), a Delaware corporation
of which the Company had been a wholly owned subsidiary prior to the initial
public offering in October 1995 (the "Common Stock Offering"), owns 50.3 percent
of the outstanding common stock of the Company (see Note 3).
The Company, through wholly owned subsidiaries, engages in the worldwide
contract drilling of offshore oil and gas wells and is a leader in deep water
drilling. The Company's fleet of 46 mobile offshore drilling rigs is one of the
largest in the world and includes the largest fleet of semisubmersible rigs
currently working in the world. The fleet is comprised of 30 semisubmersible
rigs (including an accommodation vessel), 15 jack-up rigs, and one drillship.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
after elimination of significant intercompany transactions and balances.
Cash and Cash Equivalents
Short-term, highly liquid investments that have an original maturity of
three months or less which are considered part of the Company's cash management
activities, rather than part of its investing activities, are considered cash
equivalents.
Short-Term Investments
The Company invests its excess cash under repurchase agreements with third
parties, primarily major brokerage firms, for a set rate of return callable at
any time or for periods generally less than three months. The third parties are
required to collateralize the investments with securities having fair values of
at least 102 percent of the invested amount.
The Company's investments in equity securities are classified as available
for sale and stated at fair value. Accordingly, any unrealized gains and losses,
net of applicable deferred income taxes, are recorded as a separate component of
stockholders' equity until realized. The cost of securities sold is based on the
specific identification method and realized gains or losses and declines in
value, if any, judged to be other than temporary are reported in the
Consolidated Statements of Operations in "Other income (expense)."
Supplementary Cash Flow Information
Non-cash financing activities for the year ended December 31, 1997 included
$0.7 million for the issuance of 69.6 million shares of common stock in
connection with a two-for-one stock split in the form of a stock dividend (see
Note 3).
Non-cash financing activities for the year ended December 31, 1996 included
$550.7 million for the issuance of 35.8 million shares of common stock and the
assumption of stock options for the purchase of 1.0 million shares in connection
with the merger between the Company and Arethusa (Off-Shore) Limited
("Arethusa"). Non-cash investing activities for the year ended December 31, 1996
included $532.9 million of net assets acquired in the merger with Arethusa (see
Note 2).
Non-cash financing activities for the year ended December 31, 1995 included
a capital contribution by Loews in September 1995 of $39.7 million which reduced
the outstanding debt to Loews. In addition,
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32
$27.0 million of interest expense was accrued and included in the notes payable
to Loews prior to such notes being repaid with a portion of the proceeds from
the Common Stock Offering (see Note 3). In connection with the Common Stock
Offering, the tax sharing agreement with Loews was terminated and all
liabilities were settled by offsetting $50.9 million owed by Loews to the
Company under the agreement against the notes payable to Loews.
Cash payments made for interest on long-term debt, including commitment
fees, during the years ended December 31, 1997 and 1996 were $8.7 million and
$3.5 million, respectively. No cash payments for interest were made in 1995.
Cash payments made for income taxes during the years ended December 31, 1997,
1996, and 1995 were $112.1 million, $3.9 million, and $0.8 million,
respectively.
Rig Inventory and Supplies
Inventories primarily consist of replacement parts and supplies held for
use in the operations of the Company. Inventories are stated at the lower of
cost or estimated value.
Drilling and Other Property and Equipment
Drilling and other property and equipment is carried at cost. Maintenance
and repairs are charged to income currently while replacements and betterments
are capitalized. Costs incurred for major rig upgrades are accumulated in
construction work in progress, with no depreciation recorded on the additions,
until the month the upgrade is completed and the rig is placed in service. Upon
retirement or other disposal of fixed assets, the cost and related accumulated
depreciation are removed from the respective accounts and any gains or losses
are included in the results of operations.
Depreciation is provided on the straight-line method over the remaining
estimated useful lives from the date the asset is placed in service. The Company
believes that certain offshore drilling rigs, due to their upgrade and design
capabilities and their maintenance history, have an operating life in excess of
their depreciable life as originally assigned. For this reason, a change in
accounting estimate, effective January 1, 1996, increased the estimated useful
lives for certain classes of offshore drilling rigs. As compared to the original
estimate of useful lives, the effect of such change reduced depreciation expense
and increased net income for the year ended December 31, 1996 by approximately
$8.5 million and $5.5 million ($0.04 per share), respectively. The estimated
useful lives of the Company's offshore drilling rigs, after the change in
estimate, range from 10 to 25 years. Other property and equipment is estimated
to have useful lives ranging from 3 to 10 years.
Capitalized Interest
Interest cost for construction and upgrade of qualifying assets is
capitalized. During the years ended December 31, 1997 and 1996, the Company
incurred interest cost, including amortization of debt issuance costs, of $14.7
million and $6.3 million, respectively. Interest cost capitalized during 1997
and 1996 was $4.4 million and $4.0 million, respectively.
Impairment of Long-Lived Assets
The Company reviews its long-lived assets for impairment when changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable.
Goodwill
Goodwill from the merger with Arethusa (see Note 2) is amortized on a
straight-line basis over 20 years. Amortization charged to operating expense
during the years ended December 31, 1997 and 1996 totaled $6.6 million and $4.5
million, respectively.
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33
Debt Issuance Costs
Debt issuance costs are included in the Consolidated Balance Sheets in
"Other assets" and are amortized over the term of the related debt.
Income Taxes
Taxable income (loss) of the Company and its domestic subsidiaries was
included in the consolidated U.S. federal income tax return of Loews and other
members of the Loews affiliated group for all taxable periods ending prior to
the Common Stock Offering. Thereafter, the taxable income (loss) of the Company
and its domestic subsidiaries is included in the consolidated U.S. federal
income tax return of the Company and its affiliated group.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Except for selective
dividends, the Company's practice has been to reinvest the unremitted earnings
of its non-U.S. subsidiaries and postpone their remittance indefinitely. Thus,
no additional U.S. taxes were provided on earnings of these non-U.S.
subsidiaries. However, beginning in 1997, the Company changed its practice and
intends to repatriate these earnings in the foreseeable future. As a result,
beginning January 1, 1997, the Company has accrued U.S. taxes on all
undistributed non-U.S. earnings. The Company's non-U.S. income tax liabilities
are based upon the results of operations of the various subsidiaries and foreign
branches in those jurisdictions in which they are subject to taxation.
Revenue Recognition
Income from dayrate drilling contracts is recognized currently. In
connection with such drilling contracts, the Company may receive lump-sum fees
for the mobilization of equipment and personnel. The net of mobilization fees
received and costs incurred to mobilize an offshore rig from one market to
another is recognized over the term of the related drilling contract. Absent a
contract, mobilization costs are recognized currently. Lump-sum payments
received from customers relating to specific contracts are deferred and
amortized to income over the term of the drilling contract.
Income from offshore turnkey contracts is recognized on the completed
contract method, with revenues accrued to the extent of costs until the
specified turnkey depth and other contract requirements are met. Provisions for
future losses on turnkey contracts are recognized when it becomes apparent that
expenses to be incurred on a specific contract will exceed the revenue from the
contract.
Currency Translation
The Company's primary functional currency is the U.S. dollar. Certain of
the Company's subsidiaries use the local currency in the country where they
conduct operations as their functional currency. These subsidiaries translate
assets and liabilities at year-end exchange rates while income and expense
accounts are translated at average exchange rates. Translation adjustments are
reflected in the Consolidated Balance Sheets in "Cumulative translation
adjustment." Currency transaction gains and losses are included in the
Consolidated Statements of Operations in "Other income (expense)." Additionally,
translation gains and losses of subsidiaries operating in hyperinflationary
economies are included in operating results currently.
Net Income Per Share
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings per
Share," which requires dual presentation of basic and diluted earnings per share
for entities with complex capital structures. Accordingly, basic earnings per
share was computed by dividing net income by the weighted average number of
common shares outstanding for the year. Diluted earnings per share reflects the
potential dilution that could occur if securities or other contracts to issue
common stock were exercised or converted into common stock. Diluted earnings per
share was calculated by dividing net income, adjusted to eliminate the after-tax
effect of interest expense,
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34
by the weighted average number of common shares outstanding and the weighted
average number of shares issuable assuming full conversion of the convertible
subordinated notes as of the issuance date, February 4, 1997 (see Note 8).
Because the Company does not maintain an ongoing plan for the issuance of
stock options, the options to purchase up to 1.0 million shares of common stock
assumed in the merger with Arethusa (the "Arethusa Options") have not been
included as dilutive potential shares. The effect on the computation of per
share earnings, had the Arethusa Options been included, was not material. At
December 31, 1997 and 1996, there were Arethusa Options outstanding for the
purchase of approximately 0.1 million and 0.2 million shares of common stock,
respectively.
Weighted average shares outstanding and all per share amounts included
herein for all periods presented have been restated to include the retroactive
effect of the July 1997 two-for-one stock split in the form of a stock dividend
(see Note 3).
Pro Forma Net Income Per Share Data
As described in Note 3, after its initial public offering, the Company had
100.0 million shares of common stock outstanding. Assuming the Common Stock
Offering had occurred as of January 1, 1995, the Company would have recognized
net income of $10.0 million, or $0.10 per share, for 1995, after adjusting for
the after-tax effects of a reduction in interest expense.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amount of revenues and expenses during the reporting
period. Actual results could differ from those estimated.
Reclassifications
Certain amounts applicable to the prior periods have been reclassified to
conform to the classifications currently followed. Such reclassifications do not
affect earnings.
2. MERGER WITH ARETHUSA
In April 1996, the Company acquired 100 percent of the stock of Arethusa
(the "Arethusa Merger"). Arethusa owned a fleet of 11 mobile offshore drilling
rigs, operated two additional mobile offshore drilling rigs pursuant to bareboat
charters and provided drilling services worldwide to international and
government-controlled oil and gas companies. The consideration consisted of the
following (in thousands):
Common stock issued to Arethusa shareholders................ $539,305
Arethusa stock options assumed.............................. 11,381
--------
Total equity consideration........................ $550,686
========
The Company issued 35.8 million common shares to the Arethusa shareholders
based on an exchange ratio of 1.76 shares for each share of issued and
outstanding Arethusa common stock. The shares were valued for financial
reporting purposes at $15.07 based on a seven-day average of the closing price
of the Company's common stock at the time the Arethusa Merger was announced
(December 7, 1995). In addition to equity consideration, the Company incurred
approximately $16.9 million of cash acquisition costs associated with the
Arethusa Merger.
The Arethusa Merger was accounted for as a purchase. The purchase price
included, at estimated fair value, current assets of $67.2 million, drilling and
other property and equipment of $505.5 million, and the assumption of current
liabilities of $19.0 million, other net long-term liabilities of $2.2 million,
and debt of
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35
$67.5 million. In addition, a deferred tax liability of $66.8 million was
recorded primarily for the difference in the basis for tax and financial
reporting purposes of the net assets acquired. The excess of the purchase price
over the estimated fair value of net assets acquired amounted to approximately
$133.5 million, which has been accounted for as goodwill and is being amortized
over 20 years using the straight-line method (see Note 6).
The accompanying Consolidated Statements of Operations reflect the
operating results of Arethusa since April 29, 1996, the effective date of the
Arethusa Merger. Pro forma consolidated operating results of the Company and
Arethusa for the year ended December 31, 1996 and 1995, assuming the acquisition
had been made as of January 1, 1996 and 1995, are summarized below:
YEAR ENDED DECEMBER 31,
------------------------
1996 1995
---------- ----------
(IN THOUSANDS, EXCEPT
PER SHARE DATA)
Revenue..................................................... $667,543 $456,750
Net income(loss)............................................ 153,409 (963)
Net income(loss) per share.................................. 1.13 (0.02)
The pro forma information for the years ended December 31, 1996 and 1995
includes adjustments for additional depreciation based on the fair market value
of the drilling and other property and equipment acquired and the amortization
of goodwill arising from the transaction. The pro forma information for the year
ended December 31, 1995 also includes adjustments for (i) the acquisition of the
Arethusa Yatzy by Arethusa, which occurred May 3, 1995, (ii) the sale of the
Treasure Stawinner by Arethusa, which occurred June 30, 1995, (iii) the dividend
and capital distribution declared by Arethusa on June 30, 1995 and paid July 28,
1995, (iv) the Common Stock Offering and, in connection therewith, the use of
the proceeds to repay all of the Company's then outstanding indebtedness to
Loews and to fund the payment of a special dividend to Loews, and (v) interest
expense for working capital borrowings, and commitment and other fees, under a
credit facility as if each had occurred at January 1, 1995. The pro forma
information is not necessarily indicative of the results of operations had the
transactions been effected on the assumed dates.
3. COMMON STOCK
In July 1997, the Board of Directors declared a two-for-one stock split in
the form of a stock dividend which was distributed on August 14, 1997 to
stockholders of record on July 24, 1997. The dividend was charged to retained
earnings in the amount of $0.7 million, which was based on the par value of 69.6
million shares of common stock.
In April 1997, the Company completed a public offering of 2.5 million
shares of common stock generating net proceeds of approximately $82.3 million.
The net proceeds were used to acquire the Polyconfidence, a semisubmersible
accommodation vessel (see Note 5).
Pursuant to the Common Stock Offering, the Company sold 29.9 million shares
of common stock, including 3.9 million shares from an over-allotment option.
4. SHORT-TERM INVESTMENTS
Equity securities classified as available for sale at December 31, 1997 are
stated at fair value of $13.1 million, including gross unrealized holding losses
of $0.2 million. Investments through repurchase agreements with third parties at
December 31, 1997 are stated at their contracted amounts totaling $350.0
million.
During the year ended December 31, 1997, short-term debt securities
purchased at various times during 1997 were sold for proceeds of $710.1 million,
resulting in realized gains which were immaterial. In addition, long-term debt
securities purchased in March 1997 and April 1997 were sold in July 1997 for
proceeds of $125.1 million, resulting in an after-tax gain of $0.7 million
included in the Consolidated Statements of Operations in "Other income
(expense)."
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36
During 1996, the Company was party to a pledge agreement with a bank
whereby the bank would extend various financial accommodations to or for the
account of the Company, including issuing letters of credit, entering into
foreign exchange contracts or permitting intra-day overdrafts. In consideration
of and as a condition precedent to the making of such financial accommodations
by the bank, the Company was required to maintain a pledged collateral account
in which the bank had a continuing security interest. The Company had $5.0
million in U.S. Treasury Bills deposited in such pledged collateral account
until November 1996 when the bank no longer required the maintenance of
collateral.
5. DRILLING AND OTHER PROPERTY AND EQUIPMENT
Cost and accumulated depreciation of drilling and other property and
equipment are summarized as follows:
DECEMBER 31,
------------------------
1997 1996
---------- ----------
(IN THOUSANDS)
Drilling rigs and equipment................................. $1,781,107 $1,332,980
Construction work in progress............................... 17,696 116,770
Land and buildings.......................................... 12,552 13,154
Office equipment and other.................................. 10,551 8,181
---------- ----------
Cost...................................................... 1,821,906 1,471,085
Less accumulated depreciation............................... (370,165) (272,925)
---------- ----------
Drilling and other property and equipment, net............ $1,451,741 $1,198,160
========== ==========
Asset Acquisitions
In May 1997, the Company acquired the Polyconfidence (soon to be renamed
Ocean Confidence), a semisubmersible accommodation vessel with
dynamic-positioning capabilities, for approximately $81.0 million in cash. The
Company chartered the vessel to the seller until December 1997. The
Polyconfidence will be converted to a semisubmersible drilling rig in connection
with a five-year contract in the Gulf of Mexico anticipated to commence in the
fourth quarter of 1999.
Asset Dispositions
During the year ended December 31, 1997, the Company sold a semisubmersible
drilling rig, the Ocean Zephyr, located offshore Brazil, for a $5.4 million note
receivable due July 1998 which generated an after-tax gain of $0.6 million. Also
in 1997, the Company sold a warehouse facility on approximately 6.6 acres of
land near Houston, Texas, which was acquired in the Arethusa Merger, for
approximately $0.6 million (see Note 2). No gain or loss was recognized on this
sale.
During the year ended December 31, 1996, the Company sold all of the
operational assets of Diamond M Onshore, Inc., a wholly owned subsidiary of the
Company, for approximately $26.0 million in cash which generated an after-tax
gain of $15.6 million, or $0.12 per share on a diluted basis. The assets sold
consisted of ten land drilling rigs, all of which were operating, 18 trucks, a
yard facility in Alice, Texas and various other associated equipment. In
addition, two of the Company's shallow water jack-up drilling rigs (the Ocean
Magallanes and the Ocean Conquest) and a semisubmersible (the Ocean Zephyr II),
all of which had previously been stacked, were sold during 1996 increasing net
income by $7.0 million, or $0.05 per share on a diluted basis.
Construction Work in Progress
As of December 31, 1997, $1.7 million, $9.3 million, and $6.7 million of
construction work in progress was related to the upgrades of the Polyconfidence,
the Ocean Warwick, and the Ocean Tower, respectively. As of December 31, 1996,
$64.8 million, $36.5 million and $15.5 million of construction work in progress
was related to the upgrades of the Ocean Star, the Ocean Clipper I, and the
Ocean Victory, respectively.
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Impairment of Assets
During 1995, the Company recorded impairment losses of $2.1 million to
decrease the carrying value of a semisubmersible drilling rig located in the
Gulf of Mexico which was sold in the fourth quarter of 1995. The impairment
loss, reflected in "Depreciation" in the Consolidated Statements of Operations,
reduced the carrying value of the rig to zero. The operating loss incurred by
the rig during the year ended December 31, 1995 was not material.
6. GOODWILL
The Arethusa Merger generated an excess of the purchase price over the
estimated fair value of the net assets acquired (see Note 2). Cost and
accumulated amortization of such goodwill is summarized as follows:
DECEMBER 31,
--------------------
1997 1996
-------- --------
(IN THOUSANDS)
Goodwill.................................................... $129,746 $134,331
Less: Accumulated amortization.............................. (11,123) (4,506)
-------- --------
Total............................................. $118,623 $129,825
======== ========
During the years ended December 31, 1997 and 1996, adjustments of $2.9
million and $0.8 million, respectively, were recorded to reduce goodwill before
accumulated amortization. These adjustments represent the tax benefit of the
excess of tax deductible goodwill over the reported amounts of goodwill when
realized on the tax return. In addition, an adjustment of $1.7 million was
recorded to reduce goodwill before accumulated amortization during the year
ended December 31, 1997 due to a change in the fair value of the net assets
acquired in the Arethusa Merger.
7. ACCRUED LIABILITIES
Accrued liabilities consist of the following:
DECEMBER 31,
------------------
1997 1996
------- -------
(IN THOUSANDS)
Personal injury and other claims............................ $23,960 $18,629
Payroll and benefits........................................ 15,951 8,336
Interest payable............................................ 5,684 172
Other....................................................... 3,340 1,314
------- -------
Total............................................. $48,935 $28,451
======= =======
8. LONG-TERM DEBT
Convertible Subordinated Notes
In February 1997, the Company issued $400.0 million of convertible
subordinated notes (the "Notes") due February 15, 2007. The Notes are
convertible into shares of the Company's common stock, at a conversion price of
$40.50 per share, subject to adjustment in certain circumstances. The Notes have
a stated interest rate of 3.75 percent and an effective interest rate of 3.93
percent. Interest is payable semi-annually on each February 15 and August 15.
The Notes are redeemable, in whole or, from time to time, in part, at the
option of the Company, at any time on or after February 22, 2001, at specified
redemption prices, plus accrued and unpaid interest to the date of redemption.
The Notes are general unsecured obligations of the Company, subordinated in
right of payment to the prior payment in full of the principal and premium, if
any, and interest on all indebtedness of the Company for borrowed money, other
than the Notes, with certain exceptions, and effectively subordinated in right
of payment to the prior payment in full of all indebtedness of the Company's
subsidiaries. The Notes do
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not restrict the Company's ability to incur other indebtedness or additional
indebtedness of the Company's subsidiaries.
Credit Agreements
In August 1997, the Company terminated its revolving credit facility with a
group of banks (the "Credit Facility"), which was available through December
2001 and provided a maximum credit commitment of $200.0 million, increased from
$150.0 million in December 1996. The unused credit available under the Credit
Facility at December 31, 1996 was $137.0 million. The weighted average interest
rate, including commitment and arrangement fees, was 8.5 percent for the year
ended December 31, 1996.
In connection with the Arethusa Merger, the Company assumed long-term debt
(including the current portion) of $67.5 million on two credit agreements with a
group of banks. During May 1996, using cash acquired in the Arethusa Merger
supplemented by borrowings under the Credit Facility, both Arethusa loans were
repaid in full. Interest expense for the year ended December 31, 1996 includes
interest for the period from the effective date of the Arethusa Merger to the
date of repayment of the loans and the payment of breakage and prepayment
penalty charges.
9. COMMITMENTS AND CONTINGENCIES
The Company leases office facilities under operating leases which expire
through the year 2002. Total rent expense amounted to $1.8 million, $1.6
million, and $1.5 million for the years ended December 31, 1997, 1996, and 1995,
respectively. Minimum future rental payments under leases are approximately $0.9
million, $0.4 million, $0.1 million, $0.1 million, and $43,000 for the years
1998 to 2002, respectively. There are no minimum future rental payments under
leases after the year 2002.
The Company is contingently liable as of December 31, 1997 and 1996 in the
amount of $22.6 million under certain performance, bid, and export bonds and
bonds securing obligations in connection with litigation. On the Company's
behalf, banks have issued letters of credit securing certain of these bonds.
The survivors of a deceased employee of a subsidiary of the Company,
Diamond M Onshore, Inc., sued such subsidiary in Duval County, Texas, for
damages as a result of the death of the employee. The plaintiffs obtained a
judgment in the trial court for $15.7 million plus post-judgment interest. The
Company has appealed the judgment and is currently awaiting the opinion of the
appellate court. The Company has received notices from certain of its insurance
underwriters reserving their rights to deny coverage on the Company's insurance
policies in excess of $2.0 million for damages resulting from such lawsuit.
Management believes that the Company has complied with all conditions of
coverage for final unappealable damages, if any, in the case. While the ultimate
liability in this matter is difficult to assess, it is management's belief that
the final outcome is not reasonably likely to have a material adverse effect on
the Company's consolidated financial position, results of operations, or cash
flows. The Company has not established a liability for such claim at this time.
A former subsidiary of Arethusa, which is now a subsidiary of the Company,
defended and indemnified Zapata Off-Shore Company and Zapata Corporation (the
"Zapata Defendants"), pursuant to a contractual defense and indemnification
agreement, in a suit for tortious interference with contract and conspiracy to
tortiously interfere with contract. The plaintiffs sought $14.0 million in
actual damages and unspecified punitive damages, plus costs of court, interest
and attorneys' fees. In November 1997, the jury awarded a take nothing judgment
in favor of the Zapata Defendants. It is not yet known whether the plaintiffs
will appeal the judgment. No provision for any liability has been made in the
financial statements.
Various other claims have been filed against the Company in the ordinary
course of business, particularly claims alleging personal injuries. Management
believes that the Company has established adequate reserves for any liabilities
that may reasonably be expected to result from these claims. In the opinion of
management, no pending or threatened claims, actions or proceedings against the
Company are expected to have a material adverse effect on the Company's
consolidated financial position, results of operations, or cash flows.
38
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10. FINANCIAL INSTRUMENTS
Concentrations of Credit Risk
Financial instruments which potentially subject the Company to significant
concentrations of credit risk consist primarily of periodic temporary
investments of excess cash, trade accounts receivable, and investments through
repurchase agreements with third parties. The Company places its temporary
excess cash investments in high quality short-term money market instruments
through several financial institutions. At times, such investments may be in
excess of the insurable limit. The Company's periodic evaluations of the
relative credit standing of these financial institutions are considered in the
Company's investment strategy.
Concentrations of credit risk with respect to trade accounts receivable are
limited primarily due to the entities comprising the Company's customer base.
Since the market for the Company's services is the offshore oil and gas
industry, this customer base consists primarily of major oil companies and
independent oil and gas producers. The Company provides allowances for potential
credit losses when necessary. No such allowances were deemed necessary for the
years presented and, historically, the Company has not experienced significant
losses on trade receivables. Because of the protection of collateral and the
short terms of the transactions, investments through repurchase agreements with
third parties do not impose significant credit risk on the Company. The
collateral provided for such transactions is generally valued daily and adjusted
frequently for changes in the market price of the securities comprising the
collateral.
Fair Values
The amounts reported in the Consolidated Balance Sheets for cash and cash
equivalents, short-term investments, accounts receivable, accounts payable and
short-term borrowings approximate fair value. At December 31, 1997, the fair
value of the Notes was approximately $527.0 million, as compared to a carrying
amount of $400.0 million.
The estimated fair value amounts have been determined by the Company using
appropriate valuation methodologies and information available to management as
of December 31, 1997 and 1996. Considerable judgment is required in developing
these estimates, and accordingly, no assurance can be given that the estimated
values are indicative of the amounts that would be realized in a free market
exchange. The following methods and assumptions were used to estimate the fair
value of each class of financial instrument for which it was practicable to
estimate that value:
Cash and cash equivalents and short-term borrowings -- The carrying
amounts approximate fair value because of the short maturity of these
instruments.
Short-term investments -- The fair values of equity securities
available for sale were based on quoted market prices as of December 31,
1997. The carrying amount of investments through repurchase agreements
approximates fair value because of the nature and short maturity of these
instruments.
Accounts receivable and accounts payable -- The carrying amounts
approximate fair value based on the nature of the instruments.
Long-term debt -- The fair value was based on the quoted market price
from brokers of the Notes.
11. RELATED PARTY TRANSACTIONS
The Company and Loews have entered into a services agreement which was
effective upon consummation of the Common Stock Offering (the "Services
Agreement") pursuant to which Loews agreed to continue to perform certain
administrative and technical services on behalf of the Company. Such services
include personnel, telecommunications, purchasing, internal auditing,
accounting, data processing and cash management services, in addition to advice
and assistance with respect to preparation of tax returns and obtaining
insurance. Under the Services Agreement, the Company is required to reimburse
Loews for (i) allocated personnel costs (such as salaries, employee benefits and
payroll taxes) of the Loews personnel actually providing such services and (ii)
all out-of-pocket expenses related to the provision of such services. The
Services Agreement may be terminated at the Company's option upon 30 days'
notice to Loews and at the
39
40
option of Loews upon six months' notice to the Company. In addition, the Company
has agreed to indemnify Loews for all claims and damages arising from the
provision of services by Loews under the Services Agreement, unless due to the
gross negligence or willful misconduct of Loews. Prior to the Common Stock
Offering, Loews provided such services at an allocated rate. The Company was
charged $0.3 million, $0.2 million, and $0.7 million by Loews for these support
functions during the years ended December 31, 1997, 1996, and 1995,
respectively.
12. INCOME TAXES
Prior to the Common Stock Offering, the Company and its subsidiaries were
party to a tax sharing agreement with Loews. Subsequently, the tax sharing
agreement was terminated and all assets and liabilities were settled by
offsetting amounts owed by Loews to the Company under the agreement against
notes payable to Loews.
An analysis of the Company's income tax (expense) benefit is as follows:
YEAR ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
--------- -------- ------
(IN THOUSANDS)
U.S. -- current..................................... $ (99,001) $(44,950) $ --
U.S. -- deferred.................................... (34,650) (17,278) 7,472
Non-U.S. -- current................................. (17,300) (3,486) (489)
State and other..................................... (505) (603) (206)
--------- -------- ------
Total..................................... $(151,456) $(66,317) $6,777
========= ======== ======
Significant components of the Company's deferred income tax assets and
liabilities are as follows:
DECEMBER 31,
----------------------
1997 1996
--------- ---------
(IN THOUSANDS)
Deferred tax assets:
Net operating loss carryforwards.......................... $ 19,143 $ 18,686
Investment tax credit carryforwards....................... -- 3,066
Worker's compensation accruals(1)......................... 6,188 4,562
Foreign tax credits....................................... 9,023 7,186
Other..................................................... 2,007 1,574
--------- ---------
Total deferred tax assets.............................. 36,361 35,074
--------- ---------
Deferred tax liabilities:
Depreciation and amortization............................. (196,546) (173,471)
Undistributed earnings of non-U.S. subsidiaries........... (17,668) (7,486)
Non-U.S. deferred taxes................................... (15,236) (14,466)
Other..................................................... (10,236) (11,385)
--------- ---------
Total deferred tax liabilities......................... (239,686) (206,808)
--------- ---------
Net deferred tax liability........................ $(203,325) $(171,734)
========= =========
- ---------------
(1) Reflected in "Prepaid expenses and other" in the Company's Consolidated
Balance Sheets.
Except for selective dividends, the Company's practice prior to 1997 was to
reinvest the unremitted earnings of its non-U.S. subsidiaries and postpone their
remittance indefinitely. Thus, no additional U.S. taxes were provided on such
earnings. However, beginning in 1997, the Company intends to repatriate these
earnings in the foreseeable future. As a result, the Company has accrued U.S.
taxes on all undistributed non-U.S. earnings generated since January 1, 1997.
Undistributed earnings of non-U.S. subsidiaries generated prior to 1997 for
which no deferred income tax provision has been made for possible future
remittances totaled
40
41
approximately $67.2 million at December 31, 1997. In addition, the Company has
negative undistributed earnings of non-U.S. subsidiaries generated prior to 1997
of $69.6 million for which no deferred tax benefit has been recognized. It is
not practicable to estimate the amount of taxes, if any, that might be payable
on the eventual remittance of such earnings. On remittance, certain countries
impose withholding taxes that, subject to certain limitations, are then
available for use as tax credits against a U.S. tax liability, if any.
The Company believes that it is probable that its deferred tax assets of
$36.4 million will be realized on future tax returns, primarily from the
generation of future taxable income through both profitable operations and
future reversals of existing taxable temporary differences. However, if the
Company is unable to generate sufficient taxable income in the future through
operating results, a valuation allowance will be required as a charge to
expense.
Deferred income taxes are not recorded on differences between financial
reporting and tax bases of investments in stock of the Company's subsidiaries,
unless realization of the effect is probable in the foreseeable future. The
Company also has certain income tax loss carryforwards in non-U.S. tax
jurisdictions to which it has assigned no value because of the uncertainty of
utilization of these carryforwards. Approximately $21.1 million of such
carryforwards were utilized during the year ended December 31, 1996.
In connection with the Arethusa Merger, the Company acquired net operating
loss ("NOL") carryforwards available to offset future taxable income. The
utilization of these NOL carryforwards is limited pursuant to Sections 382 and
383 of the Internal Revenue Code of 1986, as amended (the "Code"). For the year
ended December 31, 1997, the Company utilized $10.5 million of such
carryforwards and has recorded a deferred tax asset for the benefit of the
remaining NOL carryforwards available to be carried forward to future years.
Such carryforwards expire as follows:
TAX BENEFIT OF
NET OPERATING
YEAR LOSSES
---- --------------
(IN THOUSANDS)
2005............................................ $ 176
2006............................................ 3,185
2007............................................ 3,147
2008............................................ 3,169
2009............................................ 3,838
2010............................................ 5,628
-------
Total........................................... $19,143
=======
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The difference between actual income tax (expense) benefit and the tax
provision computed by applying the statutory federal income tax rate to income
(loss) before taxes is attributable to the following:
YEAR ENDED DECEMBER 31,
---------------------------------
1997 1996 1995
--------- -------- --------
(IN THOUSANDS)
Income (loss) before income tax (expense) benefit:
U.S............................................. $ 373,319 $153,615 $(19,591)
Non-U.S......................................... 56,742 59,090 5,788
--------- -------- --------
Worldwide....................................... $ 430,061 $212,705 $(13,803)
========= ======== ========
Expected income tax (expense) benefit at federal
statutory rate.................................. $(150,521) $(74,447) $ 4,831
Non-U.S. income (loss):
Impact of taxation at different rates........... -- -- 1,270
Utilization of net operating loss
carryforwards................................ -- 6,843 --
Impact of non-U.S. losses for which a current
tax benefit is not available................. -- (1,642) (1,004)
Adjustment to prior year return................... -- 1,737 --
State taxes and other............................. (935) 1,192 1,680
--------- -------- --------
Income tax (expense) benefit............ $(151,456) $(66,317) $ 6,777
========= ======== ========
13. EMPLOYEE BENEFIT PLANS
Defined Contribution Plans
The Company maintains defined contribution retirement plans for its U.S.
and U.K. employees. The plan for U.S. employees (the "401(k) Plan") is designed
to qualify under Section 401(k) of the Code. Under the 401(k) Plan, each
participant may elect to defer taxation on a portion of his or her eligible
earnings, as defined by the 401(k) Plan, by directing the Company to withhold a
percentage of such earnings. A participating employee may also elect to make
after-tax contributions to the 401(k) Plan. The Company contributes 3.75 percent
of a participant's defined compensation and matches 25 percent of the first 6
percent of each employee's compensation contributed, subject to a vesting
schedule which entitles the employee to a percentage of the matching
contributions depending on years of service. For the years ended December 31,
1997, 1996, and 1995, the Company's provision for contributions was $4.1
million, $2.5 million, and $2.4 million, respectively.
The plan for U.K. employees provides that the Company contribute amounts
equivalent to the employee's contributions generally up to a maximum of 3
percent of the employee's defined compensation per year. For the years ended
December 31, 1997, 1996, and 1995, the Company's provision for contributions was
$0.3 million, $0.3 million, and $0.2 million, respectively.
In connection with the Arethusa Merger, the Company assumed Arethusa's
Profit Sharing Plan. The plan was established as a defined contribution profit
sharing plan effective October 1, 1992 covering substantially all U.S. citizens,
U.S. permanent residents and third country national expatriates employed by
Arethusa Off-Shore Company, a wholly owned subsidiary of Arethusa. Participants
could elect to make contributions by directing the Company to withhold a
percentage of their earnings. A participating employee could also elect to make
after-tax contributions to the plan. The Company contributed 3.75 percent of a
participant's defined compensation. The Company's provision for such
contributions for the year ended December 31, 1996 was $0.3 million. Effective
January 1, 1997, the Company modified the 401(k) Plan by merging the Arethusa
Profit Sharing Plan into the Company's existing plan.
Deferred Compensation and Supplemental Retirement Plan
The Company established its Deferred Compensation and Supplemental
Executive Retirement Plan in December 1996. The Company contributes any portion
of the 3.75 percent of the base salary contribution and
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43
the matching contribution to the 401(k) Plan that cannot be contributed because
of the limitations of Sections 401(a)(17), 401(k)(3), 401(m)(2), 402(g) and 415
of the Code and because of elective deferrals that the participant makes under
the plan. Additionally, the plan provides that participants may defer up to 10
percent of base compensation and/or up to 100 percent of any performance bonus.
Participants in this plan are a select group of management or highly compensated
employees of the Company and are fully vested in all amounts paid into the plan.
The Company's provision for contributions for the years ended December 31, 1997
and 1996 were not material.
Pension Plan
The defined benefit pension plan, established by Arethusa effective October
1, 1992, was frozen on April 30, 1996. At that date, all participants were
deemed fully vested in the plan, which covered substantially all U.S. citizens
and U.S. permanent residents who were employed by Arethusa. Benefits are
calculated and paid based on an employee's years of credited service and average
compensation at the date the plan was frozen using an excess benefit formula
integrated with social security covered compensation.
Pension costs are determined actuarially and funded as required by the
Code. The plan's assets are invested in cash and cash equivalents, equity
securities, government and corporate debt securities. As a result of freezing
the plan, no service cost has been accrued for the years presented.
The significant actuarial assumptions as of the plan's year end are set
forth in the following table:
SEPTEMBER 30,
--------------
1997 1996
---- ----
Discount rate............................................... 7.25% 7.5%
Expected long-term rate..................................... 9.0% 9.0%
Compensation projection rate................................ N/A N/A
The funded status is set forth in the following table:
SEPTEMBER 30,
-------------------
1997 1996
------- -------
(IN THOUSANDS)
Benefit obligation -- Vested................................ $(9,365) $(8,536)
-- Non-vested............................ N/A N/A
------- -------
Accumulated benefit obligation.............................. (9,365) (8,536)
Effect of compensation projection........................... N/A N/A
------- -------
Projected benefit obligation................................ (9,365) (8,536)
Plan assets at fair value................................... 12,285 10,119
------- -------
Plan assets in excess of projected benefit obligation....... 2,920 1,583
Unrecognized gain........................................... (1,263) (195)
------- -------
Prepaid pension cost........................................ $ 1,657 $ 1,388
======= =======
Net periodic pension credit includes the following components:
YEAR ENDED
SEPTEMBER 30,
--------------
1997 1996
----- -----
(IN THOUSANDS)
Service cost of benefits earned............................. $ -- $ --
Interest cost on projected benefit obligations.............. 633 259
Actual return on plan assets................................ (902) (356)
----- -----
Net periodic pension credit................................. $(269) $ (97)
===== =====
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14. GEOGRAPHIC AREA ANALYSIS AND MAJOR CUSTOMERS
The following table summarizes, by geographic area, operating revenues and
operating income (loss) for the years ended December 31, 1997, 1996, and 1995,
and identifiable assets at the end of those periods. Interarea revenues from
affiliates primarily represent intercompany charter revenues and are accounted
for based on the estimated fair market value of the services.
AUSTRALIA/
UNITED EUROPE/ SOUTHEAST SOUTH OTHER
STATES AFRICA ASIA AMERICA AREAS ELIMINATIONS TOTAL
---------- -------- ---------- -------- ------- ------------ ----------
(IN THOUSANDS)
YEAR ENDED DECEMBER 31, 1997
Revenues from unaffiliated
customers..................... $ 609,470 $201,893 $ 93,963 $ 50,767 $ -- $ -- $ 956,093
Interarea revenues from
affiliates.................... 74,096 -- -- 971 14,658 (89,725) --
Operating income (loss)......... 367,148 38,190 (3,822) 4,670 13,687 -- 419,873
Identifiable assets............. 1,682,093 373,722 80,601 161,779 366 -- 2,298,561
YEAR ENDED DECEMBER 31, 1996
Revenues from unaffiliated
customers..................... $ 384,708 $126,618 $ 65,335 $ 34,769 $ -- $ -- $ 611,430
Interarea revenues from
affiliates.................... 31,147 -- -- 1,921 6,156 (39,224) --
Operating income (loss)......... 192,765 14,621 (6,106) 6,055 6,156 -- 213,491
Identifiable assets............. 1,108,761 197,948 101,093 166,698 -- -- 1,574,500
YEAR ENDED DECEMBER 31, 1995
Revenues from unaffiliated
customers..................... $ 213,998 $ 47,645 $ 53,113 $ 21,828 $ -- $ -- $ 336,584
Interarea revenues from
affiliates.................... 9,335 1,389 -- 1,460 4,563 (16,747) --
Operating income (loss)......... 25,488 (6,755) (7,675) (3,970) 4,563 -- 11,651
Identifiable assets............. 386,282 165,277 36,705 29,788 -- -- 618,052
A substantial portion of the Company's assets are mobile, therefore asset
locations at the end of the period are not necessarily indicative of the
geographic distribution of the earnings generated by such assets during the
periods.
The assets located outside the U.S. include cash and cash equivalents of
$10.0 million, $6.2 million, and $1.3 million at December 31, 1997, 1996, and
1995, respectively.
The Company's customer base includes major and independent oil and gas
companies and government-owned oil companies. During the year ended December 31,
1997, one customer contributed 14.3 percent of total revenues. During the year
ended December 31, 1996, two customers contributed 13.8 percent and 13.5 percent
of total revenues. During the year ended December 31, 1995, one customer
contributed 16.5 percent of total revenues.
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15. UNAUDITED QUARTERLY FINANCIAL DATA
Unaudited summarized financial data by quarter for the years ended December
31, 1997 and 1996 is shown below.
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
-------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
1997
Revenues............................................ $204,733 $228,534 $250,497 $272,329
Operating income.................................... 84,306 98,229 117,013 120,325
Income before income tax expense.................... 87,014 100,389 119,338 123,320
Net income.......................................... 56,230 65,234 77,831 79,310
Net income per share:
Basic............................................. 0.41 0.47 0.56 0.57
Diluted........................................... 0.39 0.45 0.54 0.55
1996
Revenues............................................ $106,868 $146,983 $170,622 $186,957
Operating income.................................... 25,696 46,614 57,520 83,661
Income before income tax expense.................... 26,130 46,784 57,929 81,862
Net income.......................................... 18,732 33,022 38,480 56,154
Net income per share:
Basic............................................. 0.19 0.27 0.28 0.41
Diluted........................................... 0.19 0.27 0.28 0.41
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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
ITEM 11. EXECUTIVE COMPENSATION
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Reference is made to the information responsive to the Items comprising
this Part III that is contained in the Company's definitive proxy statement for
its 1998 Annual Meeting of Stockholders, which is incorporated herein by
reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Index to Financial Statements, Financial Statement Schedules and
Exhibits
(1) Financial Statements
PAGE
----
Independent Auditors' Report................................ 26
Consolidated Balance Sheets................................. 27
Consolidated Statements of Operations....................... 28
Consolidated Statements of Stockholders' Equity............. 29
Consolidated Statements of Cash Flows....................... 30
Notes to Consolidated Financial Statements.................. 31
(2) Financial Statement Schedules
No schedules have been included herein because the information
required to be submitted has been included in the Company's Consolidated
Financial Statements or the notes thereto, or the required information
is inapplicable.
(3) Index of Exhibits....................................... 47
See Index of Exhibits for a list of those exhibits filed herewith,
which index also includes and identifies management contracts or
compensatory plans or arrangements required to be filed as exhibits to
this Form 10-K by Item 601(10)(iii) of Regulation S-K.
(b) Reports on Form 8-K
There were no reports on Form 8-K filed during the quarter ended
December 31, 1997.
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47
(c) Index of Exhibits
EXHIBIT NO. DESCRIPTION
----------- -----------
3.1 -- Restated Certificate of Incorporation of the Company
(incorporated by reference to Exhibit 3.1 of the
Company's Annual Report on Form 10-K for the fiscal year
ended December 31, 1995).
3.2 -- By-laws of the Company, as amended (incorporated by
reference to Exhibits 3.2, 3.2.1 and 3.2.2 of the
Company's Registration Statement No. 333-2680 on Forms
S-4/S-1).
4.1 -- Indenture, dated as of February 4, 1997, between the
Company and The Chase Manhattan Bank, as Trustee
(incorporated by reference to Exhibit 4.1 of the
Company's Current Report on Form 8-K filed February 11,
1997).
4.2 -- Supplemental Indenture, dated as of February 4, 1997,
between the Company and The Chase Manhattan Bank, as
Trustee (incorporated by reference to Exhibit 4.2 of the
Company's Current Report on Form 8-K filed February 11,
1997).
10.1 -- Registration Rights Agreement (the "Registration Rights
Agreement") dated October 16, 1995 between Loews and the
Company (incorporated by reference to Exhibit 10.2 of the
Company's Annual Report on Form 10-K for the fiscal year
ended December 31, 1995).
10.2* -- Amendment to the Registration Rights Agreement, dated
September 16, 1997 between Loews and the Company.
10.3 -- Services Agreement dated October 16, 1995 between Loews
and the Company (incorporated by reference to Exhibit
10.3 of the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 1995).
10.4+ -- Agreement ("Rose Employment Agreement"), dated November
1, 1992, between the Company and Robert E. Rose
(incorporated by reference to Exhibit 10.7 of the
Company's Registration Statement No. 33-95484 on Form
S-1).
10.5+ -- Amendment, dated December 27, 1995, to the Rose
Employment Agreement (incorporated by reference to
Exhibit 10.5 of the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1995).
10.6*+ -- Diamond Offshore Management Bonus Program, as amended and
restated, and dated as of December 31, 1997.
10.7+ -- Diamond Offshore Executive Deferred Compensation and
Supplemental Retirement Plan effective December 17, 1996
(incorporated by reference to Exhibit 10.10 of the
Company's Annual Report on Form 10-K for the fiscal year
ended December 31, 1996).
10.8*+ -- First Amendment to Diamond Offshore Executive Deferred
Compensation and Supplemental Retirement Plan dated March
18, 1998.
10.9 -- Credit Agreement among the Company, various lending
institutions, Bankers Trust Company and Christiania Bank
og Kreditkasse, New York Branch, as Co-Arrangers, Bankers
Trust Company, as Administrative Agent, Christiania Bank
og Kreditkasse, New York Branch, as Documentation Agent,
and The Fuji Bank, Limited, as Co-Agent, dated as of
February 8, 1996 and amended and restated as of March 27,
1996 and further amended and restated as of December 19,
1996 (incorporated by reference to Exhibit 10.1 of the
Company's Registration Statement No. 333-19987 on Form
S-3).
10.10 -- Diamond Offshore Drilling, Inc. Nonqualified Stock Option
Plan for Certain Former Directors of Arethusa
(incorporated by reference to Exhibit 10.17 of the
Company's Registration Statement No. 333-2680 on Forms
S-4/S-1).
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48
EXHIBIT NO. DESCRIPTION
----------- -----------
10.11 -- Diamond Offshore Drilling, Inc. Stock Option Plan for
Certain Former Employees of Arethusa (incorporated by
reference to Exhibit 10.18 of the Company's Registration
Statement No. 333-2680 on Forms S-4/S-1).
10.12 -- Asset Purchase Agreement between Diamond M Onshore, Inc.
and Drillers Inc. dated as of November 12, 1996
(incorporated by reference to Exhibit 10.2 of the
Company's Registration Statement No. 333-19987 on Form
S-3).
10.13 -- Amendment No. 1, dated as of December 31, 1996, to Asset
Purchase Agreement between Diamond M Onshore, Inc. and
Drillers Inc. dated as of November 12, 1996 (incorporated
by reference to Exhibit 10.3 of the Company's
Registration Statement No. 333-19987 on Form S-3).
11.1* -- Statement re Computation of Per Share Earnings.
12.1* -- Statement re Computation of Ratios.
21.1* -- List of Subsidiaries of the Company.
23.1* -- Consent of Deloitte & Touche LLP.
24.1* -- Powers of Attorney.
27.1* -- Financial Data Schedule.
- ---------------
* Filed herewith.
+ Management contracts or compensatory plans or arrangements.
48
49
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, on March 20, 1998.
DIAMOND OFFSHORE DRILLING, INC.
By: /s/ LAWRENCE R. DICKERSON*
----------------------------------
Lawrence R. Dickerson
Senior Vice President
and Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ ROBERT E. ROSE* President, Chief Executive Officer March 20, 1998
- ----------------------------------------------------- and Director (Principal
Robert E. Rose Executive Officer)
/s/ LAWRENCE R. DICKERSON* Senior Vice President and Chief March 20, 1998
- ----------------------------------------------------- Financial Officer (Principal
Lawrence R. Dickerson Financial Officer)
/s/ GARY T. KRENEK* Controller (Principal Accounting March 20, 1998
- ----------------------------------------------------- Officer)
Gary T. Krenek
/s/ JAMES S. TISCH* Chairman of the Board March 20, 1998
- -----------------------------------------------------
James S. Tisch
/s/ HERBERT C. HOFMANN* Director March 20, 1998
- -----------------------------------------------------
Herbert C. Hofmann
/s/ ARTHUR L. REBELL* Director March 20, 1998
- -----------------------------------------------------
Arthur L. Rebell
/s/ MICHAEL H. STEINHARDT* Director March 20, 1998
- -----------------------------------------------------
Michael H. Steinhardt
/s/ RAYMOND S. TROUBH* Director March 20, 1998
- -----------------------------------------------------
Raymond S. Troubh
*By: /s/ RICHARD L. LIONBERGER
------------------------------------------------
Richard L. Lionberger
Attorney in Fact
49
50
INDEX TO EXHIBITS
EXHIBIT NO. DESCRIPTION
----------- -----------
3.1 -- Restated Certificate of Incorporation of the Company
(incorporated by reference to Exhibit 3.1 of the
Company's Annual Report on Form 10-K for the fiscal year
ended December 31, 1995).
3.2 -- By-laws of the Company, as amended (incorporated by
reference to Exhibits 3.2, 3.2.1 and 3.2.2 of the
Company's Registration Statement No. 333-2680 on Forms
S-4/S-1).
4.1 -- Indenture, dated as of February 4, 1997, between the
Company and The Chase Manhattan Bank, as Trustee
(incorporated by reference to Exhibit 4.1 of the
Company's Current Report on Form 8-K filed February 11,
1997).
4.2 -- Supplemental Indenture, dated as of February 4, 1997,
between the Company and The Chase Manhattan Bank, as
Trustee (incorporated by reference to Exhibit 4.2 of the
Company's Current Report on Form 8-K filed February 11,
1997).
10.1 -- Registration Rights Agreement (the "Registration Rights
Agreement") dated October 16, 1995 between Loews and the
Company (incorporated by reference to Exhibit 10.2 of the
Company's Annual Report on Form 10-K for the fiscal year
ended December 31, 1995).
10.2* -- Amendment to the Registration Rights Agreement, dated
September 16, 1997 between Loews and the Company.
10.3 -- Services Agreement dated October 16, 1995 between Loews
and the Company (incorporated by reference to Exhibit
10.3 of the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 1995).
10.4+ -- Agreement ("Rose Employment Agreement"), dated November
1, 1992, between the Company and Robert E. Rose
(incorporated by reference to Exhibit 10.7 of the
Company's Registration Statement No. 33-95484 on Form
S-1).
10.5+ -- Amendment, dated December 27, 1995, to the Rose
Employment Agreement (incorporated by reference to
Exhibit 10.5 of the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1995).
10.6*+ -- Diamond Offshore Management Bonus Program, as amended and
restated, and dated as of December 31, 1997.
10.7+ -- Diamond Offshore Executive Deferred Compensation and
Supplemental Retirement Plan effective December 17, 1996
(incorporated by reference to Exhibit 10.10 of the
Company's Annual Report on Form 10-K for the fiscal year
ended December 31, 1996).
10.8*+ -- First Amendment to Diamond Offshore Executive Deferred
Compensation and Supplemental Retirement Plan dated March
18, 1998.
10.9 -- Credit Agreement among the Company, various lending
institutions, Bankers Trust Company and Christiania Bank
og Kreditkasse, New York Branch, as Co-Arrangers, Bankers
Trust Company, as Administrative Agent, Christiania Bank
og Kreditkasse, New York Branch, as Documentation Agent,
and The Fuji Bank, Limited, as Co-Agent, dated as of
February 8, 1996 and amended and restated as of March 27,
1996 and further amended and restated as of December 19,
1996 (incorporated by reference to Exhibit 10.1 of the
Company's Registration Statement No. 333-19987 on Form
S-3).
10.10 -- Diamond Offshore Drilling, Inc. Nonqualified Stock Option
Plan for Certain Former Directors of Arethusa
(incorporated by reference to Exhibit 10.17 of the
Company's Registration Statement No. 333-2680 on Forms
S-4/S-1).
51
EXHIBIT NO. DESCRIPTION
----------- -----------
10.11 -- Diamond Offshore Drilling, Inc. Stock Option Plan for
Certain Former Employees of Arethusa (incorporated by
reference to Exhibit 10.18 of the Company's Registration
Statement No. 333-2680 on Forms S-4/S-1).
10.12 -- Asset Purchase Agreement between Diamond M Onshore, Inc.
and Drillers Inc. dated as of November 12, 1996
(incorporated by reference to Exhibit 10.2 of the
Company's Registration Statement No. 333-19987 on Form
S-3).
10.13 -- Amendment No. 1, dated as of December 31, 1996, to Asset
Purchase Agreement between Diamond M Onshore, Inc. and
Drillers Inc. dated as of November 12, 1996 (incorporated
by reference to Exhibit 10.3 of the Company's
Registration Statement No. 333-19987 on Form S-3).
11.1* -- Statement re Computation of Per Share Earnings.
12.1* -- Statement re Computation of Ratios.
21.1* -- List of Subsidiaries of the Company.
23.1* -- Consent of Deloitte & Touche LLP.
24.1* -- Powers of Attorney.
27.1* -- Financial Data Schedule.
- ---------------
* Filed herewith.
+ Management contracts or compensatory plans or arrangements.