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DO > SEC Filings for DO > Form 10-Q on 1-May-2013All Recent SEC Filings

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Form 10-Q for DIAMOND OFFSHORE DRILLING INC


1-May-2013

Quarterly Report


ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion should be read in conjunction with our unaudited consolidated financial statements (including the notes thereto) included elsewhere in this report and our audited consolidated financial statements and the notes thereto, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Item 1A, "Risk Factors" included in our Annual Report on Form 10-K for the year ended December 31, 2012. References to "Diamond Offshore," "we," "us" or "our" mean Diamond Offshore Drilling, Inc., a Delaware corporation, and its subsidiaries.

We provide contract drilling services to the energy industry around the globe and are a leader in offshore drilling. Our fleet of 44 offshore drilling rigs, including four rigs held for sale, consists of 32 semisubmersibles, seven jack-ups and five dynamically positioned drillships, four of which are under construction. We expect two of our new drillships, the Ocean BlackHawk and the Ocean BlackHornet, to be delivered in the second and fourth quarters of 2013, respectively, and the deepwater floater Ocean Onyx to be available for drilling service late in the third quarter of 2013. Our remaining two newbuild drillships, the Ocean BlackRhino and Ocean BlackLion, are expected to be delivered in the second and fourth quarters of 2014, respectively. The deepwater floater Ocean Apex is expected to be delivered in the second quarter of 2014. As announced in the first quarter of 2013, the Ocean Patriot will undergo an enhancement project that will enable the rig to operate in the North Sea. The project is currently in the pre-construction phase; construction will take place in Singapore, beginning in the third quarter of 2013. Upon completion of the enhancement project, which is anticipated to occur in the first quarter of 2014, we expect the Ocean Patriot to mobilize to, and commence a three-year contract in, the United Kingdom, or U.K., sector of the North Sea.

Market Overview

Floater Markets

Ultra-Deepwater and Deepwater Floaters. The ultra-deepwater and deepwater floater markets are generally strong, particularly in the ultra-deepwater segment where there are only a few uncontracted rigs available to work in 2013, inclusive of the expected 2013 newbuild deliveries.

Regionally, the offshore basins of West Africa, Brazil and the Gulf of Mexico continue to be an area of significant ultra-deepwater and deepwater activity where demand is strong with potential for further growth, and in which dayrates are expected to remain steady throughout 2013. According to industry analysts, demand offshore Brazil is fueled primarily by aggressive exploration and development goals of Petróleo Brasileiro S.A., or Petrobras, as well as significant discoveries in the pre-salt and post-salt formations offshore Brazil. Similarly, pre-salt discoveries offshore Angola have led to a significant increase in deepwater demand in the area.

On the Outer Continental Shelf of the Gulf of Mexico, drilling activity has surpassed pre-Macondo levels, and industry analysts predict that the market will continue to strengthen in 2013 and beyond, particularly in the ultra-deepwater market. Demand in the U.S. Gulf of Mexico, or GOM, is tending more to newer deepwater and ultra-deepwater rigs due to new regulations, deeper waters and more challenging formations. Our newest rigs which we expect to be delivered in 2013, the Ocean BlackHawk, Ocean Onyx and Ocean BlackHornet, are all contracted to work in the GOM.

Despite the strong ultra-deepwater and deepwater markets, our ability to meet the strong demand in the near term is limited due to our contracted backlog in 2013 (100% and 98% for our ultra-deepwater and deepwater fleets, respectively). See "- Contract Drilling Backlog." In addition, the robust outlook for the ultra-deepwater and deepwater markets has led to a significant number of newbuild floater orders from established drilling contractors, as well as new entrants into the industry, which is expected to lead to increased competition. As of the date of this report, the total number of newbuild floaters on order or announced was reported to be in excess of 90 rigs, although newbuild orders have slowed in 2013, with only three orders having been placed in the first quarter of 2013. Based on industry analyst data, and excluding an estimated 29 rigs to be built on behalf of Petrobras, which is currently our most significant customer, 17% and 85% of the newbuilds scheduled for delivery in 2013 and 2014, respectively, are not yet contracted for future work, including two of our newbuild drillships, the Ocean BlackRhino and Ocean BlackLion, and our deepwater floater, the Ocean Apex, all of which are scheduled for delivery in 2014.

Mid-Water Floaters. Market demand for mid-water floaters is generally stable. In both the U.K. and Norway sectors of the North Sea, the mid-water market is particularly strong, with record dayrates being achieved. The mid-water market in other regions remains mixed but relatively stable. In the Mediterranean region, demand remains solid, where recent gas discoveries have led to increased interest in the region. The Southeast Asia and Australia markets also remain steady with indications of possible strengthening.


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As of the date of this report, our mid-water floaters in the aggregate were committed for 70% and 50% of 2013 and 2014, respectively. See "- Contract Drilling Backlog."

Jack-up Market

We have six actively-marketed jack-up rigs, four of which are currently operating in the Mexican waters of the Gulf of Mexico, where drilling activity remains stable and additional tendering activity is ongoing. Another jack-up rig is contracted under a two-year bareboat charter offshore Ecuador through August 2014. Our sixth marketed jack-up rig is actively seeking work in the GOM, where contracts are generally well-to-well or short-term in duration.

Contract Drilling Backlog

The following table reflects our contract drilling backlog as of April 25, 2013, February 1, 2013 (the date reported in our Annual Report on Form 10-K for the year ended December 31, 2012), and April 16, 2012 (the date reported in our Quarterly Report on Form 10-Q for the quarter ended March 31, 2012). Contract drilling backlog is calculated by multiplying the contracted operating dayrate by the firm contract period and adding one-half of any potential rig performance bonuses. Our calculation also assumes full utilization of our drilling equipment for the contract period (excluding scheduled shipyard and survey days); however, the amount of actual revenue earned and the actual periods during which revenues are earned will be different than the amounts and periods shown in the tables below due to various factors. Utilization rates, which generally approach 92-98% during contracted periods, can be adversely impacted by downtime due to various operating factors including, but not limited to, weather conditions and unscheduled repairs and maintenance. Contract drilling backlog excludes revenues for mobilization, demobilization, contract preparation and customer reimbursables. No revenue is generally earned during periods of downtime for regulatory surveys. Changes in our contract drilling backlog between periods are a function of the performance of work on term contracts, as well as the extension or modification of existing term contracts and the execution of additional contracts.

                                      April 25,      February 1,       April 16,
                                        2013             2013            2012
                                                    (In thousands)
         Contract Drilling Backlog
         Floaters:
         Ultra-Deepwater (1)         $ 4,257,000     $  4,422,000     $ 4,721,000
         Deepwater(2)                  1,143,000        1,229,000       1,133,000
         Mid-Water(3)                  2,436,000        2,649,000       2,119,000

         Total Floaters                7,836,000        8,300,000       7,973,000
         Jack-ups                        249,000          272,000         269,000

         Total                       $ 8,085,000     $  8,572,000     $ 8,242,000

(1) Contract drilling backlog as of April 25, 2013 for our ultra-deepwater floaters includes (i) $1.2 billion attributable to our contracted operations offshore Brazil for the years 2013 to 2015 and (ii) $1.8 billion attributable to future work for two of our drillships under construction for the years 2013 to 2019.

(2) Contract drilling backlog as of April 25, 2013 for our deepwater floaters includes (i) $503.0 million attributable to our contracted operations offshore Brazil for the years 2013 to 2016 and (ii) $179.0 million for the years 2013 to 2014 attributable to future work for the Ocean Onyx, which is under construction.

(3) Contract drilling backlog as of April 25, 2013 for our mid-water floaters includes $787.0 million attributable to our contracted operations offshore Brazil for the years 2013 to 2015.


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The following table reflects the amount of our contract drilling backlog by year as of April 25, 2013.

                                                          For the Years Ending December 31,
                                        Total         2013 (1)          2014            2015          2016-2019
                                                                   (In thousands)
Contract Drilling Backlog
Floaters:
Ultra-Deepwater (2)                  $ 4,257,000     $   764,000     $ 1,156,000     $ 1,099,000     $ 1,238,000
Deepwater(3)                           1,143,000         450,000         456,000         175,000          62,000
Mid-Water(4)                           2,436,000         890,000         949,000         404,000         193,000

Total Floaters                         7,836,000       2,104,000       2,561,000       1,678,000       1,493,000
Jack-ups                                 249,000         109,000          72,000          48,000          20,000

Total                                $ 8,085,000     $ 2,213,000     $ 2,633,000     $ 1,726,000     $ 1,513,000

(1) Represents a nine-month period beginning April 1, 2013.

(2) Contract drilling backlog as of April 25, 2013 for our ultra-deepwater floaters includes (i) $395.0 million, $473.0 million and $324.0 million for the years 2013 to 2015, respectively, attributable to our contracted operations offshore Brazil and (ii) $14.0 million, $300.0 million and $361.0 million for the years 2013, 2014 and 2015, respectively, and $1.1 billion in the aggregate for the years 2016 to 2019, attributable to future work for two of our drillships under construction.

(3) Contract drilling backlog as of April 25, 2013 for our deepwater floaters includes (i) $158.0 million, $149.0 million, $134.0 million and $62.0 million for the years 2013 to 2016, respectively, attributable to our contracted operations offshore Brazil and (ii) $45.0 million and $134.0 million for the years 2013 and 2014, respectively, attributable to future work for the Ocean Onyx, which is under construction.

(4) Contract drilling backlog as of April 25, 2013 for our mid-water floaters includes $366.0 million, $342.0 million and $79.0 million for the years 2013 to 2015, respectively, attributable to our contracted operations offshore Brazil.

The following table reflects the percentage of rig days committed by year as of April 25, 2013. The percentage of rig days committed is calculated as the ratio of total days committed under contracts, as well as scheduled shipyard, survey and mobilization days for all rigs in our fleet, to total available days (number of rigs multiplied by the number of days in a particular year). Total available days have been calculated based on the expected final commissioning dates for the Ocean BlackHawk, Ocean Onyx, Ocean BlackHornet, Ocean Apex, Ocean BlackRhino and Ocean BlackLion, which are all under construction.

                                          For the Years Ending December 31,
                               2013(1)          2014          2015        2016 - 2019
      Rig Days Committed (2)
      Floaters:
      Ultra-Deepwater               100 %          86 %          60 %               15 %
      Deepwater                      98 %          45 %          18 %                2 %
      Mid-Water                      75 %          50 %          18 %                2 %
      All Floaters                   85 %          56 %          30 %                6 %
      Jack-ups                       69 %          39 %          20 %                5 %

(1) Represents a nine-month period beginning April 1, 2013.

(2) As of April 25, 2013, includes approximately 1,060, 830, 70 and 70 currently known, scheduled shipyard, survey and mobilization days for the remainder of 2013, and for the years 2014, 2015 and 2016, respectively.

Important Factors That May Impact Our Operating Results, Financial Condition or Cash Flows

Regulatory Surveys and Planned Downtime. Our operating income is negatively impacted when we perform certain regulatory inspections, which we refer to as a 5-year survey, or special survey, that are due every five years for each of our rigs. Operating revenue decreases because these special surveys are generally performed during scheduled downtime in a shipyard. Operating expenses increase as a result of these special surveys due to the cost to mobilize the rigs to a shipyard, inspection costs incurred and repair and maintenance costs. Repair and maintenance activities may result from the special survey or may have been previously planned to take place during this mandatory downtime. The number of rigs undergoing a 5-year survey will vary from year to year, as well as from quarter to quarter.


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In addition, operating income may also be negatively impacted by intermediate surveys, which are performed at interim periods between 5-year surveys. Intermediate surveys are generally less extensive in duration and scope than a 5-year survey. Although an intermediate survey may require some downtime for the drilling rig, it normally does not require dry-docking or shipyard time, except for rigs located in the United Kingdom, or U.K., and Norwegian sectors of the North Sea.

During the next three quarters of 2013, nine of our rigs are expected to complete or undergo 5-year surveys. We expect these rigs to be out of service for approximately 560 days in the aggregate to complete the inspections and any shipyard projects scheduled concurrently with the surveys. We also expect to spend an additional approximately 500 days during the remainder of 2013 for the mobilization of rigs, contract acceptance testing and extended maintenance projects. We can provide no assurance as to the exact timing and/or duration of downtime associated with regulatory inspections, planned rig mobilizations and other shipyard projects. See " - Contract Drilling Backlog."

Physical Damage and Marine Liability Insurance. We are self-insured for physical damage to rigs and equipment caused by named windstorms in the U.S. Gulf of Mexico. If a named windstorm in the U.S. Gulf of Mexico causes significant damage to our rigs or equipment, it could have a material adverse effect on our financial position, results of operations and cash flows. Under our insurance policy that expires on May 1, 2014, we carry physical damage insurance for certain losses other than those caused by named windstorms in the U.S. Gulf of Mexico for which our deductible for physical damage is $25.0 million per occurrence. Our policy's war risk insurance excludes certain nationalization and deprivation coverage for the loss of use of rigs and equipment. We are evaluating the availability and cost of obtaining separate insurance coverage for these risks, although there is no assurance that we can obtain adequate insurance coverage for such events at rates we consider to be reasonable. We do not typically retain loss-of-hire insurance policies to cover our rigs.

In addition, under our insurance policy that expires on May 1, 2014, we carry marine liability insurance covering certain legal liabilities, including coverage for certain personal injury claims, with no exclusions for pollution and/or environmental risk. We believe that the policy limit for our marine liability insurance is within the range that is customary for companies of our size in the offshore drilling industry and is appropriate for our business. Our deductibles for marine liability coverage, including for personal injury claims, are $10.0 million for the first occurrence and vary in amounts ranging between $5.0 million and, if aggregate claims exceed certain thresholds, up to $100.0 million for each subsequent occurrence, depending on the nature, severity and frequency of claims which might arise during the policy year, which under the current policy commences on May 1 of each year.

Construction and Capital Upgrade Projects. We capitalize interest cost for the construction and upgrade of qualifying assets in accordance with accounting principles generally accepted in the U.S., or GAAP. The period of interest capitalization covers the duration of the activities required to make the asset ready for its intended use, and the capitalization period ends when the asset is substantially complete and ready for its intended use. During 2013, we expect to capitalize interest on qualifying expenditures related to the construction of our four new drillships, the Ocean Onyx and the Ocean Apex. We will continue to capitalize interest pursuant to these projects until such time, after the delivery of each rig, that activities related to making each respective vessel ready for service are no longer ongoing.

Critical Accounting Estimates

Our significant accounting policies are discussed in Note 1 of our notes to unaudited consolidated financial statements included in Item 1 of Part I of this report and in Note 1 of our notes to audited consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2012. There were no material changes to these policies during the three months ended March 31, 2013.


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Results of Operations

Although we perform contract drilling services with different types of drilling rigs and in many geographic locations, there is a similarity of economic characteristics among all our divisions and locations, including the nature of services provided and the type of customers for our services. We believe that the combination of our drilling rigs into one reportable segment is the appropriate aggregation in accordance with applicable accounting standards on segment reporting. However, for purposes of this discussion and analysis of our results of operations, we provide greater detail with respect to the types of rigs in our fleet to enhance the reader's understanding of our financial condition, changes in financial condition and results of operations.

Key performance indicators by equipment type are listed below.

                                               Three Months Ended
                                                   March 31,
                                              2013           2012
                REVENUE EARNING DAYS (1)
                Floaters:
                Ultra-Deepwater                   526            620
                Deepwater                         423            400
                Mid-Water                       1,042          1,124
                Jack-ups (2)                      448            522
                UTILIZATION (3)
                Floaters:
                Ultra-Deepwater                    73 %           85 %
                Deepwater                          94 %           88 %
                Mid-Water                          64 %           65 %
                Jack-ups (4)                       71 %           44 %
                AVERAGE DAILY REVENUE (5)
                Floaters:
                Ultra-Deepwater             $ 360,400      $ 364,000
                Deepwater                     389,100        358,900
                Mid-Water                     261,600        266,200
                Jack-ups                       85,200         86,700

(1) A revenue earning day is defined as a 24-hour period during which a rig earns a dayrate after commencement of operations and excludes mobilization, demobilization and contract preparation days.

(2) Revenue earning days for the quarter ended March 31, 2012 included approximately 87 days earned by certain of our jack-up rigs during the period prior to being sold in 2012.

(3) Utilization is calculated as the ratio of total revenue-earning days divided by the total calendar days in the period for all of the specified rigs in our fleet (including cold-stacked rigs).

(4) Utilization for our jack-up rigs would have been 68% for the quarter ended March 31, 2012, excluding revenue earning days and total calendar days associated with rigs that we sold in 2012.

(5) Average daily revenue is defined as contract drilling revenue for all of the specified rigs in our fleet (excluding revenues for mobilization, demobilization and contract preparation) per revenue earning day.


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Comparative data relating to our revenues and operating expenses by equipment type are listed below.

Three Months Ended March 31, 2013 and 2012



                                                       Three Months Ended
                                                            March 31,
                                                      2013            2012
                                                         (In thousands)
        CONTRACT DRILLING REVENUE
        Floaters:
        Ultra-Deepwater                             $ 191,357      $  244,589
        Deepwater                                     164,420         146,003
        Mid-Water                                     305,221         318,595

        Total Floaters                                660,998         709,187
        Jack-ups                                       38,975          45,968
        Other                                              -               -

        Total Contract Drilling Revenue             $ 699,973      $  755,155

        Revenues Related to Reimbursable Expenses   $  29,768      $   13,487
        CONTRACT DRILLING EXPENSE
        Floaters:
        Ultra-Deepwater                             $ 135,776      $  139,961
        Deepwater                                      56,436          58,594
        Mid-Water                                     143,647         162,779

        Total Floaters                                335,859         361,334
        Jack-ups                                       29,667          31,443
        Other                                           9,568           4,325

        Total Contract Drilling Expense             $ 375,094      $  397,102

        Reimbursable Expenses                       $  29,289      $   13,151
        OPERATING INCOME
        Floaters:
        Ultra-Deepwater                             $  55,581      $  104,628
        Deepwater                                     107,984          87,409
        Mid-Water                                     161,574         155,816

        Total Floaters                                325,139         347,853
        Jack-ups                                        9,308          14,525
        Other                                          (9,568 )        (4,325 )
        Reimbursable expenses, net                        479             336
        Depreciation                                  (96,821 )      (101,393 )
        General and administrative expense            (16,815 )       (17,586 )
        Bad debt (expense) recovery                        -              618
        Gain on disposition of assets                   2,004          25,382

        Total Operating Income                      $ 213,726      $  265,410

        Other income (expense):
        Interest income                                   617           1,783
        Interest expense                               (8,069 )       (15,329 )
        Foreign currency transaction gain (loss)          159            (104 )
        Other, net                                       (254 )          (325 )

        Income before income tax expense              206,179         251,435
        Income tax expense                            (30,190 )       (66,266 )

        NET INCOME                                  $ 175,989      $  185,169


Table of Contents

The following is a summary as of the date of this report of the most significant transfers of our rigs during 2013 and 2012 between the geographic areas in which we operate:

Rig                    Rig Type                   Relocation Details                     Date
Floaters:
Ocean Monarch       Ultra-Deepwater   Vietnam to Singapore (shipyard survey)        August 2012
Ocean Confidence    Ultra-Deepwater   Congo to Angola                               January 2013

Ocean Guardian      Mid-Water         Falkland Islands to U.K.                      January 2012
Ocean Saratoga      Mid-Water         GOM to Guyana                                 January 2012
Ocean Saratoga      Mid-Water         Guyana to GOM                                 May 2012
Ocean Whittington   Mid-Water         Brazil to GOM(a)                              May 2012
Ocean Apex          Mid-Water         Singapore shipyard(b)                         September 2012
Ocean Ambassador    Mid-Water         Brazil to GOM                                 October 2012
Ocean Lexington     Mid-Water         Brazil to Trinidad                            March 2013

Jack-ups:
Ocean Columbia      Jack-up           Sold                                          March 2012
Ocean Heritage      Jack-up           Sold                                          April 2012
Ocean Drake         Jack-up           Sold (cold stacked June 2009)                 May 2012
Ocean Champion      Jack-up           Sold (cold stacked June 2009)                 May 2012
Ocean Crusader      Jack-up           Sold (cold stacked June 2009)                 May 2012
Ocean Sovereign     Jack-up           Sold (cold stacked October 2011)              June 2012
Ocean Spur          Jack-up           Egypt to Ecuador; two year bareboat charter   August 2012
Ocean King          Jack-up           Montenegro to GOM                             December 2012

(a) Rig held for sale at December 31, 2012.

(b) Rig formerly operated as the Ocean Bounty and was cold stacked in July 2009. Rig has been used in the construction of a deepwater floater in Singapore.

Overview

Operating Income. Operating income decreased $51.7 million, or 19%, during the first quarter of 2013 compared to the same period of 2012, primarily due to a $55.2 million reduction in contract drilling revenue earned, partially offset by reductions in contract drilling expense ($22.0 million) and depreciation expense ($4.5 million) attributable to the sale of six rigs in 2012 and the transfer of . . .

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