1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
----------------- -------------------
Commission file number 1-13926
DIAMOND OFFSHORE DRILLING, INC.
(Exact name of registrant as specified in its charter)
Delaware 76-0321760
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)
15415 Katy Freeway
Houston, Texas
77094
(Address of principal executive offices)
(Zip Code)
(281) 492-5300
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
As of October 18, 1999 Common stock, $0.01 par value per share
135,824,281 shares
2
DIAMOND OFFSHORE DRILLING, INC.
TABLE OF CONTENTS FOR FORM 10-Q
QUARTER ENDED SEPTEMBER 30, 1999
PAGE NO.
COVER PAGE.......................................................................................1
TABLE OF CONTENTS................................................................................2
PART I. FINANCIAL INFORMATION...................................................................3
ITEM 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets....................................................3
Consolidated Statements of Income..............................................4
Consolidated Statements of Cash Flows..........................................5
Notes to Consolidated Financial Statements.....................................6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS......................................................12
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ....................22
PART II. OTHER INFORMATION......................................................................23
ITEM 1. LEGAL PROCEEDINGS..............................................................23
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS......................................23
ITEM 3. DEFAULTS UPON SENIOR SECURITIES................................................23
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............................23
ITEM 5. OTHER INFORMATION..............................................................23
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K...............................................23
SIGNATURES.......................................................................................24
EXHIBIT INDEX....................................................................................25
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
DIAMOND OFFSHORE DRILLING, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
SEPTEMBER 30, DECEMBER 31,
---------------- ------------------
1999 1998
---------------- ------------------
(UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents .................................................... $ 97,981 $ 101,198
Marketable securities ........................................................ 582,466 535,774
Accounts receivable .......................................................... 153,036 233,719
Rig inventory and supplies ................................................... 38,093 35,794
Prepaid expenses and other ................................................... 44,996 31,939
----------- -----------
Total current assets ................................................ 916,572 938,424
DRILLING AND OTHER PROPERTY AND EQUIPMENT, NET OF
ACCUMULATED DEPRECIATION ....................................................... 1,680,248 1,551,820
GOODWILL, NET OF ACCUMULATED AMORTIZATION ...................................... 88,547 109,825
OTHER ASSETS ................................................................... 8,946 9,647
----------- -----------
Total assets ........................................................ $ 2,694,313 $ 2,609,716
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable ............................................................. $ 68,017 $ 93,938
Accrued liabilities .......................................................... 41,036 53,283
Taxes payable ................................................................ 48,242 13,180
----------- -----------
Total current liabilities ........................................... 157,295 160,401
LONG-TERM DEBT ................................................................. 400,000 400,000
DEFERRED TAX LIABILITY ......................................................... 283,128 263,797
OTHER LIABILITIES .............................................................. 11,660 30,260
----------- -----------
Total liabilities ................................................... 852,083 854,458
----------- -----------
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, 500,000,000 shares authorized, 139,342,381
issued and 135,824,281 outstanding at September 30, 1999 and 139,333,635
issued and 135,815,535 outstanding at December 31, 1998) .................... 1,393 1,393
Additional paid-in capital ................................................... 1,302,841 1,302,806
Retained earnings ............................................................ 639,741 547,783
Accumulated other comprehensive losses ....................................... (13,019) (7,998)
Treasury stock, at cost (3,518,100 shares) ................................... (88,726) (88,726)
----------- -----------
Total stockholders' equity .......................................... 1,842,230 1,755,258
----------- -----------
Total liabilities and stockholders' equity .......................... $ 2,694,313 $ 2,609,716
=========== ===========
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 INCOME
(Unaudited)
(In thousands, except per share data)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------ -------------------------------
1999 1998 1999 1998
-------------- -------------- --------------- --------------
REVENUES ........................................... $ 206,740 $ 315,786 $ 650,114 $ 925,372
OPERATING EXPENSES:
Contract drilling............................. 115,123 116,503 324,642 357,939
Depreciation and amortization................. 36,085 33,305 107,448 98,051
General and administrative.................... 5,364 5,984 17,286 18,975
Gain on sale of assets........................ (38) (255) (182) (337)
--------------- -------------- ---------------- --------------
Total operating expenses................. 156,534 155,537 449,194 474,628
--------------- -------------- ---------------- --------------
OPERATING INCOME .................................... 50,206 160,249 200,920 450,744
OTHER INCOME (EXPENSE):
Interest income............................... 9,065 8,207 26,014 22,234
Interest expense.............................. (2,152) (3,615) (7,474) (11,239)
Other, net.................................... 1,094 2,379 328 2,559
--------------- -------------- ---------------- --------------
INCOME BEFORE INCOME TAX EXPENSE..................... 58,213 167,220 219,788 464,298
INCOME TAX EXPENSE................................... (20,367) (58,518) (76,897) (163,209)
--------------- -------------- ---------------- --------------
NET INCOME........................................... $ 37,846 $ 108,702 142,891 $ 301,089
=============== ============== ================ ==============
EARNINGS PER SHARE:
Basic......................................... $ 0.28 $ 0.79 $ 1.05 $ 2.17
=============== ============== ================ ==============
Diluted....................................... $ 0.27 $ 0.75 $ 1.01 $ 2.07
=============== ============== ================ ==============
WEIGHTED AVERAGE SHARES OUTSTANDING:
Shares of common stock........................ 135,824 137,652 135,821 138,762
Dilutive potential shares of common stock..... 9,876 9,876 9,876 9,876
--------------- -------------- ---------------- --------------
Total weighted average shares outstanding.. 145,700 147,528 145,697 148,638
=============== ============== ================ ==============
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 CASH FLOWS
(Unaudited)
(In thousands)
NINE MONTHS ENDED
SEPTEMBER 30,
------------------------
1999 1998
--------- ---------
OPERATING ACTIVITIES:
Net income .................................................. $ 142,891 $ 301,089
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization ............................. 107,448 98,051
Gain on sale of assets .................................... (182) (337)
Gain on sale of investment securities ..................... (23) (2,342)
Deferred tax provision .................................... 22,858 37,778
Accretion of discounts on investment securities ........... (7,163) (11,051)
Amortization of debt issuance costs ....................... 404 389
Changes in operating assets and liabilities:
Accounts receivable ....................................... 80,812 (28,930)
Rig inventory and supplies and other current assets ....... (15,356) (17,081)
Other assets, non-current ................................. 297 (956)
Accounts payable and accrued liabilities .................. (38,168) 243
Taxes payable ............................................. 34,245 10,992
Other liabilities, non-current ............................ (1,414) 2,242
Other, net ................................................ (509) (981)
--------- ---------
Net cash provided by operating activities ............. 326,140 389,106
--------- ---------
INVESTING ACTIVITIES:
Capital expenditures ........................................ (232,180) (132,600)
Proceeds from sale of assets ................................ 578 930
Net change in marketable securities ......................... (46,857) (97,061)
--------- ---------
Net cash used in investing activities ................. (278,459) (228,731)
--------- ---------
FINANCING ACTIVITIES:
Reacquisition of common stock ............................... -- (88,726)
Payment of dividends ........................................ (50,933) (52,249)
Proceeds from stock options exercised ....................... 35 289
--------- ---------
Net cash used in financing activities ................. (50,898) (140,686)
--------- ---------
NET CHANGE IN CASH AND CASH EQUIVALENTS ........................... (3,217) 19,689
Cash and cash equivalents, beginning of period .............. 101,198 102,958
--------- ---------
Cash and cash equivalents, end of period .................... $ 97,981 $ 122,647
========= =========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE
CONSOLIDATED FINANCIAL STATEMENTS.
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DIAMOND OFFSHORE DRILLING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. GENERAL
The consolidated financial statements of Diamond Offshore Drilling,
Inc. and subsidiaries (the "Company") should be read in conjunction with the
Annual Report on Form 10-K for the year ended December 31, 1998 (File No.
1-13926).
Interim Financial Information
The accompanying consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all disclosures required by
generally accepted accounting principles for complete financial statements. The
consolidated financial information has not been audited but, in the opinion of
management, includes all adjustments (consisting only of normal recurring
accruals) necessary for a fair presentation of the consolidated balance sheets,
statements of income, and statements of cash flows at the dates and for the
periods indicated. Results of operations for interim periods are not necessarily
indicative of results of operations for the respective full years.
Cash and Cash Equivalents
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.
Marketable Securities
The Company's investments are classified as available for sale and
stated at fair value. Accordingly, any unrealized gains and losses, net of
taxes, are reported in the Consolidated Balance Sheets in "Accumulated other
comprehensive losses" until realized. The cost of debt securities is adjusted
for amortization of premiums and accretion of discounts to maturity and such
adjustments are included in the Consolidated Statements of Income in "Interest
income." The cost of debt securities sold is based on the specific
identification method and the cost of equity securities sold is based on the
average cost method. Realized gains or losses and declines in value, if any,
judged to be other than temporary are reported in the Consolidated Statements of
Income in "Other income (expense)."
Supplementary Cash Flow Information
Cash payments made for interest on long-term debt totaled $15.0 million
during both the nine months ended September 30, 1999 and 1998. Cash payments
made, net of refunds, for income taxes during the nine months ended September
30, 1999 and 1998 totaled $35.5 million and $114.4 million, respectively.
Capitalized Interest
Interest cost for construction and upgrade of qualifying assets is
capitalized. The Company incurred interest cost, including amortization of debt
issuance costs, of $3.9 million and $11.6 million during the quarter and nine
months ended September 30, 1999, respectively. Interest cost capitalized during
the quarter and nine months ended September 30, 1999 was $1.7 million and $4.1
million, respectively. The Company incurred interest costs of $3.8 million and
$11.6 million during the quarter and nine months ended September 30, 1998,
respectively. Interest cost capitalized during the quarter and nine months ended
September 30, 1998 was not material.
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Goodwill
Goodwill from the merger with Arethusa (Off-Shore) Limited ("Arethusa")
is amortized on a straight-line basis over 20 years. Amortization expense
totaled $1.3 million and $4.1 million for the quarter and nine months ended
September 30, 1999, respectively. For the quarter and nine months ended
September 30, 1998, amortization expense totaled $1.6 million and $4.8 million,
respectively.
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.
Treasury Stock
In July 1998, the Board of Directors authorized the purchase of shares
of the Company's common stock in the open market, from time to time, depending
on market conditions. The purchase of treasury stock is accounted for using the
cost method, which reports the cost of the shares acquired in "Treasury stock"
as a deduction from stockholders' equity in the Consolidated Balance Sheets. No
purchases of treasury stock were made during the nine months ended September 30,
1999. During the quarter and nine months ended September 30, 1998, the Company
purchased 3.5 million shares of its common stock at an aggregate cost of $88.7
million, or $25.22 per share.
Comprehensive Income
Comprehensive income is the change in equity of a business enterprise
during a period from transactions and other events and circumstances from
non-owner sources. It includes all changes in equity during a period except
those resulting from investments by owners and distributions to owners. For the
quarter and nine months ended September 30, 1999, comprehensive income totaled
$37.1 million and $137.8 million, respectively. For the quarter and nine months
ended September 30, 1998, comprehensive income totaled $106.4 million and $297.7
million, respectively. Comprehensive income includes net income, foreign
currency translation gains and losses, and unrealized holding gains and losses
on investments.
Earnings Per Share
Basic earnings per share excludes dilution and is computed by dividing
net income by the weighted average number of shares of common stock outstanding
for the period. 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, by the weighted average number of shares of common stock
outstanding and the weighted average number of shares of common stock issuable
assuming full conversion of the convertible subordinated notes as of the
beginning of the periods presented.
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.
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2. MARKETABLE SECURITIES
Investments classified as available for sale are summarized as follows:
SEPTEMBER 30, 1999
----------------------------------------
UNREALIZED MARKET
COST GAIN (LOSS) VALUE
------------ ------------- -----------
(IN THOUSANDS)
Debt securities issued by the U.S. Treasury
Due within one year...................... $ 258,798 $ (311) $ 258,487
Due after one year through five years 174,806 (1,183) 173,623
Collateralized mortgage obligations........... 153,019 (4,109) 148,910
Equity securities............................. 12,117 (10,671) 1,446
------------ ------------- -----------
Total.................................... $ 598,740 $ (16,274) $ 582,466
============ ============= ===========
DECEMBER 31, 1998
----------------------------------------
UNREALIZED MARKET
COST GAIN (LOSS) VALUE
------------ ------------- -----------
Debt securities issued by the U.S. Treasury
Due within one year..................... $ 304,224 $ (21) $ 304,203
Due after one year through five years... 24,982 91 25,073
Collateralized mortgage obligations.......... 203,504 (452) 203,052
Equity securities............................ 12,117 (8,671) 3,446
------------ ------------- -----------
Total................................... $ 544,827 $ (9,053) $ 535,774
============ ============= ===========
All of the Company's investments are included as current assets in the
Consolidated Balance Sheets in "Marketable securities," representing the
investment of cash available for current operations.
During the nine months ended September 30, 1999 and 1998, certain debt
securities due within one year were sold or matured for proceeds of $505.9
million and $208.8 million, respectively. Certain debt securities due after one
year were sold for proceeds of $50.5 million and $501.9 million during the nine
months ended September 30, 1999 and 1998, respectively. Also during the nine
months ended September 30, 1998, equity securities were sold for proceeds of
$2.4 million and investments through repurchase agreements with third parties
were sold for their contracted amounts totaling $350.0 million. The resulting
after-tax realized gains and losses during the nine months ended September 30,
1999 were not material. An after-tax gain of $1.3 million was realized on the
sale of debt securities due after one year during the nine months ended
September 30, 1998.
The Company believes the declines in the fair values of its financial
instruments due to interest rate and equity price sensitivity are temporary in
nature. This determination was based on the marketability of the instruments,
the Company's ability to retain its investment in the instruments, past market
movements and reasonably possible, near-term market movements. Therefore, the
Company does not believe that potential, near-term losses in future earnings,
fair values, or cash flows are likely to be material.
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3. DRILLING AND OTHER PROPERTY AND EQUIPMENT
Cost and accumulated depreciation of drilling and other property and
equipment is summarized as follows:
SEPTEMBER 30, DECEMBER 31,
--------------- ----------------
1999 1998
--------------- ----------------
(IN THOUSANDS)
Drilling rigs and equipment........................... $ 2,021,648 $ 1,929,540
Construction work in progress......................... 224,900 88,266
Land and buildings.................................... 13,896 13,874
Office equipment and other............................ 17,110 14,100
--------------- ----------------
Cost.............................................. 2,277,554 2,045,780
Less accumulated depreciation......................... (597,306) (493,960)
--------------- ----------------
Drilling and other property and equipment, net... $ 1,680,248 $ 1,551,820
=============== ================
4. GOODWILL
The merger with Arethusa in 1996 generated an excess of the purchase
price over the estimated fair value of the net assets acquired. Cost and
accumulated amortization of such goodwill is summarized as follows:
SEPTEMBER 30, DECEMBER 31,
--------------- ----------------
1999 1998
--------------- ----------------
(IN THOUSANDS)
Goodwill........................................... $ 110,232 $ 127,418
Less accumulated amortization...................... (21,685) (17,593)
-------------- ----------------
Total.................................... $ 88,547 $ 109,825
============== ================
During the nine months ended September 30, 1999, an adjustment of $17.2
million was recorded to reduce goodwill before accumulated amortization. The
adjustment represents tax benefits not previously recognized for the excess of
tax deductible goodwill over the book goodwill amount.
5. ACCRUED LIABILITIES
Accrued liabilities consist of the following:
SEPTEMBER 30, DECEMBER 31,
--------------- ----------------
1999 1998
--------------- ----------------
(IN THOUSANDS)
Personal injury and other claims................... $ 18,830 $ 20,676
Payroll and benefits............................... 16,344 18,701
Interest payable................................... 1,917 5,667
Other.............................................. 3,945 8,239
--------------- ----------------
Total.................................... $ 41,036 $ 53,283
=============== ================
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6. COMMITMENTS AND CONTINGENCIES
In August 1999, a customer terminated a contract for use of one of the
Company's drilling rigs located offshore Australia. The termination was made in
accordance with the terms of the contract and was not the result of performance
failures by the Company or its equipment. The Company believes the contract
requires the customer to pay approximately $16.5 million in remaining revenue
through the end of the contract period, which was previously scheduled to end in
early January 2000, with set off for revenues earned by the rig from other
contracts during that period. However, the customer believes that there are no
further obligations under the contract and has refused to pay the $16.5 million
early termination fee. The Company filed suit in Australia in August 1999
requesting reconstruction of the contract and a declaratory judgment requiring
the customer to pay such early termination fee. The Company intends to
vigorously pursue its claim. For financial statement purposes, the $16.5 million
early termination fee has been fully reserved as a reduction of revenues in the
Company's results of operations for the quarter ended September 30, 1999.
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. The plaintiffs appealed the judgment
and the appellate court ordered the parties to mediation. The case went to
mediation in July 1998 with no resolution. In May 1999, the case went before the
Texas First Court of Appeals, Houston, which affirmed the jury verdict. The
plaintiffs obtained an extension to file a petition for review with the Supreme
Court of Texas by November 18, 1999. The Company has not established a provision
for any liability for this case.
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.
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7. SEGMENTS AND GEOGRAPHIC AREA ANALYSIS
The Company reports its operations as one reportable segment, contract
drilling of offshore oil and gas wells. Although the Company provides contract
drilling services from different types of offshore drilling rigs and provides
such services in many geographic locations, these operations have been
aggregated into one reportable segment based on the similarity of economic
characteristics among all divisions and locations, including the nature of
services provided and the type of customers of such services. The data below is
presented in accordance with Statement of Financial Accounting Standards No.
131, "Disclosures about Segments of an Enterprise and Related Information,"
which the Company has retroactively adopted for all periods presented.
Similar Services
Revenues from external customers for contract drilling and similar
services by equipment-type are listed below (eliminations offset dayrate
revenues earned when the Company's rigs are utilized in its integrated
services):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------- -----------------------------
1999 1998 1999 1998
------------- ------------- -------------- -------------
(IN THOUSANDS)
Fourth-Generation Semisubmersibles.. $ 64,279 $ 78,229 $ 201,148 $ 217,204
Other Semisubmersibles.............. 114,344 184,183 374,187 528,835
Jack-ups............................ 15,202 52,985 59,249 176,307
Integrated Services................. 18,213 389 25,623 21,538
Eliminations........................ (5,298) -- (10,093) (18,512)
------------- ------------- -------------- -------------
Total revenues.............. $ 206,740 $ 315,786 $ 650,114 $ 925,372
============= ============= ============== =============
Geographic Areas
At September 30, 1999, the Company had drilling rigs located offshore
eight countries other than the United States. As a result, the Company is
exposed to the risk of changes in social, political and economic conditions
inherent in foreign operations and the Company's results of operations and the
value of its foreign assets are affected by fluctuations in foreign currency
exchange rates. Revenues by geographic area are presented by attributing
revenues to the individual country where the services were performed.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------- -----------------------------
1999 1998 1999 1998
------------- ------------- -------------- -------------
(IN THOUSANDS)
Revenues from unaffiliated customers:
United States.......................... $ 118,252 $ 175,933 $ 326,408 $ 543,962
Foreign:
Europe/Africa....................... 35,384 80,077 156,468 222,599
Australia/Southeast Asia............ 18,650 37,322 75,003 101,877
South America....................... 34,454 22,454 92,235 56,934
------------- ------------- -------------- -------------
Total revenues.............. $ 206,740 $ 315,786 $ 650,114 $ 925,372
============= ============= ============== =============
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following discussion should be read in conjunction with the
Company's Consolidated Financial Statements (including the Notes thereto)
included elsewhere herein.
The Company is a leader in deep water drilling with a fleet of 46
offshore drilling rigs. The fleet consists of 30 semisubmersibles, 15 jack-ups
and one drillship.
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.
Revenues from offshore turnkey contracts are accrued to the extent of
costs until the specified turnkey depth and other contract requirements are met.
Income is recognized on the completed contract method. Provisions for future
losses on turnkey contracts are recognized when it becomes apparent that
expenses to be incurred on a specific contract will exceed the revenue from that
contract.
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 the loss of revenues. The Company
recognizes as operating expenses 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 and upgrades 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.
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THREE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
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). Certain amounts applicable to the prior period have been reclassified
to conform to the classifications currently followed. Such reclassifications do
not affect earnings.
THREE MONTHS ENDED
SEPTEMBER 30,
---------------------------- INCREASE/
1999 1998 (DECREASE)
------------- --------------- -------------
(IN THOUSANDS)
REVENUES
Fourth-Generation Semisubmersibles.... $ 64,279 $ 78,229 $ (13,950)
Other Semisubmersibles................ 114,344 184,183 (69,839)
Jack-ups.............................. 15,202 52,985 (37,783)
Integrated Services................... 18,213 389 17,824
Eliminations.......................... (5,298) -- (5,298)
------------- --------------- -------------
Total Revenues..................... $ 206,740 $ 315,786 $ (109,046)
============= ============== =============
CONTRACT DRILLING EXPENSE
Fourth-Generation Semisubmersibles.... $ 28,066 $ 21,250 $ 6,816
Other Semisubmersibles................ 52,772 65,049 (12,277)
Jack-ups.............................. 21,152 27,764 (6,612)
Integrated Services................... 16,998 489 16,509
Other................................. 1,433 1,951 (518)
Eliminations.......................... (5,298) -- (5,298)
------------- -------------- -------------
Total Contract Drilling Expense.... $ 115,123 $ 116,503 $ (1,380)
============= ============== =============
OPERATING INCOME
Fourth-Generation Semisubmersibles.... $ 36,213 $ 56,979 $ (20,766)
Other Semisubmersibles................ 61,572 119,134 (57,562)
Jack-ups.............................. (5,950) 25,221 (31,171)
Integrated Services................... 1,215 (100) 1,315
Other................................. (1,433) (1,951) 518
Depreciation and Amortization Expense. (36,085) (33,305) (2,780)
General and Administrative Expense.... (5,364) (5,984) 620
Gain on Sale of Assets.............. 38 255 (217)
------------- --------------- -------------
Total Operating Income...... $ 50,206 $ 160,249 $ (110,043)
============= ============== =============
Fourth-Generation Semisubmersibles.
Revenues. Revenues from fourth-generation semisubmersibles during the
three months ended September 30, 1999 decreased by $14.0 million from the same
period in 1998. This decrease resulted primarily from a decrease in revenues of
approximately $13.4 million from the Ocean Valiant, which was in the shipyard
during most of the third quarter of 1999 for stability enhancements and other
repairs. Revenues were also reduced by approximately $3.3 million from the Ocean
Clipper which spent approximately one-half of the third quarter of 1999 in a
shipyard undergoing modifications and preparing for its upcoming three-year
contract offshore Brazil. See "--Outlook."
Contract Drilling Expense. Contract drilling expense for
fourth-generation semisubmersibles during the three months ended September 30,
1999 increased $6.8 million from the same period in 1998. This increase resulted
primarily from an increase of $4.9 million for repairs performed on the Ocean
Valiant, which was placed in the shipyard during the third quarter of 1999.
Also, contract drilling expense increased approximately $1.0 million for the
Ocean Victory primarily due to costs associated with mooring system repairs
during the three months ended September 30, 1999.
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Other Semisubmersibles.
Revenues. Revenues from other semisubmersibles during the three months
ended September 30, 1999 decreased $69.8 million from the same quarter in 1998.
This decrease resulted primarily from reduced revenues of $38.2 million
attributable to a decline in utilization as compared to the three months ended
September 30, 1998 and $3.1 million due to rigs removed from service in late
1998. Revenues were also reduced by approximately $28.3 million from decreased
operating dayrates as compared to the same period of 1998. The average operating
dayrate for other semisubmersibles was $77,100 per day during the third quarter
of 1999, as compared to $95,700 per day during the third quarter of 1998.
Contract Drilling Expense. Contract drilling expense for other
semisubmersibles during the three months ended September 30, 1999 decreased
$12.3 million from the same quarter in 1998. This decrease resulted primarily
from expense reductions from rigs that were idle for all or part of the current
quarter and from rigs removed from service in late 1998.
Jack-Ups.
Revenues. Revenues from jack-ups during the three months ended
September 30, 1999 decreased $37.8 million from the same quarter in 1998. This
decrease was primarily due to reductions in revenues of $30.1 million resulting
from decreased operating dayrates as compared to the same period of 1998. The
average operating dayrate for jack-ups was $16,500 per day during the third
quarter of 1999, as compared to $49,200 per day during the third quarter of
1998. In addition, revenues decreased by $7.7 million from an overall decrease
in utilization and rigs removed from service in late 1998 and the first quarter
of 1999. See "--Outlook."
Contract Drilling Expense. Contract drilling expense for jack-ups
during the three months ended September 30, 1999 decreased $6.6 million from the
same quarter in 1998. This decrease was the result of the decline in utilization
and the removal of rigs from service in late 1998 and the first quarter of 1999.
Integrated Services.
Revenues and contract drilling expense for integrated services
increased primarily due to three turnkey wells completed during the third
quarter of 1999. See "--Integrated Services."
Depreciation and Amortization Expense.
Depreciation and amortization expense for the three months ended
September 30, 1999 of $36.1 million increased $2.8 million from $33.3 million
for the three months ended September 30, 1998. This increase resulted primarily
from increased expenditures associated with the Company's continuing rig
enhancement program.
Interest Income.
Interest income of $9.1 million for the three months ended September
30, 1999 increased $0.9 million from $8.2 million for the same period in 1998.
This increase resulted primarily from the investment of additional excess cash
in 1999. See " --Liquidity."
Interest Expense.
Interest expense of $2.2 million for the three months ended September
30, 1999 decreased $1.4 million from $3.6 million for the same period in 1998.
This decrease resulted primarily from an increase in capitalized interest cost
based on the average amount of accumulated expenditures for the Ocean
Confidence. See "--Capital Resources."
Income Tax Expense.
Income tax expense of $20.4 million for the three months ended
September 30, 1999 decreased $38.1 million from $58.5 million for the three
months ended September 30, 1998. This decrease resulted primarily from
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the $109.0 million decrease in income before income tax expense as compared to
the three months ended September 30, 1998.
NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
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). Certain amounts applicable to the prior period have been reclassified
to conform to the classifications currently followed. Such reclassifications do
not affect earnings.
NINE MONTHS ENDED
SEPTEMBER 30,
------------------------------ INCREASE/
1999 1998 (DECREASE)
------------- --------------- -------------
(IN THOUSANDS)
REVENUES
Fourth-Generation Semisubmersibles..... $ 201,148 $ 217,204 $ (16,056)
Other Semisubmersibles................. 374,187 528,835 (154,648)
Jack-ups............................... 59,249 176,307 (117,058)
Integrated Services.................... 25,623 21,538 4,085
Eliminations........................... (10,093) (18,512) 8,419
------------- --------------- -------------
Total Revenues..................... $ 650,114 $ 925,372 $ (275,258)
============= =============== =============
CONTRACT DRILLING EXPENSE
Fourth-Generation Semisubmersibles..... $ 73,839 $ 61,826 $ 12,013
Other Semisubmersibles................. 169,761 209,948 (40,187)
Jack-ups............................... 63,847 76,804 (12,957)
Integrated Services.................... 23,948 21,444 2,504
Other.................................. 3,340 6,429 (3,089)
Eliminations........................... (10,093) (18,512) 8,419
------------- --------------- -------------
Total Contract Drilling Expense.... $ 324,642 $ 357,939 $ (33,297)
============= =============== =============
OPERATING INCOME
Fourth-Generation Semisubmersibles..... $ 127,309 $ 155,378 $ (28,069)
Other Semisubmersibles................. 204,426 318,887 (114,461)
Jack-ups............................... (4,598) 99,503 (104,101)
Integrated Services.................... 1,675 94 1,581
Other.................................. (3,340) (6,429) 3,089
Depreciation and Amortization Expense.. (107,448) (98,051) (9,397)
General and Administrative Expense..... (17,286) (18,975) 1,689
Gain on Sale of Assets................. 182 337 (155)
------------- --------------- -------------
Total Operating Income............. $ 200,920 $ 450,744 $ (249,824)
============= =============== =============
Fourth-Generation Semisubmersibles.
Revenues. Revenues from fourth-generation semisubmersibles during the
nine months ended September 30, 1999 decreased $16.1 million from the same
period in 1998. This decrease resulted primarily from a decrease in revenues of
$14.5 million from the Ocean Valiant due to decreased utilization as the rig was
in the shipyard for stability enhancements and other repairs during most of the
third quarter of 1999. Revenues were also reduced by approximately $11.7 million
due to rig downtime for upgrades and repairs performed on the Ocean Clipper
during 1999 and $6.8 million due to rig downtime associated with the mandatory
inspection and repairs of the Ocean America. These decreases were partially
offset by an increase in revenues of approximately $14.2 million from the Ocean
Victory, which was in the shipyard during part of 1998 for repairs required as a
result of the February 1998 engine room fire. The decrease in revenue was also
offset by an increase of approximately $2.7 million in deferred revenue
recognized in 1999 associated with the mobilization of the Ocean Alliance from
the North Sea to Angola in late 1998.
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Contract Drilling Expense. Contract drilling expense for
fourth-generation semisubmersibles during the nine months ended September 30,
1999 increased $12.0 million from the same period in 1998. This increase
resulted in part from an increase of $4.9 million for repairs performed on the
Ocean Valiant, which was placed in the shipyard during the third quarter of
1999. Also contributing to this increase was $3.8 million in costs associated
with the mandatory inspection and repairs of the Ocean America and $2.0 million
in costs incurred for the mobilization of the Ocean Alliance from the North Sea
to Angola during late 1998 and the first quarter of 1999. In addition, contract
drilling expense for the Ocean Victory increased approximately $2.1 million due
to the capitalization of costs associated with shipyard repairs during most of
the first half of 1998.
Other Semisubmersibles.
Revenues. Revenues from other semisubmersibles during the nine months
ended September 30, 1999 decreased $154.6 million from the same period in 1998.
This decrease resulted, in part, from reduced revenues of $80.3 million
attributable to a decline in utilization as compared to 1998 and $33.9 million
due to rigs removed from service in late 1998. In addition, revenues were
reduced by $30.1 million due to rig downtime during 1999 for mandatory
inspections and repairs for the Ocean New Era, the Ocean Yatzy, the Ocean
Concord, and the Ocean Winner. Also contributing to the decrease in revenues was
a $28.3 million decrease in operating dayrates as compared to the same period in
1998. The average operating dayrate for other semisubmersibles was $85,900 per
day during the first nine months of 1999, as compared to $92,700 per day during
the first nine months of 1998. Partially offsetting these decreases in revenues
were increases of $27.8 million from eight other rigs which were undergoing
mandatory inspections during the first nine months of 1998.
Contract Drilling Expense. Contract drilling expense for other
semisubmersibles during the nine months ended September 30, 1999 decreased $40.2
million from the same period in 1998. This decrease resulted primarily from
expense reductions of approximately $30.8 million from rigs that were idle for
all or part of the first nine months of 1999. Contract drilling expense also
decreased by approximately $16.9 million due to fewer mandatory inspections and
repairs performed during the first nine months of 1999 as compared to 1998.
Partially offsetting these decreases was an increase in costs of $7.4 million
associated with the mobilization of the Ocean Winner from the Gulf of Mexico to
Brazil during the first half of 1999.
Jack-Ups.
Revenues. Revenues from jack-ups during the nine months ended September
30, 1999 decreased $117.1 million from the same period in 1998. This decrease
was primarily due to reductions in revenues of $57.3 million resulting from
decreased operating dayrates and $58.0 million resulting from decreased
utilization and the removal of rigs from service in late 1998 and the first
quarter of 1999. See "--Outlook." The average operating dayrate for jack-ups was
$23,900 per day during the first nine months of 1999 as compared to $51,200 per
day during the first nine months of 1998.
Contract Drilling Expense. Contract drilling expense for jack-ups
during the nine months ended September 30, 1999 decreased $13.0 million over the
same period in 1998. This decrease resulted primarily from expense reductions
from rigs that were removed from service in late 1998 and the first quarter of
1999.
Integrated Services.
Revenues and contract drilling expense for integrated services
increased primarily from three turnkey wells completed during 1999. See
"--Integrated Services."
Other.
Other contract drilling expense of $3.3 million during the first nine
months of 1999 decreased $3.1 million from $6.4 million during the first nine
months of 1998. This decrease resulted primarily from a reduction in
expenditures during the first nine months of 1999 for crew training programs and
various other non-recurring charges.
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Depreciation and Amortization Expense.
Depreciation and amortization expense for the nine months ended
September 30, 1999 of $107.4 million increased $9.4 million from $98.0 million
for the nine months ended September 30, 1998. This increase resulted primarily
from increased expenditures associated with the Company's continuing rig
enhancement program.
General and Administrative Expense.
General and administrative expense of $17.3 million for the nine months
ended September 30, 1999 decreased $1.7 million from $19.0 million for the same
period in 1998 primarily due to a decrease in legal and personnel costs.
Interest Income.
Interest income of $26.0 million for the nine months ended September
30, 1999 increased $3.8 million from $22.2 million for the same period in 1998.
This increase resulted primarily from the investment of additional excess cash
in 1999. See "--Liquidity."
Interest Expense.
Interest expense of $7.5 million for the nine months ended September
30, 1999 decreased $3.7 million from $11.2 million for the same period in 1998.
This decrease resulted primarily from an increase in capitalized interest cost
based on the average amount of accumulated expenditures for the Ocean
Confidence. See "--Capital Resources."
Income Tax Expense.
Income tax expense of $76.9 million for the nine months ended September
30, 1999 decreased $86.3 million from $163.2 million for the nine months ended
September 30, 1998. This decrease resulted primarily from the $244.5 million
decrease in income before income tax expense as compared to the nine months
ended September 30, 1998.
OUTLOOK
Recent product prices have improved considerably as compared to late
1997 and throughout 1998. If sustained long-term, this improvement suggests the
offshore drilling industry could see a gradual improvement in utilization and
dayrates. But in the near-term, however, customers are taking a very cautious
approach to exploration and development until product prices display some level
of stability at a sustainable level. Continued improvements in market conditions
depend upon, among other factors, the Company's customer's belief that the
improved product prices currently in effect are sustainable. Currently, the
Company has eight rigs removed from service and several of the Company's other
rigs remain idle in various markets. The Company will continually assess the
need to cold stack additional rigs or reactivate equipment depending on market
conditions. The Company believes that, with its fleet size and composition, it
is well positioned to take advantage of opportunities when market conditions
improve.
The depressed conditions in the oil and gas industry have also
increased the susceptibility of term contracts previously committed at dayrates
in excess of current market rates to be terminated or renegotiated by the
customer. Although the Company has not been advised, other than as discussed
below, of contracts at risk, certain of its existing term contracts provide for
dayrates in excess of current market rates. Cancellation or renegotiation of
these contracts could have an adverse effect on the Company's results of
operations.
In August 1999, a customer terminated a contract for use of one of the
Company's drilling rigs located offshore Australia. The termination was made in
accordance with the terms of the contract and was not the result of performance
failures by the Company or its equipment. The Company believes the contract
requires the customer to pay approximately $16.5 million in remaining revenue
through the end of the contract period, which was previously scheduled to end in
early January 2000, with set off for revenues earned by the rig from other
contracts during that period. However, the customer believes that there are no
further obligations under the contract and has refused to pay the $16.5 million
early termination fee. The Company filed suit in Australia in August 1999
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requesting reconstruction of the contract and a declaratory judgment requiring
the customer to pay such early termination fee. The Company intends to
vigorously pursue its claim. For financial statement purposes, the $16.5 million
early termination fee has been fully reserved as a reduction of revenues in the
Company's results of operations for the quarter ended September 30, 1999.
The conversion of the Ocean Confidence from an accommodation vessel to
a semisubmersible drilling unit capable of operating in harsh environments and
ultra-deep water continues. The upgrade and associated sea trials are
anticipated to be completed in April 2000, when the rig is scheduled to begin a
five-year contract in the Gulf of Mexico. See "--Capital Resources." Increased
rig construction and enhancement programs are also ongoing by the Company's
competitors. This increase in the supply of technologically advanced rigs
capable of drilling in deep water has produced a marginal oversupply of such
equipment in the current market and, in turn, adversely affected the utilization
level and average operating dayrates available for the Company's rigs,
particularly its higher specification semisubmersible units.
The Company's drillship, the Ocean Clipper, successfully drilled the
world's deepest water depth turnkey well in the Gulf of Mexico in August 1999.
See "--Integrated Services." The Ocean Clipper is currently undergoing
installation of required equipment and performing necessary modifications in
connection with its upcoming three-year contract offshore Brazil. This contract
is anticipated to commence at the end of 1999 and is expected to generate
revenues of at least $103.0 million over the three-year period.
The Company's results of operations for 1999 have been adversely
affected by the loss of revenues and associated costs incurred during required
regulatory inspections of its drilling rigs. Five of these inspections were
completed during the nine months ended September 30, 1999. Also, in late
September 1999, the Company began the regulatory inspection of the Ocean
Guardian, which was previously scheduled for the first quarter of 2000, to
utilize idle time between contracts. While no further inspections are scheduled
for the remainder of 1999, the Company may perform additional inspections or
undertake modifications to take advantage of rig downtime. The Company intends
to focus on returning these rigs to operation as soon as reasonably possible, in
order to minimize downtime and associated loss of revenues, but the extent of
such downtime cannot be accurately predicted.
Historically, the offshore contract drilling market has been highly
competitive and cyclical, and the Company cannot predict the extent to which
current conditions may or may not continue.
LIQUIDITY
At September 30, 1999, cash and marketable securities totaled $680.4
million, up from $637.0 million at December 31, 1998. Cash provided by operating
activities for the nine months ended September 30, 1999 decreased by $63.0
million to $326.1 million, as compared to $389.1 million for the same period of
the prior year. This decrease in cash was primarily attributable to a $158.2
million decrease in net income and a $38.4 million decrease in accounts payable
and accrued liabilities. These decreases were partially offset by a $109.7
million increase in cash resulting from a decrease in accounts receivable and a
$23.3 million increase in cash resulting from a decrease in taxes payable.
Investing activities used $278.5 million of cash during the nine months
ended September 30, 1999, as compared to $228.7 million during the same period
of the prior year. This increase resulted primarily from a $99.6 million
increase in cash used for capital expenditures, primarily the conversion of the
Ocean Confidence, partially offset by a $50.2 million decrease in cash used for
investments in marketable securities.
In April 1999, the Company entered into a $20.0 million short-term
revolving credit agreement with a U.S. bank. The agreement provides for
borrowings at various interest rates and varying commitment fees dependent upon
public credit ratings. The Company intends to use the facility primarily for
letters of credit that the Company must post, from time to time, for bid and
performance guarantees required in certain parts of the world. The agreement
contains certain financial and other covenants and provisions that must be
maintained by the Company for compliance. As of September 30, 1999, there were
no outstanding borrowings under this agreement and the Company was in compliance
with each of the covenants and provisions.
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
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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 it has the financial resources needed to meet its
business requirements in the foreseeable future, including capital expenditures
for rig upgrades and continuing rig enhancements, and working capital
requirements.
CAPITAL RESOURCES
Cash required to meet the Company's capital commitments is determined
by evaluating rig upgrades to meet specific customer requirements and by
evaluating the Company's continuing rig enhancement program, including water
depth and drilling capability upgrades. In current market conditions, the
Company may determine that rig upgrades or enhancements in addition to those
budgeted should be undertaken while rigs are idle in order to prudently make use
of funds and take advantage of rig downtime.
It is management's opinion that operating cash flows and the Company's
cash reserves will be sufficient to meet its capital commitments; however,
periodic assessments will be made based on industry conditions. In addition, the
Company may, from time to time, issue debt or equity securities, or a
combination thereof, to finance capital expenditures, the acquisition of assets
and businesses, or for general corporate purposes. The Company's ability to
effect any such issuance will be dependent on the Company's results of
operations, its current financial condition, current market conditions, and
other factors beyond its control.
The Company has budgeted $173.7 million for rig upgrade capital
expenditures during 1999, including approximately $138.7 million for 1999
expenditures associated with the conversion of the Ocean Confidence. During the
nine months ended September 30, 1999, the Company expended $156.8 million,
including capitalized interest expense, for rig upgrades, primarily the
conversion of the Ocean Confidence from an accommodation vessel to a
semisubmersible drilling unit capable of operating in harsh environments and
ultra-deep waters. The Company originally estimated its net cost of conversion
for this rig to be approximately $210.0 million. However, previous estimates
were developed prior to the completion of all required structural engineering.
The Company now estimates its net cost of conversion for this rig at
approximately $285.0 million. Upon completion of the conversion and acceptance,
the rig is scheduled to begin a five-year drilling program in the Gulf of
Mexico, which is expected to generate approximately $320.0 million of revenues.
The drilling contract contains a provision allowing the customer to cancel the
contract should the unit not be delivered by July 1, 2000, but such date may be
adjusted in certain circumstances. The Company believes that the project will be
completed timely and within the revised budget, although, as with any major rig
conversion, the possibility of unforeseen delays and cost overruns exists.
The Company has also budgeted $134.1 million for 1999 capital
expenditures associated with its continuing rig enhancement program, spare
equipment inventory, and other corporate requirements. During the nine months
ended September 30, 1999, the Company expended $75.4 million in association with
its continuing rig enhancement program to maintain spare equipment inventory
levels and meet other corporate requirements. These expenditures included
purchases of riser, drill pipe, and other drilling equipment.
The Company continues to consider transactions which include, but are
not limited to, the purchase of existing rigs, construction of new rigs and the
acquisition of other companies engaged in contract drilling or related
businesses. Certain of these potential transactions reviewed by the Company
would, if completed, result in its entering new lines of business. In general,
however, these opportunities have been related in some manner to the Company's
existing operations. 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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INTEGRATED SERVICES
The Company, through its wholly owned subsidiary, Diamond Offshore Team
Solutions, Inc. ("DOTS"), from time to time, selectively engages in drilling
services pursuant to turnkey or modified-turnkey contracts under which DOTS
agrees to drill a well to a specified depth for a fixed price. Generally, DOTS
is not entitled to payment unless the well is drilled to the specified depth and
profitability of the contract depends upon its ability to keep expenses within
the estimates used by DOTS in determining the contract price. Drilling a well
under a turnkey contract therefore typically requires a greater cash commitment
by the Company and exposes the Company to risks of potential financial losses
that generally are substantially greater than those that would ordinarily exist
when drilling under a conventional dayrate contract. DOTS also offers a
portfolio of drilling services including overall project management, extended
well tests, and completion operations. During the first nine months of 1999,
DOTS successfully completed three turnkey wells in the Gulf of Mexico and
contributed operating income of $1.7 million to the Company's consolidated
results of operations.
YEAR 2000 ISSUES
Introduction.
The Company began to address Year 2000 ("Y2K") compliance issues in
1997 when it formed a committee (the "Y2K Committee") to develop the Company's
Y2K compliance initiative. The Company is continuing to take steps to determine
the potential effect of the change to calendar Year 2000 on its computer
hardware, software and embedded technology systems and any impact it may have on
the Company's business.
State of Readiness.
The Company manages its Y2K compliance initiative through the Y2K
Committee. The Y2K Committee has focused its efforts on both information
technology ("IT") systems (e.g., computer software and hardware) and
non-information technology ("Non-IT") systems (e.g., embedded technology such as
micro-controllers) in the Company's domestic and international onshore
locations, aboard the Company's drilling rigs and among its key suppliers. The
Y2K Committee is focusing on critical safety, production, and operational
systems on-board the Company's fleet of drilling rigs. The Company's Y2K
initiative consists of the following five phases:
Phase 1 Awareness of Y2K Issues (appointment of the Y2K Committee,
initial research on Y2K compliance issues);
Phase 2 Identification and Investigation of the Company's Systems
(inventory of systems and investigation of readiness);
Phase 3 Communications with Suppliers (discussions and requests for
information regarding Y2K initiatives and compliance status);
Phase 4 Development and Implementation of Corrective Measures
(coordination with the Company's software and hardware vendors); and
Phase 5 Risk Assessment and Contingency Planning (evaluation of risk of
business interruptions and development of contingency plans).
The Company has completed Phases 1, 2 and 3 for IT and Non-IT systems
utilized in the Company's onshore and offshore operations and substantially
completed the final two phases of its Y2K initiative.
Cost to Address the Company's Y2K Issues.
The total cost associated with required modifications to become Y2K
compliant is not expected to be material to the Company's financial position
primarily because the Company has utilized existing personnel resources to
assist in the implementation of its Y2K compliance initiative. The Company has
recently completed the implementation of certain major business and financial
systems apart from the Y2K compliance initiative. However, because the replaced
systems were not Y2K compliant, the Y2K initiative also benefited from their
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replacement. The total cost of the implementation was approximately $5.6
million, of which approximately $3.3 million was incurred and capitalized prior
to 1999. The total cost does not include the Company's internal costs,
principally the related payroll cost for its information systems group, which
are not separately tracked.
Y2K Risks and Contingency Planning.
The Company is continuing to monitor, on an ongoing basis, the problems
and uncertainties associated with its Y2K issues and their potential
consequences on the Company's onshore locations, drilling operations and
suppliers as well as the legal risks associated with interruption in the
provision of drilling services and/or the delivery of supplies and equipment.
The Company has developed contingency plans intended to address worst-case
business interruptions, such as the interruption of drilling services aboard the
Company's drilling rigs or interruptions in the delivery of equipment and
materials utilized in the Company's drilling operations. Such contingency plans
take into account the existence of certain redundant systems on some of the
Company's drilling rigs and may, in part, involve manual operation of certain
systems for a period of time in the event of Y2K related disruptions.
The Company's failure to fully implement its Y2K initiative or the
occurrence of an unexpected Y2K problem could result in the disruption of normal
business activities or operations and have a material adverse effect on the
Company's results of operations, liquidity or financial condition. However,
based upon the work performed to date, the Company does not believe that such
matters will have a material adverse effect on its results of operations. With
respect to third parties, there can be no assurance that their systems will be
rendered Y2K compliant on a timely basis or that any resulting Y2K issues would
not have a material adverse effect on the results of operations of the Company.
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. Statements by the Company in this Report that contain
forward-looking statements include, but are not limited to, discussions
regarding the effect of market conditions on the Company's future results of
operations (see "--Outlook"), completion dates for construction or other
capital projects (see "--Outlook"), commencement and completion dates of
drilling contracts and upgrade projects (see "--Outlook" and "--Capital
Resources"), future uses of and requirements for financial resources, including
but not limited to, expenditures related to the upgrade of the Ocean Confidence
(see "--Liquidity" and "--Capital Resources"), and the impact of the Y2K
issues on the Company's business (see "--Year 2000 Issues").
Forward-looking 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, 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, customer
preferences, Y2K issues and various other matters, many of which are beyond the
Company's control. The risks included here are not exhaustive. Other sections of
this Report and the Company's other filings with the Securities and Exchange
Commission include additional factors that could adversely affect the Company's
business 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.
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ITEM 3. 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 2 Part I 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 Company's convertible subordinated notes
and investments in debt securities, including U.S. Treasury securities and
collateralized mortgage obligations ("CMO's"). The Company's convertible
subordinated 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. The fair value
of these notes at September 30, 1999, based on quoted market prices, was
approximately $420.8 million, as compared to a carrying amount of $400.0
million. At September 30, 1999, the fair market value of the Company's
investment in debt securities issued by the U.S. Treasury was approximately
$432.1 million, which includes an unrealized holding loss of $1.5 million. These
securities bear interest at rates ranging from 4.00 percent to 5.00 percent and
do not impose a significant market risk to the Company as they are U.S.
government-backed and generally short-term and readily marketable. The fair
value of the Company's investment in CMO's at September 30, 1999 was
approximately $148.9 million, which includes an unrealized holding loss of $4.1
million. The CMO's are also short-term and readily marketable with an implied
AAA rating backed by U.S. government guaranteed mortgages.
In addition, the Company's investment in equity securities is sensitive
to equity price risk. At September 30, 1999, the fair value of the Company's
investment in equity securities was approximately $1.4 million, which includes
an unrealized holding loss of $10.7 million.
The Company believes the declines in the fair values of its investments
in debt and equity securities due to interest rate and equity price sensitivity
are temporary in nature. This determination was based on the marketability of
the instruments, the Company's ability to retain its investment in the
instruments, past market movements and reasonably possible, near-term market
movements. Therefore, 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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PART II. OTHER INFORMATION
ITEM 1. 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 (Off-Shore) Limited, 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. The
plaintiffs appealed the judgment and the appellate court ordered the parties to
mediation. The case went to mediation in July 1998 with no resolution. In May
1999, the case went before the Texas First Court of Appeals, Houston, which
affirmed the jury verdict. The plaintiffs obtained an extension to file a
petition for review with the Supreme Court of Texas by November 18, 1999. The
Company has not established a provision for any liability for this case.
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 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
ITEM 5. OTHER INFORMATION.
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
See Exhibit Index for a list of those exhibits filed herewith.
(b) There were no reports on Form 8-K filed during the third quarter of
1999.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DIAMOND OFFSHORE DRILLING, INC.
(Registrant)
Date 2-Nov-1999 By: /s/ Gary T. Krenek
--------------- --------------------------------------------
Gary T. Krenek
Vice President and Chief Financial Officer
Date 2-Nov-1999 /s/ Leslie C. Knowlton
--------------- --------------------------------------------
Leslie C. Knowlton
Controller (Chief Accounting Officer)
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EXHIBIT INDEX
Exhibit No. Description
- ----------- -----------
3.1 Amended and Restated Certificate of Incorporation of the Company
(incorporated by reference to Exhibit 3.1 of the Company's
Quarterly Report on Form 10-Q for the quarterly period ended June
30, 1998).
3.2 Amended and Restated By-laws of the Company (incorporated by
reference to Exhibit 3.2 of the Company's Quarterly Report on
Form 10-Q for the quarterly period ended September 30, 1998).
11.1* Statement Re Computation of Per Share Earnings.
27.1* Financial Data Schedule.
- -------------------
* Filed herewith.
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