Edgar Filing: DIAMOND OFFSHORE DRILLING INC

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, 2005

[ ] 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 (I.R.S. Employer
incorporation or organization) Identification No.)

15415 Katy Freeway
Houston, Texas
77094
(Address of principal executive offices)
(Zip Code)

(281) 492-5300
(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days.

Yes [X] No [ ]

Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act).

Yes [X] No [ ]

Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act).

Yes [ ] No [X]

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 25, 2005 Common stock, $0.01 par value per share 128,693,267 shares

DIAMOND OFFSHORE DRILLING, INC.

TABLE OF CONTENTS FOR FORM 10-Q

QUARTER ENDED SEPTEMBER 30, 2005

PAGE NO.
--------

COVER PAGE........................................................... 1

TABLE OF CONTENTS.................................................... 2

PART I. FINANCIAL INFORMATION....................................... 3

ITEM 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets............................... 3
Consolidated Statements of Operations..................... 4
Consolidated Statements of Cash Flows..................... 5
Notes to Unaudited Consolidated Financial Statements...... 6

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS....................... 19

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK .............................................. 41

ITEM 4. CONTROLS AND PROCEDURES................................... 42

PART II. OTHER INFORMATION........................................... 42

ITEM 6. EXHIBITS.................................................. 42

SIGNATURES........................................................... 43

EXHIBIT INDEX........................................................ 44

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS.

DIAMOND OFFSHORE DRILLING, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

SEPTEMBER 30, DECEMBER 31,
2005 2004
------------- ------------

ASSETS

CURRENT ASSETS:
Cash and cash equivalents ........................................ $ 486,710 $ 266,007
Investments and marketable securities ............................ 302,414 661,849
Accounts receivable .............................................. 303,484 187,558
Rig inventory and supplies ....................................... 47,733 47,590
Prepaid expenses and other ....................................... 34,430 32,677
---------- ----------
Total current assets .......................................... 1,174,771 1,195,681
DRILLING AND OTHER PROPERTY AND EQUIPMENT, NET OF
ACCUMULATED DEPRECIATION ......................................... 2,204,523 2,154,593
OTHER ASSETS ........................................................ 24,285 29,112
---------- ----------
Total assets .................................................. $3,403,579 $3,379,386
========== ==========

LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES:
Current portion of long-term debt ................................ $ 12,818 $ 484,102
Accounts payable ................................................. 36,129 27,530
Accrued liabilities .............................................. 117,330 87,614
Taxes payable .................................................... 15,236 14,661
---------- ----------
Total current liabilities ..................................... 181,513 613,907
LONG-TERM DEBT ...................................................... 977,470 709,413
DEFERRED TAX LIABILITY .............................................. 423,959 369,722
OTHER LIABILITIES ................................................... 66,321 60,516
---------- ----------
Total liabilities ............................................. 1,649,263 1,753,558
---------- ----------

COMMITMENTS AND CONTINGENCIES (NOTE 8) .............................. -- --

STOCKHOLDERS' EQUITY:
Common stock (par value $0.01, 500,000,000 shares authorized,
133,729,154 shares issued and 128,812,354 shares outstanding
at September 30, 2005; 133,483,820 shares issued and
128,567,020 shares outstanding at December 31, 2004) .......... 1,337 1,335
Additional paid-in capital ....................................... 1,271,896 1,264,512
Retained earnings ................................................ 597,662 476,382
Accumulated other comprehensive losses ........................... (2,166) (1,988)
Treasury stock, at cost (4,916,800 shares at September 30, 2005
and December 31, 2004) ........................................ (114,413) (114,413)
---------- ----------
Total stockholders' equity .................................... 1,754,316 1,625,828
---------- ----------
Total liabilities and stockholders' equity .................... $3,403,579 $3,379,386
========== ==========

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE
CONSOLIDATED FINANCIAL STATEMENTS.

DIAMOND OFFSHORE DRILLING, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except per share data)

THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -------------------
2005 2004 2005 2004
-------- -------- -------- --------

REVENUES:
Contract drilling ................................ $300,535 $200,610 $823,222 $554,535
Revenues related to reimbursable expenses ........ 9,987 7,588 29,457 22,807
-------- -------- -------- --------
Total revenues ................................ 310,522 208,198 852,679 577,342
-------- -------- -------- --------

OPERATING EXPENSES:
Contract drilling ................................ 160,537 140,607 471,240 408,768
Reimbursable expenses ............................ 8,350 6,620 24,784 20,373
Depreciation and amortization .................... 46,494 45,043 137,944 134,117
General and administrative ....................... 8,928 6,728 27,587 24,277
(Gain) loss on sale of assets .................... (761) 1,536 (8,753) 1,341
Casualty gain on Ocean Warwick ................... (33,605) -- (33,605) --
-------- -------- -------- --------
Total operating expenses ...................... 189,943 200,534 619,197 588,876
-------- -------- -------- --------

OPERATING INCOME (LOSS) ............................. 120,579 7,664 233,482 (11,534)

OTHER INCOME (EXPENSE):
Interest income .................................. 6,078 2,899 17,974 7,581
Interest expense ................................. (8,341) (7,657) (33,664) (20,384)
Gain (loss) on sale of marketable securities ..... (12) (27) (1,209) 231
Other, net ....................................... 1,115 78 1,985 (333)
-------- -------- -------- --------

INCOME (LOSS) BEFORE INCOME TAX (EXPENSE) BENEFIT ... 119,419 2,957 218,568 (24,439)
INCOME TAX (EXPENSE) BENEFIT ..................... (37,380) (16) (65,129) 5,913
-------- -------- -------- --------
NET INCOME (LOSS) ................................... $ 82,039 $ 2,941 $153,439 $(18,526)
======== ======== ======== ========
INCOME (LOSS) PER SHARE:
BASIC ............................................ $ 0.64 $ 0.02 $ 1.19 $ (0.14)
======== ======== ======== ========
DILUTED .......................................... $ 0.60 $ 0.02 $ 1.14 $ (0.14)
======== ======== ======== ========

WEIGHTED AVERAGE SHARES OUTSTANDING:
Shares of common stock ........................... 128,748 128,899 128,638 129,180
Dilutive potential shares of common stock ........ 9,819 42 9,551 --
-------- -------- -------- --------
Total weighted average shares outstanding ..... 138,567 128,941 138,189 129,180
======== ======== ======== ========

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED
FINANCIAL STATEMENTS.

DIAMOND OFFSHORE DRILLING, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)

NINE MONTHS ENDED
SEPTEMBER 30,
-------------------------
2005 2004
----------- -----------

OPERATING ACTIVITIES:
Net income (loss) ................................................. $ 153,439 $ (18,526)
Adjustments to reconcile net income (loss) to net cash provided
by operating activities:
Depreciation ................................................... 137,944 134,117
Casualty gain on Ocean Warwick ................................. (33,605) --
(Gain) loss on sale of assets .................................. (8,753) 1,341
Loss (gain) on sale of marketable securities, net .............. 1,209 (231)
Deferred tax provision (benefit) ............................... 54,085 (1,025)
Accretion of discounts on marketable securities ................ (5,884) (2,256)
Amortization of debt issuance costs ............................ 7,557 819
Amortization of debt discounts ................................. 7,339 12,010
Changes in operating assets and liabilities:
Accounts receivable ............................................ (110,995) 201
Rig inventory and supplies and other current assets ............ (7,973) (11,444)
Accounts payable and accrued liabilities ....................... 16,354 19,525
Taxes payable .................................................. 575 (2,914)
Other items, net ............................................... 3,234 841
----------- -----------
Net cash provided by operating activities ................... 214,526 132,458
----------- -----------

INVESTING ACTIVITIES:
Capital expenditures (including rig acquisitions) ................. (187,066) (69,719)
Proceeds from sale of assets ...................................... 19,551 1,521
Proceeds from casualty loss of Ocean Warwick ...................... 44,088 --
Proceeds from sale of marketable securities ....................... 4,863,752 2,773,630
Purchases of marketable securities ................................ (4,511,361) (2,913,971)
Purchases of Australian dollar time deposits ...................... -- (42,073)
Proceeds from maturities of Australian dollar time deposits ....... 11,761 19,846
Proceeds from settlement of forward contracts ..................... 939 --
----------- -----------
Net cash provided (used) by investing activities ............ 241,664 (230,766)
----------- -----------

FINANCING ACTIVITIES:
Issuance of 4.875% senior unsecured notes ......................... 249,462 --
Issuance of 5.15% senior unsecured notes .......................... -- 249,397
Debt issue costs .................................................. (1,866) (1,565)
Redemption of zero coupon debentures .............................. (460,015) --
Acquisition of treasury stock ..................................... -- (18,077)
Payment of dividends .............................................. (32,159) (24,249)
Proceeds from stock options exercised ............................. 9,565 --
----------- -----------
Net cash (used) provided by financing activities ............ (235,013) 205,506
----------- -----------

EFFECT OF EXCHANGE RATE CHANGES ON CASH .............................. (474) 332
----------- -----------

NET CHANGE IN CASH AND CASH EQUIVALENTS .............................. 220,703 107,530
Cash and cash equivalents, beginning of period .................... 266,007 106,345
----------- -----------
Cash and cash equivalents, end of period .......................... $ 486,710 $ 213,875
=========== ===========

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED
FINANCIAL STATEMENTS.

DIAMOND OFFSHORE DRILLING, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1. GENERAL INFORMATION

The unaudited consolidated financial statements of Diamond Offshore
Drilling, Inc. and subsidiaries, which we refer to as "Diamond Offshore," "we,"
"us" or "our," should be read in conjunction with our Annual Report on Form 10-K
for the year ended December 31, 2004 (File No. 1-13926).

As of October 25, 2005 Loews Corporation, or Loews, owned 54.5% of our
outstanding shares of common stock.

Interim Financial Information

The accompanying unaudited consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do
not include all disclosures required by generally accepted accounting principles
for complete financial statements. The consolidated financial information has
not been audited but, in the opinion of management, includes all adjustments
(consisting only of normal recurring accruals) necessary for a fair presentation
of the consolidated balance sheets, statements of operations, and statements of
cash flows at the dates and for the periods indicated. Results of operations for
interim periods are not necessarily indicative of results of operations for the
respective full years.

Cash and Cash Equivalents, Marketable Securities and Other Investments

We consider short-term, highly liquid investments that have an original
maturity of three months or less and deposits in money market mutual funds that
are readily convertible into cash to be cash equivalents.

Our investments in marketable securities are classified as available for
sale and stated at fair value. Accordingly, any unrealized gains and losses, net
of taxes, are reported in our Consolidated Balance Sheets in "Accumulated other
comprehensive losses" until realized. The cost of debt securities is adjusted
for amortization of premiums and accretion of discounts to maturity and such
adjustments are included in our Consolidated Statements of Operations in
"Interest income." The sale and purchase of marketable securities are recorded
on the date of the trade. The cost of debt securities sold is based on the
specific identification method. Realized gains or losses and declines in value
judged to be other than temporary, if any, are reported in our Consolidated
Statements of Operations in "Other income (expense)."

Repurchase Agreements

From time to time we may enter into repurchase agreements with unrelated
parties, primarily major brokerage firms. Under these agreements, which are
effectively secured loans, funds are transferred to the seller and the purchaser
holds the marketable securities as collateral. These transactions are generally
settled the following business day. At September 30, 2005, we had purchased two
marketable securities for a total of $300.0 million under repurchase agreements,
which were held as collateral. The agreements are classified as "Investments and
marketable securities" in our Consolidated Balance Sheet at September 30, 2005.
We recognized interest of $0.4 million on repurchase agreements during 2005,
which is included in "Interest income" in our Consolidated Statement of
Operations. We did not have any outstanding repurchase agreements at December
31, 2004. See Note 3.

Derivative Financial Instruments

Our derivative financial instruments include forward currency exchange
contracts and a contingent interest provision that is embedded in our 1.5%
Convertible Senior Debentures Due 2031, or the 1.5% Debentures, issued on April
11, 2001. See Note 4.

Supplementary Cash Flow Information

We paid interest on long-term debt totaling $89.7 million for the nine
months ended September 30, 2005, which included $73.3 million in accreted
interest paid in connection with the June 2005 partial redemption of our Zero
Coupon Convertible Debentures due 2020, or Zero Coupon Debentures. See Note 7.
During the nine months ended September 30, 2004, we paid interest on long-term
debt of $3.5 million.

We paid $5.4 million and $0.8 million in foreign income taxes, net of
foreign tax refunds, during the nine months ended September 30, 2005 and 2004,
respectively. We received refunds of U.S. income taxes of $7.7 million and $0.4
million during the nine months ended September 30, 2005 and 2004, respectively.

Capitalized Interest

Interest cost for construction and upgrade of qualifying assets is
capitalized. In April 2005, we began capitalizing interest on expenditures
related to our upgrade of the Ocean Endeavor for ultra-deepwater service. A
reconciliation of our total interest cost to "Interest expense" as reported in
our Consolidated Statements of Operations is as follows:

THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -----------------
2005 2004 2005 2004
------ ------ ------- -------
(IN THOUSANDS)

Total interest cost including
amortization of debt issuance costs...... $8,590 $7,657 $34,000 $20,384
Capitalized interest........................ (249) -- (336) --
------ ------ ------- -------
Total interest expense as reported....... $8,341 $7,657 $33,664 $20,384
====== ====== ======= =======

Debt Issuance Costs

Debt issuance costs are included in our Consolidated Balance Sheets in
"Other assets" and are amortized over the respective terms of the related debt.
Interest expense for the nine months ended September 30, 2005 includes $6.9
million in debt issuance costs that we wrote-off in connection with the June
2005 partial redemption of our outstanding Zero Coupon Debentures.

Treasury Stock

Depending on market conditions, we may, from time to time, purchase shares
of our common stock in the open market or otherwise. The purchase of treasury
stock is accounted for using the cost method which reports the cost of the
shares acquired in "Treasury stock" as a deduction from stockholders' equity in
our Consolidated Balance Sheets. We did not purchase any treasury stock during
the nine months ended September 30, 2005. During the nine months ended September
30, 2004, we purchased 782,200 shares of our common stock at an aggregate cost
of $18.1 million, or at an average cost of $23.11 per share.

Comprehensive Income (Loss)

A reconciliation of net income (loss) to comprehensive income (loss) is as
follows:

THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -------------------
2005 2004 2005 2004
------- ------ -------- --------
(IN THOUSANDS)

Net income (loss)..................................... $82,039 $2,941 $153,439 $(18,526)
Other comprehensive gains (losses), net of tax:
Foreign currency translation gain (loss)........... 308 138 (102) (294)
Unrealized holding gain (loss) on investments...... (11) 32 14 484
Reclassification adjustment for gain
included in net income (loss)................... (5) -- (90) (25)
------- ------ -------- --------
Comprehensive income (loss)........................... $82,331 $3,111 $153,261 $(18,361)
======= ====== ======== ========

Currency Translation

Our primary functional currency is the U.S. dollar. Certain of our
subsidiaries use the local currency in the country where they conduct operations
as their functional currency. These subsidiaries translate assets and
liabilities at period-end exchange rates while income and expense accounts are
translated at average exchange rates. Translation adjustments are reflected in
our Consolidated Balance Sheets in "Accumulated other comprehensive losses."
Currency transaction gains and losses are included in our Consolidated
Statements of Operations in "Other income (expense)." Re-measurement translation
gains and losses of subsidiaries operating in hyperinflationary economies, when
applicable, are included in our operating results.

Stock-Based Compensation

Our Second Amended and Restated 2000 Stock Option Plan is accounted for in
accordance with Accounting Principles Board, or APB, Opinion No. 25, "Accounting
for Stock Issued to Employees." Accordingly, no compensation expense has been
recognized for the options granted to our employees under the plan. If
compensation expense had been recognized for stock options granted to our
employees based on the fair value of the options at the grant dates, valued
using the Binomial Option pricing model, our net income (loss) and earnings
(loss) per share would have been as follows:

THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -------------------
2005 2004 2005 2004
------- ------ -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)

Net income (loss) as reported........................................ $82,039 $2,941 $153,439 $(18,526)
Add: Stock-based employee compensation expense included
in reported net income (loss), net of related tax effects...... -- -- -- --
Deduct: Total stock-based employee compensation
expense determined under fair value based method,
net of related tax effects..................................... (355) (234) (995) (792)
------- ------ -------- --------
Pro forma net income (loss).......................................... $81,684 $2,707 $152,444 $(19,318)
======= ====== ======== ========
Earnings (loss) per share of common stock:
As reported....................................................... $ 0.64 $ 0.02 $ 1.19 $ (0.14)
Pro forma......................................................... $ 0.63 $ 0.02 $ 1.19 $ (0.15)
Earnings (loss) per share of common stock - assuming dilution:
As reported....................................................... $ 0.60 $ 0.02 $ 1.14 $ (0.14)
Pro forma......................................................... $ 0.60 $ 0.02 $ 1.13 $ (0.15)

Revenue Recognition

Revenue from our dayrate drilling contracts is recognized as services are
performed. In connection with such drilling contracts, we may receive lump-sum
fees for the mobilization of equipment. These fees are earned as services are
performed over the initial term of the related drilling contracts. We previously
accounted for the excess of mobilization fees received over costs incurred to
mobilize an offshore rig from one market to another as revenue over the term of
the related drilling contracts. Effective July 1, 2004 we changed our accounting
to defer mobilization fees received as well as direct and incremental
mobilization costs incurred and began to amortize each, on a straight line
basis, over the term of the related drilling contracts (which is the period
estimated to be benefited from the mobilization activity). Straight line
amortization of mobilization revenues and related costs over the term of the
related drilling contracts (which generally range from two to 60 months) is
consistent with the timing of net cash flows generated from the actual drilling
services performed. If we had used this method of accounting in periods prior to
July 1, 2004, previously reported operating income (loss) and net income (loss)
would not have changed and the impact on contract drilling revenues and expenses
would have been immaterial. Absent a contract, mobilization costs are recognized
currently.

We record reimbursements received for the purchase of supplies, equipment,
personnel services and other services provided at the request of our customers
in accordance with a contract or agreement, for the gross amount billed to the
customer, as "Revenues related to reimbursable expenses" in our Consolidated
Statements of Operations.

Use of Estimates in the Preparation of Financial Statements

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amount of revenues and
expenses during the reporting period. Actual results could differ from those
estimated.

Reclassifications

We have reclassified certain amounts applicable to prior periods to conform
to the classifications currently followed. Such reclassifications do not affect
earnings.

Recent Accounting Pronouncements

In June 2005 the Financial Accounting Standards Board, or FASB, issued
Statement of Financial Accounting Standards, or SFAS, No. 154, "Accounting
Changes and Error Corrections," or SFAS 154, a replacement of APB Opinion No. 20
and SFAS No. 3. SFAS 154 provides guidance on the accounting for and reporting
of accounting changes and error corrections and is effective for accounting
changes and corrections of errors made in fiscal years beginning after December
15, 2005. We do not expect adoption of SFAS 154 to have a material impact on our
consolidated results of operations, financial position or cash flows.

In December 2004 the FASB revised SFAS No. 123, "Accounting for Stock-Based
Compensation," or SFAS 123 (R). This statement supersedes APB Opinion No. 25 and
its related implementation guidance. This statement requires that the
compensation cost relating to share-based payment transactions be recognized in
financial statements. That cost will be measured based on the fair value of the
equity or liability instruments issued. SFAS 123 (R) was originally effective as
of the first interim or annual reporting period beginning after June 15, 2005.
In April 2005, however, the Securities and Exchange Commission adopted a rule
that defers the required effective date of SFAS 123 (R) for registrants such as
us until the beginning of the first fiscal year beginning after June 15, 2005.
This statement applies to all awards granted after the required effective date
and to awards modified, repurchased or cancelled after that date, as well as the
unvested portion of awards granted prior to the effective date of SFAS 123 (R).
We do not expect adoption of SFAS 123 (R) to have a material impact on our
consolidated results of operations, financial position or cash flows.

2. EARNINGS (LOSSES) PER SHARE

A reconciliation of the numerators and the denominators of the basic and
diluted per-share computations follows:

THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -------------------
2005 2004 2005 2004
-------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)

Net income (loss) - basic (numerator): $ 82,039 $ 2,941 $153,439 $(18,526)
Effect of dilutive potential shares
1.5% Debentures ......................... 1,136 -- 3,467 --
Zero Coupon Debentures .................. 104 -- -- --
-------- -------- -------- --------
Net income (loss) including conversions -
diluted (numerator) $ 83,279 $ 2,941 $156,906 $(18,526)
======== ======== ======== ========
Weighted average shares - basic (denominator): 128,748 128,899 128,638 129,180
Effect of dilutive potential shares
1.5% Debentures ......................... 9,383 -- 9,383 --
Zero Coupon Debentures .................. 266 -- -- --
Stock options ........................... 170 42 168 --
-------- -------- -------- --------
Weighted average shares including conversions -
diluted (denominator) 138,567 128,941 138,189 129,180
======== ======== ======== ========
Earnings (losses) per share:
Basic ................................... $ 0.64 $ 0.02 $ 1.19 $ (0.14)
======== ======== ======== ========
Diluted ................................. $ 0.60 $ 0.02 $ 1.14 $ (0.14)
======== ======== ======== ========

The computation of diluted earnings per share, or EPS, for the nine month
period ended September 30, 2005 excludes approximately 4.1 million potentially
dilutive shares of common stock issuable upon conversion of our Zero Coupon
Debentures because the inclusion of such potentially dilutive shares would have
been antidilutive. For the nine months ended September 30, 2005, we also
excluded stock options representing 1,000 shares of common stock from the
computation of diluted EPS because the options' exercise prices were higher than
the average market price per share of our common stock for the period.

The computations of diluted EPS for the three and nine month periods ended
September 30, 2004 exclude approximately 9.4 million and 6.9 million potentially
dilutive shares of common stock issuable upon conversion of our 1.5% Debentures
and our Zero Coupon Debentures, respectively. Such shares were not included in
the EPS computations for 2004 because the inclusion of such potentially dilutive
shares would have been antidilutive.

For the three and nine month periods ended September 30, 2004, we excluded
stock options representing 302,550 shares and 327,117 shares of common stock,
respectively, from the computations of diluted EPS because the options' exercise
prices were higher than the average market price per share of our common stock.
We also excluded other stock options representing 184,425 shares of our common
stock with an average market price in excess of their exercise prices from the
computations of diluted EPS for the nine month period ended September 30, 2004
because there was a net loss for the period.

3. INVESTMENTS AND MARKETABLE SECURITIES

We report investments as current assets in our Consolidated Balance Sheets
in "Investments and marketable securities," representing our investment of cash
available for current operations. At September 30, 2005, our "Investments and
marketable securities" included $300.0 million in securities held as collateral
under repurchase agreements, which had an approximate fair value of $302.9
million. At December 31, 2004, "Investments and marketable securities" also
included $11.6 million of time deposits (converted from 15.0 million Australian
dollars) which matured through March 2005. These marketable securities did not
meet the definition of debt securities under SFAS No. 115, "Accounting for
Certain Investments in Debt and Equity Securities," and were therefore carried
at cost, which we determined to approximate fair value.

Our other investments in marketable securities are classified as available
for sale and are summarized as follows:

SEPTEMBER 30, 2005
------------------------------------------------
AMORTIZED COST UNREALIZED GAIN MARKET VALUE
--------------- --------------- ------------
(IN THOUSANDS)

Debt securities issued by the U.S. Treasury
and other U.S. government agencies:
Mortgage-backed securities................. $2,394 $20 $2,414
====== === ======

DECEMBER 31, 2004
------------------------------------------------
UNREALIZED GAIN
AMORTIZED COST (LOSS) MARKET VALUE
--------------- --------------- ------------
(IN THOUSANDS)

Debt securities issued by the U.S. Treasury
and other U.S. government agencies:
Due within one year ..................... $498,011 $ 189 $498,200
Due within one year through five years .. 148,877 (119) 148,758
Mortgage-backed securities .............. 3,221 68 3,289
-------- ----- --------
Total ................................... $650,109 $ 138 $650,247
======== ===== ========

Proceeds from sales and maturities of marketable securities and gross
realized gains and losses are summarized as follows:

THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -----------------------
2005 2004 2005 2004
-------- -------- ---------- ----------
(IN THOUSANDS)

Proceeds from sales ........ $ 250 $449,383 $2,613,752 $1,648,630
Proceeds from maturities ... 800,000 375,000 2,250,000 1,125,000
Gross realized gains ....... -- -- 184 2,558
Gross realized losses ...... (12) (27) (1,393) (2,327)

4. DERIVATIVE FINANCIAL INSTRUMENTS

Forward Currency Exchange Contracts

Our international operations expose us to foreign exchange risk, primarily
associated with our costs payable in foreign currencies for employee
compensation and for purchases from foreign suppliers. From time to time, we may
use a foreign exchange forward contract to reduce the forward exchange risk. A
forward currency exchange contract obligates a contract holder to exchange
predetermined amounts of specified foreign currencies at specified foreign
exchange rates on specified dates.

During 2005, we entered into various foreign currency forward exchange
contracts which resulted in net realized gains totaling $0.7 million and $0.9
million for the three- and nine-month periods ended September 30,

2005, respectively. As of September 30, 2005, we had foreign currency exchange
contracts outstanding requiring us to purchase the equivalent of $3.0 million in
Mexican pesos in October and November 2005, the equivalent of $3.0 million in
Australia dollars in October 2005 and the equivalent of $7.0 million in British
pounds sterling in November 2005.

These forward contracts are derivatives as defined by SFAS No. 133,
"Accounting for Derivatives and Hedging Activities," or SFAS 133. The forward
contracts we entered into in 2005 did not qualify for hedge accounting. In
accordance with SFAS 133, we recorded a net pre-tax unrealized loss of $0.1
million and a net pre-tax unrealized gain of $0.1 million in our Consolidated
Statements of Operations for the three- and nine-month periods ended September
30, 2005, respectively, as "Other income (expense)" to adjust the carrying value
of these derivative financial instruments to their fair value.

Contingent Interest

Our 1.5% Debentures, of which an aggregate principal amount of
approximately $460 million are outstanding, contain a contingent interest
provision. The contingent interest component is an embedded derivative as
defined by SFAS 133 and accordingly must be split from the host instrument and
recorded at fair value on the balance sheet. The contingent interest component
had no value at issuance, at December 31, 2004 or at September 30, 2005.

5. DRILLING AND OTHER PROPERTY AND EQUIPMENT

Cost and accumulated depreciation of drilling and other property and
equipment are summarized as follows:

SEPTEMBER 30, DECEMBER 31,
2005 2004
------------- ------------
(IN THOUSANDS)

Drilling rigs and equipment ......................... $ 3,587,309 $ 3,529,593
Construction work-in-progress ....................... 104,400 --
Land and buildings .................................. 16,250 15,770
Office equipment and other .......................... 24,046 22,895
----------- -----------
Cost ............................................. 3,732,005 3,568,258
Less: accumulated depreciation ...................... (1,527,482) (1,413,665)
----------- -----------
Drilling and other property and equipment, net ... $ 2,204,523 $ 2,154,593
=========== ===========

Construction work-in-progress at September 30, 2005 consisted of $47.6
million related to the major upgrade of the Ocean Endeavor to ultra-deepwater
service, which we expect to be completed in mid-2007, and shipyard deposits of
$56.8 million for the construction of two new jack-up drilling units, which is
scheduled to commence in the first quarter of 2006. Additionally, in August
2005, we purchased a Victory-class semi-submersible drilling rig, the Enserch
Garden Banks, or Garden Banks, and related equipment for $20.0 million.

On August 29, 2005, our jack-up drilling rig, the Ocean Warwick, was
declared a constructive total loss as a result of damages sustained during
Hurricane Katrina, and we wrote-off its net carrying value of $14.0 million in
the third quarter of 2005. See Note 12.

6. ACCRUED LIABILITIES

Accrued liabilities consist of the following:

SEPTEMBER 30, DECEMBER 31,
2005 2004
------------- ------------
(IN THOUSANDS)

Payroll and benefits .............. $ 28,773 $26,221
Personal injury and other claims .. 7,901 8,076
Interest payable .................. 8,575 5,938
Deferred revenue .................. 12,406 6,514
Accrued project/upgrade expenses .. 27,391 14,920
Hurricane related expenses ........ 5,213 --
Other ............................. 27,071 25,945
-------- -------
Total .......................... $117,330 $87,614
======== =======

7. LONG-TERM DEBT

Long-term debt consists of the following:

SEPTEMBER 30, DECEMBER 31,
2005 2004
------------- ------------
(IN THOUSANDS)

Zero Coupon Debentures (due 2020) .. $ 18,559 $ 471,284
1.5% Debentures (due 2031) ......... 459,987 460,000
5.15% Senior Notes (due 2014) ...... 249,449 249,413
4.875% Senior Notes (due 2015) ..... 249,475 --
Ocean Alliance lease-leaseback ..... 12,818 12,818
-------- ----------
990 288 1,193,515
Less: Current maturities ........... (12,818) (484,102)
-------- ----------
Total ........................... $977,470 $ 709,413
======== ==========

Payments of certain of our long-term debt may be accelerated due to certain
rights that the holders of our debt have to put the securities to us. The
holders of our outstanding 1.5% Debentures have the right to require us to
purchase all or a portion of their 1.5% Debentures on April 15, 2008, at a price
equal to 100% of the principal amount of the debentures to be purchased plus
accrued and unpaid interest to such date.

The aggregate maturities of long-term debt for each of the five years
subsequent to September 30, 2005, are as follows:

(DOLLARS IN THOUSANDS)
--------------------------------------

2005 ...................... $ 12,818
2006 ...................... --
2007 ...................... --
2008 ...................... 459,987
2009 ...................... --
Thereafter ................ 517,483
--------
990,288
Less: Current maturities .. (12,818)
--------
Total .................. $977,470
========

1.5% DEBENTURES

During the third quarter of 2005, the holders of $13,000 in principal
amount of our 1.5% Debentures elected to convert their outstanding debentures
into shares of our common stock. The debentures were converted at the initial

conversion rate of 20.3978 shares per $1,000 principal amount of debentures, or
$49.02 per share, resulting in the issuance of 264 shares of our common stock in
the third quarter of 2005.

4.875% SENIOR NOTES

On June 14, 2005, we issued $250.0 million aggregate principal amount of
4.875% Senior Notes Due July 1, 2015, or 4.875% Senior Notes, at an offering
price of 99.785% of the principal amount resulting in net proceeds to us of
$247.7 million, exclusive of accrued issuance costs.

The notes bear interest at 4.875% per year, payable semiannually in arrears
on January 1 and July 1 of each year, beginning January 1, 2006, and mature on
July 1, 2015. The 4.875% Senior Notes are unsecured and unsubordinated
obligations of Diamond Offshore Drilling, Inc., and they rank equal in right of
payment to our existing and future unsecured and unsubordinated indebtedness,
although the 4.875% Senior Notes will be effectively subordinated to all
existing and future obligations of our subsidiaries. We have the right to redeem
all or a portion of these notes for cash at any time or from time to time on at
least 15 days but not more than 60 days prior written notice, at the redemption
price specified in the governing indenture plus accrued and unpaid interest to
the date of redemption.

ZERO COUPON DEBENTURES

On June 7, 2005, we repurchased $460.0 million accreted value, or $774.1
million in aggregate principal amount at maturity, of our Zero Coupon Debentures
at a purchase price of $594.25 per $1,000 principal amount at maturity, which
represents approximately 96% of our then outstanding Zero Coupon Debentures. The
holders of our remaining outstanding Zero Coupon Debentures have the right to
require us to repurchase the Zero Coupon Debentures on June 6, 2010 and June 6,
2015 at their accreted value through the date of purchase.

Also in connection with the retirement of a portion of our Zero Coupon
Debentures, we expensed $6.9 million in debt issuance costs associated with the
retired debentures, which we have included in interest expense in our
Consolidated Statement of Operations for the nine months ended September 30,
2005.

8. COMMITMENTS AND CONTINGENCIES

Various claims have been filed against us in the ordinary course of
business, including claims by offshore workers alleging personal injuries. Our
management believes that we have established adequate reserves for any
liabilities that may reasonably be expected to result from these claims. In the
opinion of our management, no pending or threatened claims, actions or
proceedings against us are expected to have a material adverse effect on our
consolidated financial position, results of operations or cash flows.

Litigation. In January 2005, we were notified that we had been named as a
defendant in a lawsuit filed in the U.S. District Court for the Eastern District
of Louisiana on behalf of Total E&P USA, Inc. and several oil companies alleging
that the Ocean America had damaged a natural gas pipeline in the Gulf of Mexico
during Hurricane Ivan in September 2004. The lawsuit was formally served on us
May 16, 2005 and it alleges that on or about September 15, 2004 the Ocean
America broke free from its moorings and, as the rig drifted, its anchor, wire
cable and other parts struck and damaged various components of the Canyon
Express Common System curtailing its supply of natural gas to, and preventing
production from, several fields. The plaintiffs seek damages from us including,
but not limited to, loss of revenue, that are currently estimated to be in
excess of $100 million, together with interest, attorneys fees and costs. We do
not believe that ultimate liability, if any, resulting from this litigation will
have a material adverse effect on our financial condition, results of operations
or cash flows. In addition, we have given notice to our insurance underwriters
that a potential loss may exist with respect to this incident. Our deductible
for this type of loss is $2 million.

During the third quarter of 2004, we were notified that some of our
subsidiaries had been named, along with other defendants, in several complaints
that had been filed in the Circuit Courts of the State of Mississippi by
approximately 800 persons alleging that they were employed by some of the named
defendants between approximately 1965 and 1986. The complaints also named as
defendants over 25 other companies that are not affiliated with us. The
complaints alleged that the defendants manufactured, distributed or utilized
drilling mud containing asbestos and, in our case and the several other offshore
drilling companies named as defendants, that such defendants allowed such
drilling mud to have been utilized aboard their offshore drilling rigs. The
plaintiffs seek, among other things, an award of unspecified compensatory and
punitive damages. To date, we have been served with 29 complaints, of which 13
complaints were filed against Arethusa Off-Shore Company and 16

complaints were filed against Diamond Offshore (USA), Inc. (now known as Diamond
Offshore (USA) L.L.C. and formerly known as Odeco Drilling, Inc.). We filed
motions to dismiss each of these cases based upon a number of legal grounds,
including naming improper parties. In April 2005 the plaintiffs agreed to
dismiss, with prejudice, all 13 complaints filed against Arethusa Off-Shore
Company after we demonstrated that the claims could not be maintained against us
or any of our subsidiaries. In addition, we expect to receive complete defense
and indemnity for the remaining 16 complaints from Murphy Exploration &
Production Company pursuant to the terms of our 1992 asset purchase agreement
with them. Accordingly, we are unable to estimate our potential exposure, if
any, to these lawsuits at this time but do not believe that ultimate liability,
if any, resulting from this litigation will have a material adverse effect on
our financial condition, results of operations or cash flows.

Various other claims have been filed against us in the ordinary course of
business. In the opinion of our management, no pending or known threatened
claims, actions or proceedings against us are expected to have a material
adverse effect on our consolidated financial position, results of operations or
cash flows.

Other. Our operations in Brazil have exposed us to various claims and
assessments related to our personnel, customs duties and municipal taxes, among
other things, that have arisen in the ordinary course of business. In accordance
with SFAS No. 5, "Accounting for Contingencies," we have assessed each claim or
exposure to determine the likelihood that the resolution of the matter might
ultimately result in an adverse effect on our financial condition, results of
operations or cash flows. When we determine that an unfavorable resolution of a
matter is probable and such amount of loss can be determined, we record a
reserve for the estimated loss at the time that both of these criteria are met.
At September 30, 2005, our loss reserves related to our Brazilian operations
aggregated $13.8 million, of which $0.6 million and $13.2 million were recorded
in "Accrued liabilities" and "Other liabilities," respectively, in our
Consolidated Balance Sheets. Loss reserves related to our Brazilian operations
totaled $13.0 million at December 31, 2004, of which $0.9 million was recorded
in "Accrued liabilities" and $12.1 million was recorded in "Other liabilities"
in our Consolidated Balance Sheets.

We intend to defend these matters vigorously; however, we cannot predict
with certainty the outcome or effect of any litigation matters specifically
described above or any other pending litigation or claims. There can be no
assurance as to the ultimate outcome of these lawsuits.

Personal Injury Claims. Our uninsured retention of liability for personal
injury claims, which primarily results from Jones Act liability in the Gulf of
Mexico, is $0.5 million per claim with an additional aggregate annual deductible
of $1.5 million. Our in-house claims department estimates the amount of our
liability for our retention. This department establishes a reserve for each of
our personal injury claims by evaluating the existing facts and circumstances of
each claim and comparing the circumstances of each claim to historical
experiences with similar past personal injury claims. Our claims department also
estimates our liability for claims that are incurred but not reported by using
historical data. Historically, our ultimate liability for personal injury claims
has not differed materially from our recorded estimates. At September 30, 2005,
our estimated liability for personal injury claims was $37.3 million, of which
$7.9 million and $29.4 million were recorded in "Accrued liabilities" and "Other
liabilities," respectively, in our Consolidated Balance Sheets. At December 31,
2004, we had recorded loss reserves for personal injury claims aggregating $33.4
million, of which $8.0 million and $25.4 million were recorded in "Accrued
liabilities" and "Other liabilities," respectively, in our Consolidated Balance
Sheets. The eventual settlement or adjudication of these claims could differ
materially from our estimated amounts due to uncertainties such as:

- the severity of personal injuries claimed,

- significant changes in the volume of personal injury claims,

- the unpredictability of legal jurisdictions where the claims will
ultimately be litigated,

- inconsistent court decisions and

- the risks and lack of predictability inherent in personal injury
litigation.

9. SEGMENTS AND GEOGRAPHIC AREA ANALYSIS

We report our operations as one reportable segment, contract drilling of
offshore oil and gas wells. Although we provide contract drilling services from
different types of offshore drilling rigs and provide such services in many
geographic locations, these operations have been aggregated into one reportable
segment based on the similarity of economic characteristics among all divisions
and locations, including the nature of services provided and the type of
customers for such services.

Contract Drilling Services

Revenues from customers for contract drilling and similar services by
equipment-type are listed below:

THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -------------------
2005 2004 2005 2004
-------- -------- -------- --------
(IN THOUSANDS)

High Specification Floaters ................ $113,133 $ 75,502 $304,824 $199,342
Other Semisubmersibles ..................... 118,293 79,357 325,634 225,620
Jack-ups ................................... 68,971 45,268 192,834 128,391
Other ...................................... 138 483 (70) 1,182
-------- -------- -------- --------
Total contract drilling revenues ........ 300,535 200,610 823,222 554,535
Revenues related to reimbursable expenses .. 9,987 7,588 29,457 22,807
-------- -------- -------- --------
Total revenues ....................... $310,522 $208,198 $852,679 $577,342
======== ======== ======== ========

Geographic Areas

At September 30, 2005 our drilling rigs were located offshore nine
countries other than the United States. As a result, we are exposed to the risk
of changes in social, political, economic and other conditions inherent in
foreign operations and our results of operations and the value of our foreign
assets are affected by fluctuations in foreign currency exchange rates. Revenues
by geographic area are presented by attributing revenues to the individual
country or areas where the services were performed.

THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -------------------
2005 2004 2005 2004
-------- -------- -------- --------
(IN THOUSANDS)

United States ......... $169,637 $ 91,615 $457,766 $249,317

Foreign:
South America ...... 33,625 32,186 86,762 89,953
Europe/Africa ...... 30,313 19,538 74,961 50,976
Australia/Asia ..... 49,001 43,420 161,241 123,215
Mexico ............. 21,420 21,439 63,753 63,881
Middle East ........ 6,526 -- 8,196 --
-------- -------- -------- --------
Total revenues .. $310,522 $208,198 $852,679 $577,342
======== ======== ======== ========

10. INCOME TAXES

Our net income tax expense or benefit is a function of the mix between our
domestic and international pre-tax earnings or losses, respectively, as well as
the mix of international tax jurisdictions in which we operate. Certain of our
international rigs are owned or operated, directly or indirectly, by Diamond
Offshore International Limited, a Cayman Island company which is one of our
wholly owned subsidiaries. Earnings from this subsidiary are reinvested
internationally and remittance to the U.S. is indefinitely postponed.
Consequently, no U.S. tax expense

or benefits were recognized on these earnings or losses in 2005 or 2004. Our
estimated annual effective tax rate was 29.5% as of September 30, 2005 and 27.7%
as of September 30, 2004.

Tax expense for the nine months ended September 30, 2005 also included
expense of $0.9 million related to finalizing prior year tax returns in the U.K.
and $0.2 million related to an increase in the settlement of a tax dispute in
East Timor. Partially offsetting the higher tax expense was a $0.2 million
reduction to the valuation allowance for prior year tax credits which arose
primarily from our ability to carryback certain prior year foreign tax credits
to earlier years. These additional items of net expense were not included in the
current year estimated annual effective tax rate of 29.5% and resulted in an
actual effective tax rate of 29.8% for the nine months ended September 30, 2005.

The net tax benefit recognized for the nine months ended September 30, 2004
also included a $0.9 million adjustment related to finalizing prior year tax
returns in two foreign jurisdictions. This additional expense was not included
in the 2004 estimated annual effective rate of 27.7%.

11. PENSION PLAN

The defined benefit pension plan established by Arethusa (Off-Shore)
Limited, a company which we acquired in 1996, or Arethusa, effective October 1,
1992 was frozen on April 30, 1996. At that date all participants were deemed
fully vested in the plan, which covered substantially all U.S. citizens and U.S.
permanent residents who were employed by Arethusa.

As a result of freezing the plan, no service cost has been accrued for the
periods presented.

Components of net periodic benefit costs were as follows:

THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -----------------
2005 2004 2005 2004
----- ----- ----- -----
(IN THOUSANDS)

Interest cost ...................... $ 260 $ 256 $ 780 $ 766
Expected return on plan assets ..... (294) (296) (927) (890)
Amortization of unrecognized loss .. 76 76 229 230
----- ----- ----- -----
Net periodic pension expense ....... $ 42 $ 36 $ 82 $ 106
===== ===== ===== =====

During each of the three-month periods ended September 30, 2005 and 2004,
we made voluntary contributions to the plan of $0.2 million. We are not
required, nor do we expect, to make further contributions to our pension plan in
2005.

12. HURRICANE DAMAGE

In the third quarter of 2005, the U.S. Gulf Coast and Gulf of Mexico were
seriously affected by two hurricanes, Katrina and Rita. In late August 2005, one
of our jack-up drilling rigs, the Ocean Warwick, was seriously damaged during
Hurricane Katrina and other rigs in our fleet sustained lesser damage in
Hurricanes Katrina or Rita, or in some cases from both storms. We believe that
the physical damage to our rigs, as well as related removal and recovery costs,
are covered by insurance, after applicable deductibles.

The Ocean Warwick, with a net book value of $14.0 million, was declared a
constructive total loss effective August 29, 2005. We issued a proof of loss in
the amount of $50.5 million to our insurers, representing the insured value of
the rig less a $4.5 million deductible. As of September 30, 2005, we had
received $44.1 million in insurance proceeds related to the claim for the Ocean
Warwick, and the remaining receivable of $6.4 million is presented in "Accounts
receivable" in our Consolidated Balance Sheets at September 30, 2005. Recovery
and removal of the Ocean Warwick are subject to separate insurance deductibles
totaling $2.5 million. The drilling unit has been moved to a dock-side location
and will be disposed of in accordance with underwriter instructions.

In the third quarter of 2005, we recorded a $33.6 million, pre-tax, net
casualty gain for the Ocean Warwick, representing net insurance proceeds of
$50.5 million, less the write-off of the $14.0 million net carrying value of the
drilling rig and $0.4 million in rig-based inventory, and $2.5 million in
insurance deductibles for salvage and wreck removal as a result of Hurricanes
Katrina and Rita. We have presented this as "Casualty Gain on Ocean Warwick" in

our Consolidated Statements of Operations for the three- and nine-month periods
ended September 30, 2005.

Damage to our other affected rigs and warehouse in New Iberia, Louisiana
was less severe, and we believe that such repair costs and lost equipment will
be covered by insurance, less estimated deductibles. Insurance deductibles
relating to the remaining rigs damaged during Hurricane Katrina and our rigs and
facility damaged by Hurricane Rita total $2.6 million in the aggregate, of which
$1.2 million and $1.4 million have been recorded as additional contract drilling
expense and loss on sale of assets, respectively, for the three and nine months
ended September 30, 2005 in our Consolidated Statement of Operations.

In addition, in the third quarter of 2005, we wrote-off the net book value
of approximately $4.2 million, pre-tax, in rig equipment that was either lost or
damaged beyond repair during the storms as loss on sale of assets and recorded a
corresponding insurance receivable in an amount equal to our expected recovery
from insurers. The write-off of this equipment and recognition of insurance
receivables had no net effect on our consolidated results of operations for the
three and nine months ended September 30, 2005.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.

The following discussion should be read in conjunction with our unaudited
Consolidated Financial Statements (including the Notes thereto) included
elsewhere in this report. References to "Diamond Offshore," "we," "us" or "our"
mean Diamond Offshore Drilling, Inc., a Delaware corporation, and its
subsidiaries.

We are a leader in deep water drilling with a fleet of 44 offshore drilling
rigs. Our fleet currently consists of 30 semisubmersibles, 13 jack-ups and one
drillship. In August 2005, we purchased the Enserch Garden Banks, or Garden
Banks, a Victory-class semisubmersible drilling rig and related equipment, for
$20 million and removed from service one of our jack-up rigs, the Ocean Warwick,
as a result of damages sustained during Hurricane Katrina (see "- Overview -
Impact of 2005 Hurricanes." In June 2005, we completed the sale of the Ocean
Liberator and received net cash proceeds of $13.6 million.

OVERVIEW

INDUSTRY CONDITIONS

The market for our mid and deepwater semisubmersible rigs continued to
experience steady improvement during the third quarter of 2005, as did the
market for our jack-up rigs. Solid demand for all classes of offshore drilling
rigs in the face of tight supply is continuing to lift dayrates and maintain
high utilization rates around the world; however, actual revenues received in
future periods could be reduced by various operating factors.

Gulf of Mexico. In the U.S. Gulf of Mexico, or GOM, drilling activities
were significantly impacted by two severe hurricanes, Katrina and Rita, which
disrupted operations and damaged equipment throughout the offshore drilling
industry in August and September 2005, respectively. We experienced various
degrees of damage to our fleet during the two storms, and one jack-up unit, the
Ocean Warwick, was declared a constructive total loss. Excluding the Ocean
Warwick, all of our other rigs damaged by these hurricanes have now been
repaired and returned to service, with the exception of Ocean Star, which is
expected to return to work in mid-November of this year. See " - Impact of 2005
Hurricanes."

Dayrates continue to escalate in the GOM. A commitment for one of our
high-specification rigs has reached as high as $325,000 per day for work
beginning in the fourth quarter of 2006 and extending until the fourth quarter
of 2008. This contrasts with a dayrate of $185,000 that the unit is currently
earning. All seven of our high-specification semisubmersible rigs in the GOM,
including the recently relocated Ocean Baroness which is expected to commence
drilling operations in November 2005, are currently contracted at higher
dayrates than those earned during the first quarter of 2005. Five of these seven
high-specification rigs have future contracts at improved dayrates beginning in
the fourth quarter of 2005 or early 2006, compared to their current operating
dayrates.

The dayrates for our four mid-water semisubmersibles currently operating in
the GOM have reached as high as $175,000 for a one-well contract beginning in
the fourth quarter of 2005. This contrasts with an average dayrate in the upper
$40,000 range earned during the third quarter of 2004 by our mid-water drilling
units in the GOM. Additionally, the Ocean New Era, which is currently being
reactivated from cold-stack status, is expected to commence operations in the
GOM in December 2005 at a dayrate of $100,000. We continue to view the deepwater
and mid-water markets in the GOM as under-supplied, and believe that additional
improvement in backlog and dayrates is likely in these market segments during
the remainder of 2005 and in 2006.

Our jack-up fleet in the GOM also continued to experience high utilization
and improving dayrates during the third quarter of 2005. Dayrates for our
jack-up fleet operating in the GOM have increased from an average in the
mid-$30,000 range in 2004 to an average dayrate in the upper $50,000 range
during the third quarter of 2005. Industry-wide, up to six jack-up units are
reportedly scheduled to leave the GOM for other international markets by the end
of 2005, and up to eight additional jack-up rigs were seriously damaged and
could ultimately be declared lost by the industry because of the two hurricanes.
As a result, we view the jack-up market in the GOM as under-supplied and believe
that additional improvement in backlog and dayrates is likely in this market
segment during the remainder of 2005 and in 2006.

In the Mexican sector of the Gulf of Mexico, or Mexican GOM, our four
semisubmersible rigs remain under long-term contracts that extend into late 2006
and 2007. We believe that future work for other of our semisubmersibles and
jack-ups in this market is possible, though limited. We view the market for the
Mexican GOM as firm and expect it to remain so during 2005.

Brazil. Two of our rigs operating in Brazil are currently working under
term contracts that expire in 2009 and an additional two rigs are operating
under contracts expiring in 2010. We do not currently contemplate any change in
our market position in Brazil. We view the Brazilian semisubmersible market as
balanced and expect it to remain so during the remainder of 2005 and in 2006.

North Sea. Drilling activity in both the U.K. and Norwegian sectors of the
North Sea has mirrored that in the GOM since mid-2004. Our three mid-water
semisubmersible rigs operating in the U.K. sector have received future contracts
at dayrates ranging from $152,500 to $160,000 for work beginning in the first
quarter of 2006, compared to current dayrates of approximately $80,000. In
Norway, the Ocean Vanguard is working under a $140,000 per day contract that
expires early in the third quarter of 2006. Effective industry utilization
remains near 100 percent in the North Sea, and leading-edge dayrates currently
exceed our present and future contract rates in both the U.K. and Norwegian
sectors. We believe this market will continue to improve throughout the balance
of 2005 and in 2006.

Australia/Asia/Middle East. We currently have five semisubmersible rigs and
one jack-up rig operating in the Australia/Asia market under contracts or
commitments for work extending well into 2006 at increasing dayrates, compared
to current dayrates averaging in the middle $70,000-range during the third
quarter of 2005. One of our jack-up units, the Ocean Heritage, mobilized from
Southeast Asia to Qatar during the second quarter of 2005, where the unit is
operating under an approximately seven-month agreement at a dayrate of $71,000.
We view demand in the Australia/Asia and Middle Eastern markets as increasing,
and with high utilization, we believe continuing improvement in dayrates is
probable.

IMPACT OF 2005 HURRICANES

In the third quarter of 2005, the U.S. Gulf Coast and GOM were seriously
affected by two hurricanes, Katrina and Rita. In late August 2005, one of our
jack-up drilling rigs, the Ocean Warwick, was seriously damaged during Hurricane
Katrina and other rigs in our fleet sustained lesser damage in Hurricanes
Katrina or Rita, or in some cases from both storms. We believe that the physical
damage to our rigs, as well as related removal and recovery costs, are covered
by insurance, after applicable deductibles. Our results for the third quarter of
2005 reflect the impact of Hurricanes Katrina and Rita. As further described
below, we recorded an after-tax gain of $21.8 million (or $0.16 per shared on a
diluted basis) related to net insurance proceeds from the casualty loss of the
Ocean Warwick, and other damage to our fleet, as well as our relief and recovery
efforts, resulted in the recording of hurricane-related after-tax costs of $2.6
million (or $0.02 per share on a diluted basis).

The Ocean Warwick, with a net book value of $14.0 million, was declared a
constructive total loss effective August 29, 2005. We issued a proof of loss in
the amount of $50.5 million to our insurers, representing the insured value of
the rig less a $4.5 million deductible. To date, we have received insurance
proceeds totaling $49.9 million related to the claim for the Ocean Warwick
($44.1 million through September 30, 2005). Recovery and removal of the Ocean
Warwick are subject to separate insurance deductibles totaling $2.5 million. The
drilling unit has been moved to a dock-side location and will be disposed of in
accordance with underwriter instructions.

Damage to our other affected rigs and warehouse in New Iberia, Louisiana
was less severe, and we believe that repair costs for such damage and lost
equipment will be covered by insurance, less estimated deductibles. All of our
damaged rigs have now been repaired and returned to service, with the exception
of the Ocean Star, which is expected to return to work in mid-November 2005.
Insurance deductibles relating to the remaining rigs damaged during Hurricane
Katrina and our rigs and facility damaged by Hurricane Rita total $2.6 million
in the aggregate, of which $1.2 million and $1.4 million have been recorded as
additional contract drilling expense and loss on sale of assets, respectively,
for the three- and nine-month periods ended September 30, 2005.

In addition, in the third quarter of 2005, we wrote-off the net book value
of approximately $4.2 million, pre-tax, in rig equipment that was either lost or
damaged beyond repair during these storms as loss on sale of assets and recorded
a corresponding insurance receivable in an amount equal to our expected recovery
from insurers. The write-off of this equipment and recognition of insurance
receivables had no net effect on our consolidated results of operations for the
three- and nine-month periods ended September 30, 2005.

Our operating results for the third quarter of 2005 were negatively
impacted by lost revenues as a result of the casualty loss of the Ocean Warwick
and an aggregate of 41.5 days of unpaid downtime for several of our other
drilling rigs in the U.S. GOM for hurricane-related repairs. We expect our
revenues for the fourth quarter of 2005 also to be negatively impacted by these
same factors, as well as the later than expected start-up of drilling operations
for the Ocean Lexington and Ocean New Era, which were in shipyards located on
the U.S. Gulf Coast during these hurricanes. Unpaid downtime for the fourth
quarter of 2005 associated with hurricane-related repairs is estimated to be an
aggregate of approximately 110 days. The impact of lost revenues associated with
the Ocean Warwick is estimated to be $2.3 million, pre-tax, and $6.4 million,
pre-tax, for the third and fourth quarters of 2005, respectively. We expect the
additional unpaid downtime in the third and fourth quarters of 2005 resulting
from hurricane damage to reduce our revenues by approximately $5.1 million,
pre-tax, and $11.8 million, pre-tax, respectively. However, actual downtime and
loss of revenues may vary as repairs are completed, and our drilling rigs
resume/commence drilling operations ahead of or behind our initial estimates.

During the third quarter of 2005, we also incurred additional operating
expenses, including but not limited to the cost of reconnaissance aircraft, rig
crew over-time and employee assistance, hurricane relief supplies and temporary
housing and office space, of $1.4 million, pre-tax, relating to relief and
recovery efforts in the aftermath of Hurricanes Katrina and Rita, which we do
not expect to be recoverable through our insurance. In addition, we expect to
incur similar charges in the fourth quarter of 2005 of approximately $0.7
million, pre-tax, and an additional $1.7 million, pre-tax, for the rental of
mooring equipment for two of our drilling rigs.

GENERAL

Revenues. Our revenues vary based upon demand, which affects the number of
days our fleet is utilized and the dayrates earned. When a rig is idle, no
dayrate is earned and revenues will decrease as a result. Revenues can also be
affected as a result of the acquisition or disposal of rigs, required surveys
and shipyard upgrades. In order to improve utilization or realize higher
dayrates, we may mobilize our rigs from one market to another. However, during
periods of mobilization, revenues may be adversely affected. As a response to
changes in demand, we may withdraw a rig from the market by stacking it or may
reactivate a rig stacked previously, which may decrease or increase revenues,
respectively. The two most significant variables affecting revenues are dayrates
for rigs and rig utilization rates, each of which is a function of rig supply
and demand in the marketplace. As utilization rates increase, dayrates tend to
increase as well, reflecting the lower supply of available rigs, and vice versa.
The same factors, primarily demand for drilling services, which is dependent
upon the level of expenditures set by oil and gas companies for offshore
exploration and development as well as a variety of political and economic
factors, and availability of rigs in a particular geographical region, affect
both dayrates and utilization rates. These factors are not within our control
and are difficult to predict with any degree of specificity beyond broad market
trends.

Revenue from dayrate drilling contracts is recognized as services are
performed. In connection with such drilling contracts, we may receive lump-sum
fees for the mobilization of equipment. These fees are earned as services are
performed over the initial term of the related drilling contracts. We previously
accounted for the excess of mobilization fees received over costs incurred to
mobilize an offshore rig from one market to another as revenue over the term of
the related drilling contracts. Effective July 1, 2004 we changed our accounting
to defer mobilization fees received as well as direct and incremental
mobilization costs incurred and began to amortize each, on a straight line
basis, over the term of the related drilling contracts (which is the period
estimated to be benefited from the mobilization activity). Straight line
amortization of mobilization revenues and related costs over the term of the
related drilling contracts (which generally range from two to 60 months) is
consistent with the timing of net cash flows generated from the actual drilling
services performed. If we had used this method of accounting in periods prior to
July 1, 2004, previously reported operating income (loss) and net income (loss)
would not have changed and the impact on contract drilling revenues and expenses
would have been immaterial. Absent a contract, mobilization costs are recognized
currently.

Operating Income. Operating income is primarily affected by revenue
factors, but is also a function of varying levels of operating expenses.
Operating expenses generally are not affected by changes in dayrates and may not
be significantly affected by fluctuations in utilization. For instance, if a rig
is to be idle for a short period of time, few decreases in operating expenses
may actually occur since the rig is typically maintained in a prepared or "ready
stacked" state with a full crew. In addition, when a rig is idle, we are
responsible for certain operating expenses such as rig fuel and supply boat
costs, which are typically costs of the operator when a rig is under contract.
However, if the rig

is to be idle for an extended period of time, we may reduce the size of a rig's
crew and take steps to "cold stack" the rig, which lowers expenses and partially
offsets the impact on operating income. We recognize, as incurred, operating
expenses such as inspections, painting projects and routine overhauls that meet
certain criteria and which maintain rather than upgrade our rigs. These expenses
vary from period to period. Costs of rig enhancements are capitalized and
depreciated over the expected useful lives of the enhancements. Higher
depreciation expense decreases operating income in periods subsequent to capital
upgrades.

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

In addition, operating income may 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 and require downtime for the drilling rig, but normally do not
require dry-docking or shipyard time.

In May 2005 we renewed our insurance policies for hull and machinery
damage, workers' compensation and general liability coverages, among other
things, at an aggregate annual cost of approximately $17 million, which
represents approximately a 15% increase in insurance costs compared to the
previous policy period. Insurance premiums will be amortized as expense over the
applicable policy periods which generally expire at the end of April 2006.

CRITICAL ACCOUNTING ESTIMATES

Our significant accounting policies are included in Note 1 of our Notes to
Unaudited Consolidated Financial Statements in Item 1 of Part I of this report.
Management's judgments, assumptions and estimates are inherent in the
preparation of our financial statements and the application of its significant
accounting policies. We believe that our most critical accounting estimates are
as follows:

Property, Plant and Equipment. Drilling and other property and equipment is
carried at cost. Maintenance and routine repairs are charged to income currently
while replacements and betterments, which meet certain criteria, are
capitalized. Depreciation is amortized up to applicable salvage values by
applying the straight-line method over the remaining estimated useful lives. Our
management makes judgments, assumptions and estimates regarding capitalization,
useful lives and salvage values. Changes in these judgments, assumptions and
estimates could produce results that differ from those reported.

We evaluate our property and equipment for impairment whenever changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. We utilize a probability-weighted cash flow analysis in testing an
asset for potential impairment. The assumptions and estimates underlying this
analysis include:

- dayrate by rig,

- utilization rate by rig (expressed as the actual percentage of time
per year that the rig would be used),

- the per day operating cost for each rig if active, ready stacked or
cold stacked and

- salvage value for each rig.

Based on these assumptions and estimates a matrix is developed assigning
probabilities to various combinations of assumed utilization rates and dayrates.
The impact of a 5% reduction in assumed dayrates for the cold stacked rigs
(holding all other assumptions and estimates in the model constant), or
alternatively the impact of a 5% reduction in utilization (again holding all
other assumptions and estimates in the model constant) is also considered as
part of this analysis.

At September 30, 2005, there were no changes in circumstances that
indicated that the carrying value of our property and equipment, primarily
drilling equipment, may not be recoverable.

Management's assumptions are an inherent part of an asset impairment
evaluation and the use of different assumptions could produce results that
differ from those reported.

Personal Injury Claims. Our uninsured retention of liability for personal
injury claims, which primarily results from Jones Act liability in the Gulf of
Mexico, is $0.5 million per claim with an additional aggregate annual deductible
of $1.5 million. Our in-house claims department estimates the amount of our
liability for our retention. This department establishes a reserve for each
personal injury claim by evaluating the existing facts and circumstances and
comparing the circumstances of each claim to historical experiences with similar
past personal injury claims. Our claims department also estimates our liability
for claims which are incurred but not reported by using historical data.
Historically, our ultimate liability for personal injury claims has not differed
materially from our recorded estimates. At September 30, 2005, our estimated
liability for personal injury claims was $37.3 million. The eventual settlement
or adjudication of these claims could differ materially from the estimated
amounts due to uncertainties such as:

- the severity of personal injuries claimed,

- significant changes in the volume of personal injury claims,

- the unpredictability of legal jurisdictions where the claims will
ultimately be litigated,

- inconsistent court decisions and

- the risks and lack of predictability inherent in personal injury
litigation.

Income Taxes. We account for income taxes in accordance with Statement of
Financial Accounting Standards, or SFAS, No. 109, "Accounting for Income Taxes,"
which requires the recognition of the amount of taxes payable or refundable for
the current year and an asset and liability approach in recognizing the amount
of deferred tax liabilities and assets for the future tax consequences of events
that have been currently recognized in our financial statements or tax returns.
In each of our tax jurisdictions we recognize a current tax liability or asset
for the estimated taxes payable or refundable on tax returns for the current
year and a deferred tax asset or liability for the estimated future tax effects
attributable to temporary differences and carryforwards. Deferred tax assets are
reduced by a valuation allowance, if necessary, which is determined by the
amount of any tax benefits that, based on available evidence, are not expected
to be realized under a "more likely than not" approach. For interim periods, we
estimate our annual effective tax rate by forecasting our annual income before
income tax, taxable income and tax expense in each of our tax jurisdictions. We
make judgments regarding future events and related estimates especially as they
pertain to forecasting of our effective tax rate, the potential realization of
deferred tax assets such as utilization of foreign tax credits, and exposure to
the disallowance of items deducted on tax returns upon audit.

THREE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004

Comparative data relating to our revenues and operating expenses by
equipment type are listed below. Certain amounts applicable to the prior period
have been reclassified to conform to the classifications currently followed.
Such reclassifications do not affect earnings.

THREE MONTHS ENDED
SEPTEMBER 30,
------------------- FAVORABLE/
2005 2004 (UNFAVORABLE)
-------- -------- -------------
(In thousands)

CONTRACT DRILLING REVENUE
High Specification Floaters ................. $113,133 $ 75,502 $ 37,631
Other Semisubmersibles ...................... 118,293 79,357 38,936
Jack-ups .................................... 68,971 45,268 23,703
Other ....................................... 138 483 (345)
-------- -------- --------
TOTAL CONTRACT DRILLING REVENUE ............. $300,535 $200,610 $ 99,925
======== ======== ========

REVENUES RELATED TO REIMBURSABLE EXPENSES ... $ 9,987 $ 7,588 $ 2,399

CONTRACT DRILLING EXPENSE
High Specification Floaters ................. $ 44,747 $ 43,697 $ (1,050)
Other Semisubmersibles ...................... 82,888 62,185 (20,703)
Jack-ups .................................... 29,930 34,354 4,424
Other ....................................... 2,972 371 (2,601)
-------- -------- --------
TOTAL CONTRACT DRILLING EXPENSE ............. $160,537 $140,607 $(19,930)
======== ======== ========

REIMBURSABLE EXPENSES ....................... $ 8,350 $ 6,620 $ (1,730)

OPERATING INCOME (LOSS)
High Specification Floaters ................. $ 68,386 $ 31,805 $ 36,581
Other Semisubmersibles ...................... 35,405 17,172 18,233
Jack-ups .................................... 39,041 10,914 28,127
Other ....................................... (2,834) 112 (2,946)
Reimbursable expenses, net .................. 1,637 968 669
Depreciation ................................ (46,494) (45,043) (1,451)
General and administrative expense .......... (8,928) (6,728) (2,200)
Gain (loss) on sale of assets ............... 761 (1,536) 2,297
Casualty gain on Ocean Warwick .............. 33,605 -- 33,605
-------- -------- --------
TOTAL OPERATING INCOME ...................... $120,579 $ 7,664 $112,915
======== ======== ========

High Specification Floaters.

Revenues. Revenues generated by our high specification floaters (deepwater
semisubmersibles) increased $37.6 million during the quarter ended September 30,
2005 compared to the same period in 2004.

Average operating dayrates earned by our entire fleet of high specification
floaters in the third quarter of 2005 increased approximately 58% compared to
average operating dayrates earned during the third quarter of 2004. Our average
operating revenues per day rose to $144,700 during the third quarter of 2005
from $91,700 during the third quarter of 2004, generating an additional $41.2
million in revenues in the 2005 period. Except for the Ocean Baroness, which
recently relocated to the GOM in the third quarter of 2005, all of our high
specification floaters operated under contracts with higher operating dayrates
during the third quarter of 2005 compared to the same period in 2004. This is
reflective of a continued improvement in the deepwater market, most notably in
the GOM, which began in the third quarter of 2004.

Utilization for our deepwater fleet fell from 89% during the third quarter
of 2004 to 85% during the same period of 2005, reducing revenues by $3.8 million
for the third quarter of 2005 compared to the third quarter of 2004. The decline
in utilization in the third quarter of 2005 is primarily due to downtime for the
Ocean Baroness which did not operate for the entire third quarter of 2005 and 30
days of unpaid downtime for the Ocean Quest for

hurricane-related repairs. The Ocean Baroness, which was stacked in Singapore
for an intermediate survey beginning in June 2005 and then relocated to the GOM,
is expected to recommence drilling operations in the GOM in November 2005.

These unfavorable utilization variances were partly offset by the nearly
full utilization of the Ocean Victory, the Ocean Alliance, and the Ocean Clipper
in the third quarter of 2005 compared to the same period in 2004. During the
third quarter of 2004, the Ocean Victory was ready-stacked for 45 days, and the
Ocean Alliance and the Ocean Clipper had 29 days and 12 days, respectively, of
unpaid downtime for repairs.

Contract Drilling Expense. Contract drilling expense for our deepwater
semisubmersibles increased $1.1 million for the third quarter ended September
30, 2005 compared to the same period in 2004, primarily due to:

- increased labor costs for our rig-based and shore-based personnel due
to 2005 wage increases; and

- higher insurance costs in the third quarter of 2005 associated with
increased premiums for the 2005/2006 policy year, additional loss of
hire insurance coverage and the reversal of overaccrued insurance
premiums during the third quarter of 2004.

Higher contract drilling expenses during the third quarter of 2005,
compared to the third quarter of 2004, were partially offset by lower normal
operating costs for the Ocean Baroness, which was stacked for a portion of the
third quarter of 2005 and subsequently relocated to the GOM, and lower
non-reimbursable fuel charges for the Ocean Alliance.

During the quarters ended September 30, 2005 and 2004, we recorded
insurance deductibles relating to hurricane damage to our high-specification
floaters of $0.5 million and $1.7 million, respectively.

Other Semisubmersibles.

Revenues. Revenues generated by our other semisubmersibles operating in the
mid-water market increased $38.9 million, or 49%, during the quarter ended
September 30, 2005, as compared to the same period in 2004. Average operating
revenue per day for our mid-water semisubmersibles fleet increased from $55,900
in the third quarter of 2004 to $77,300 in the third quarter of 2005 due to the
continuing improvement in the mid-water market. This favorable trend in revenues
resulted in $23.8 million in additional revenues in the third quarter of 2005,
as compared to the same period in 2004.

Average utilization for our rigs in the mid-water market (excluding the
Ocean Endeavor, which is being upgraded for ultra-deepwater service and the
recently acquired Garden Banks) increased from 80% in the third quarter of 2004
to 86% in the third quarter of 2005, which resulted in additional revenues of
$14.3 million during the third quarter of 2005 as compared to the same period in
2004. Utilization rates for our mid-water fleet during the third quarter of 2005
reflect the nearly full utilization of the Ocean Concord, as compared to the
same period in 2004 when this unit was in a shipyard for a 5-year survey and
life enhancement maintenance. In addition, the Ocean Voyager, which was
reactivated from cold-stack status in the fourth quarter of 2004, operated the
entire third quarter of 2005. The overall improvement in utilization in the
third quarter of 2005, as compared to the same period in 2004, was partially
offset by 31 days of unpaid downtime for anchor winch repairs to the Ocean
Vanguard and downtime for the Ocean Lexington, which was in a shipyard for a
5-year survey and steel renewal project during the entire third quarter of 2005.
Both of these drilling units worked the entire third quarter of 2004.

Contract Drilling Expense. Contract drilling expense for our mid-water
semisubmersibles increased $20.7 million during the third quarter of 2005
compared to the same period in 2004. Significant factors impacting our operating
costs in the third quarter of 2005, as compared to the third quarter of 2004,
include:

- reactivation and stand-by crew costs for the Ocean New Era and normal
operating costs for the Ocean Voyager during the third quarter of
2005, as compared to reduced costs during the comparable period of
2004 when these rigs were cold-stacked;

- normal operating costs for the Ocean Concord, which worked most of the
third quarter of 2005, compared to the same period in 2004 when this
rig was in a shipyard for a survey and life enhancement maintenance;
and

- higher operating costs for the Ocean Bounty while working in Australia
during the third quarter of 2005, as compared to working offshore New
Zealand for a majority of the third quarter of 2004 at a lower cost
structure.

Labor and related costs comprise a significant portion of our operating
expenses. During the third quarter of 2005, as compared to the same period in
2004, our operating costs were negatively impacted by increased labor and
related costs and shorebase support costs, primarily for:

- our operations in Norway, mostly due to Norwegian pay allowances and
additional personnel required to comply with Norwegian regulations;

- December 2004 and September 2005 wage increases for our rig-based and
shore-based personnel, including a Brazilian wage increase resulting
from completion of a local competency program;

- the Ocean Patriot, which worked the entire third quarter of 2005
offshore Australia, as compared to the third quarter of 2004 when the
drilling rig was mobilizing from offshore South Africa to New Zealand
and Australia; and

- the Ocean Nomad, which incurred higher labor costs during the third
quarter of 2005 associated with its operations in the U.K., as
compared to the same period in 2004 when this drilling rig was working
offshore western Africa.

Partially offsetting these higher expenses were lower comparative expenses
in the third quarter of 2005 for:

- the Ocean Epoch, which had lower labor and shore-based costs while
working in Malaysia, as compared to working in Australia the entire
third quarter of 2004; and

- lower labor benefits costs for the Ocean Guardian and the Ocean
Princess due to a third quarter 2004 accrual for retroactive U.K.
mandated labor benefits, a portion of which was subsequently reversed
in the second quarter of 2005 as a result of our interpretation of a
recent ruling by the U.K. Court of Appeals.

Jack-Ups.

Revenues. Revenues for our jack-up fleet increased $23.7 million during the
third quarter of 2005 compared to the same quarter in 2004.

Improvements in average operating dayrates contributed $19.8 million
(excluding the Ocean Warwick) to the overall revenue increase as average
operating dayrates rose from $38,000 for the third quarter of 2004 to $57,500
during the same period of 2005. All of our jack-up rigs experienced an increase
in average operating dayrates during the third quarter of 2005 compared to the
third quarter of 2004, reflective of the continued improvement in the jack-up
market.

Utilization for our jack-up fleet improved from 89% to 94% (excluding the
Ocean Warwick) during the third quarter of 2005 and resulted in an increase in
revenues of $2.9 million for the third quarter of 2005. Our current jack-up
fleet experienced nearly full utilization during the third quarter of 2005,
except for the Ocean Spur which was down for leg repairs during July and August
of 2005. During the same period in 2004, the Ocean Champion was reactivated from
cold-stack status in mid-August, the Ocean Nugget and Ocean Spur were
ready-stacked for part of the period, and the Ocean Heritage was in a shipyard
for two weeks preparing for its mobilization from Ecuador to India.

In late August 2005, the Ocean Warwick was declared a constructive total
loss by our insurers as a result of damage sustained during Hurricane Katrina.
During the third quarter of 2005 and 2004, this drilling rig generated $4.0
million and $3.3 million, respectively, in revenues. See "- Overview - Impact of
2005 Hurricanes."

Contract Drilling Expense. Contract drilling expense for our jack-up fleet
for the third quarter of 2005 decreased $4.4 million compared to the same period
in 2004 primarily due to lower operating costs in the third quarter of 2005
primarily due to:

- a $3.0 million insurance deductible recorded in the third quarter of
2004 for damages to the Ocean Warwick during Hurricane Ivan;

- higher costs associated with the reactivation of the Ocean Champion
during the third quarter of 2004 compared to normal operating costs
during the third quarter of 2005; and

- higher mobilization costs in the third quarter of 2004 for the Ocean
Heritage related to its third quarter demobilization from Ecuador to
Singapore and then deployment to India.

Partially offsetting the lower overall contract drilling expenses during
the third quarter of 2005 were:

- normal operating costs for the Ocean Heritage which operated for the
majority of the third quarter of 2005 compared to the same period of
2004 when this rig was stacked for part of the quarter preparing for
its mobilization from Ecuador to India;

- higher repair, maintenance and inspection costs for the Ocean Spur
during the third quarter of 2005 while in a shipyard for leg repairs
compared to lower costs during the third quarter of 2004; and

- higher overall labor and benefits costs for our domestic jack-ups due
to December 2004 and mid-September 2005 wage increases.

Reimbursable expenses, net.

Revenues related to reimbursable items, offset by the related expenditures
for these items, were $1.6 million and $1.0 million for the quarters ended
September 30, 2005 and 2004, respectively. Reimbursable expenses include items
that we purchase, and/or services we perform, at the request of our customers.
We charge our customers for purchases and/or services performed on their behalf
at cost, plus a mark-up where applicable. Therefore, net reimbursables fluctuate
based on customer requirements, which vary.

Depreciation.

Depreciation expense increased $1.5 million to $46.5 million in the third
quarter of 2005 compared to $45.0 million in the third quarter of 2004 primarily
due to depreciation associated with capital additions in 2004 and the first nine
months of 2005. Partially offsetting this increase was a reduction in
depreciation for the Ocean Liberator, which we removed from our
actively-marketed fleet in December 2004 and subsequently sold in June 2005.

General and Administrative Expense.

General and administrative expense for the three months ended September 30,
2005 increased by $2.2 million to $8.9 million compared to general and
administrative expenses of $6.7 million for the same period in 2004. The
increase in overhead costs for the third quarter of 2005, as compared to the
third quarter of 2004, was primarily due to higher compensation expense related
to our management bonus plan, as well as the current year impact of lower legal
fees during the comparable period in 2004. During the third quarter of 2004, we
received reimbursements from our insurers for legal costs incurred in connection
with litigation that was subsequently settled in December 2004.

Gain (loss) on Sale of Assets.

We recognized a net gain of $0.8 million on the sale of assets during the
third quarter of 2005, resulting primarily from the sale of drill pipe and
partly offset by a $1.4 million loss due to the retirement of equipment lost or
damaged during Hurricanes Katrina and Rita. During the same period in 2004, we
recorded a net loss of $1.5 million primarily from the retirement of equipment
lost in Hurricane Ivan.

Casualty Gain on Ocean Warwick

We recognized a $33.6 million casualty gain during the third quarter of
2005 as a result of the constructive total loss of the Ocean Warwick, resulting
from damage sustained during Hurricane Katrina in August 2005. See " - Overview
- Impact of 2005 Hurricanes."

Income Tax (Expense).

We recognized income tax expense of $37.4 million on pre-tax income of
$119.4 million during the three months ended September 30, 2005 compared to
income tax expense of $16,000 on pre-tax income of $3.0 million for the three
months ended September 30, 2004. Our net income tax expense or benefit is a
function of the mix between our domestic and international pre-tax earnings or
losses, respectively, as well as the mix of international tax jurisdictions in
which we operate. Our estimated annual effective rate increased from 27.1% in
the second quarter of 2005 to 29.5% in the third quarter of 2005 due to the
expectation of a higher percentage of domestic pre-tax income in 2005, primarily
as a result of the Ocean Warwick casualty gain in the third quarter of 2005. Our
effective income tax rate of 31.3% for the three months ended September 30, 2005
included a $2.4 million adjustment which resulted from applying the higher
estimated annual income tax rate to our June 30, 2005 year-to-date pre-tax
income. The 0.5% effective tax rate for the three months ended September 30,
2004 resulted from a revision of the 2004 estimated annual effective rate from
24.8% to 27.7% in the third quarter of 2004.

NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004

Comparative data relating to the Company's revenues and operating expenses
by equipment type are listed below. Certain amounts applicable to the prior
periods have been reclassified to conform to the classifications currently
followed. Such reclassifications do not affect earnings.

NINE MONTHS ENDED
SEPTEMBER 30,
--------------------- FAVORABLE/
2005 2004 (UNFAVORABLE)
--------- --------- -------------
(In thousands)

CONTRACT DRILLING REVENUE
High Specification Floaters ............. $ 304,824 $ 199,342 $105,482
Other Semisubmersibles .................. 325,634 225,620 100,014
Jack-ups ................................ 192,834 128,391 64,443
Other ................................... (70) 1,182 (1,252)
--------- --------- --------
TOTAL CONTRACT DRILLING REVENUE ......... $ 823,222 $ 554,535 $268,687
========= ========= ========

REVENUES RELATED TO REIMBURSABLE
EXPENSES ............................. $ 29,457 $ 22,807 $ 6,650

CONTRACT DRILLING EXPENSE
High Specification Floaters ............. $ 134,792 $ 126,835 $ (7,957)
Other Semisubmersibles .................. 238,853 193,137 (45,716)
Jack-ups ................................ 90,587 86,373 (4,214)
Other ................................... 7,008 2,423 (4,585)
--------- --------- --------
TOTAL CONTRACT DRILLING EXPENSE ......... $ 471,240 $ 408,768 $(62,472)
========= ========= ========

REIMBURSABLE EXPENSES ................... $ 24,784 $ 20,373 $ (4,411)

OPERATING INCOME (LOSS)
High Specification Floaters ............. $ 170,032 $ 72,507 $ 97,525
Other Semisubmersibles .................. 86,781 32,483 54,298
Jack-ups ................................ 102,247 42,018 60,229
Other ................................... (7,078) (1,241) (5,837)
Reimbursable expenses, net .............. 4,673 2,434 2,239
Depreciation ............................ (137,944) (134,117) (3,827)
General and administrative expense ...... (27,587) (24,277) (3,310)
Gain on sale and disposition of assets .. 8,753 (1,341) 10,094
Casualty gain on Ocean Warwick .......... 33,605 -- 33,605
--------- --------- --------
TOTAL OPERATING INCOME (LOSS) ........... $ 233,482 $ (11,534) $245,016
========= ========= ========

High Specification Floaters.

Revenues. Revenues generated by our high specification floaters (deepwater
semisubmersibles) increased $105.5 million during the nine months ended
September 30, 2005 compared to the same period in 2004.

The average operating dayrate for our rigs in this market increased 33% to
$124,300 for the nine months ended September 30, 2005 from $93,800 for the same
period in 2004, which reflects the continued strengthening of the market for
this class of rig. Average operating revenue per day increased for all of our
deepwater semisubmersibles, generating an additional $76.9 million in revenues
in the first nine months of 2005 compared to the same period in 2004.

During the first nine months of 2005, average utilization for our rigs in
the deepwater market increased significantly over average utilization for the
same period in 2004. Average utilization increased to 90% during the first nine
months of 2005 from 78% for the first nine months of 2004, generating additional
revenues of $28.6 million in the 2005 period. Significant improvements in
utilization were achieved by:

- the Ocean Star and the Ocean Victory, which operated for most of the
first nine months of 2005 compared to being ready-stacked for five
months and three months during the comparable period in 2004,
respectively;

- the Ocean America, which worked the entire first nine months of 2005
compared to the same period in 2004 when this unit was in a shipyard
for three months for a 5-year survey and upgrade; and

- the Ocean Alliance, which worked a majority of the first nine months
of 2005 but had nearly five months of unpaid downtime during the
comparable period of 2004 for repairs, a 5-year survey and a planned
sub-sea equipment upgrade.

The overall increase in utilization for our rigs in this market during the
first nine months of 2005 was partially offset by downtime for the Ocean
Baroness, which completed its contract in Indonesia in mid-May 2005 and
mobilized to a shipyard in Singapore for an intermediate survey and repairs
prior to commencing its dry tow to the GOM in August 2005. This compares with
93% utilization for the Ocean Baroness in the first nine months of 2004. Other
changes in utilization were primarily due to the timing of scheduled surveys,
related repairs and maintenance activities.

Contract Drilling Expense. Contract drilling expense for our deepwater
semisubmersibles increased $8.0 million during the first nine months of 2005
compared to the same period in 2004, primarily due to higher labor and benefits
costs. Increased labor and benefits costs reflect the impact of December 2004
pay increases (and to a lesser extent September 2005 pay increases), both
domestically and in Brazil, as well as additional staffing requirements
resulting from the increased utilization of our rigs. In addition, contract
drilling expenses were higher in 2005 due to:

- equipment rental costs for replacement anchor chain on the Ocean
America which was lost during Hurricane Ivan in September 2004; and

- higher insurance costs in the first nine months of 2005 associated
with increased premiums for the 2005/2006 policy year, which began in
May 2005, additional loss of hire insurance coverage and the reversal
of overaccrued insurance premiums during the third quarter of 2004.

Partially offsetting these higher costs during the first nine months of 2005
compared to the same period in 2004 were:

- lower inspection and other related costs in the first nine months of
2005 for the Ocean Alliance and the Ocean America which completed
5-year surveys in 2004; and

- lower shorebase and other operating costs in 2005 for the Ocean
Baroness, which operated through mid-May 2005 and was then mobilized
to a shipyard in Singapore and subsequently relocated to the GOM,
compared to working a majority of the first nine months in 2004.

Other Semisubmersibles.

Revenues. Revenues generated by our other (or mid-water) semisubmersibles
for the first nine months of 2005 increased $100.0 million compared to the same
period in 2004.

Average operating revenue per day for our mid-water semisubmersibles rose
to $71,700 for the nine months ended September 30, 2005 from $55,500 for the
same period in 2004, generating $60.0 million in additional revenues in the 2005
period. The effect of this upward trend in operating dayrates was first realized
in the fourth quarter of 2004 and has continued throughout 2005.

Utilization for our rigs in the mid-water market also improved during the
first nine months of 2005, compared to the same period in 2004, resulting in an
additional $34.9 million in revenue. Average utilization (excluding the Ocean
Endeavor and Garden Banks) increased from 77% during the first nine months of
2004 to 86% in the comparable period of 2005. Significant improvements in
utilization were achieved by:

- the Ocean Voyager, which was cold-stacked all of the first nine months
of 2004 and worked the entire first nine months of 2005;

- the Ocean Concord and the Ocean Winner, each of which spent part of
the first nine months of 2004 in shipyards for 5-year surveys, as well
as life enhancement maintenance for the Ocean Concord; and

- the Ocean Patriot, which was ready-stacked for nearly 110 days at
various points during the first nine months of 2004, compared to
working a majority of the comparable period in 2005.

Partially offsetting the overall increase in average utilization was:

- downtime associated with a steel renewal project and 5-year survey for
the Ocean Lexington, which commenced late in the second quarter of
2005;

- downtime for the Ocean Epoch, which mobilized during the first quarter
of 2005 to a shipyard in Singapore for a 5-year survey and contract
preparation work, as compared to the same period in 2004 when the rig
worked a majority of the period; and

- two months of unpaid downtime for the Ocean Nomad while waiting on a
contract and for repairs during the first nine months of 2005.

During the nine months ended September 30, 2005, we also recognized in
income $7.4 million in deferred mobilization fees received, of which $5.7
million related to the Ocean Patriot's 2004 mobilization from South Africa to
New Zealand and the Bass Strait, compared to $2.3 million in deferred
mobilization fees recognized in income during the nine months ended September
30, 2004.

Contract Drilling Expense. Contract drilling expense for our mid-water
semisubmersibles increased $45.7 million during the first nine months of 2005
compared to the same period in 2004 primarily due to:

- increased labor costs, both domestically and internationally,
primarily due to December 2004 and September 2005 salary increases for
our rig-based personnel and higher national labor and related costs in
Australia, Brazil, Norway and the U.K. as compared to other regions;

- normal operating costs for the Ocean Voyager during the first nine
months of 2005, as compared to reduced costs during the comparable
period of 2004 when the unit was cold-stacked in the GOM;

- additional costs related to repair work on the Ocean Vanguard during
2005 resulting from wave damage sustained in December 2004;

- the Ocean Patriot, which incurred normal operating costs, including
the amortization of deferred mobilization expenses, while working in
Australia as compared to the first nine months of 2004 when this rig
was stacked for inspections and related repairs in South Africa;

- reactivation costs for the Ocean New Era during the first nine months
of 2005, as compared to reduced costs during the comparable period of
2004 when this rig was cold-stacked in the GOM; and

- higher routine maintenance and repair costs for the Ocean Epoch and
Ocean Lexington, which were in shipyards for portions of the first
nine months of 2005, as compared to the nearly full utilization of
these units during the first nine months of 2004.

Partially offsetting the higher overall operating expenses were lower
comparative expenses for the Ocean Epoch, which had higher national labor costs
during the first nine months of 2004 while working in Australia compared to
reduced labor costs in the first nine months of 2005 when the rig mobilized to
Singapore.

Jack-Ups.

Revenues. Our jack-up fleet generated revenues of $192.8 million during the
nine months ended September 30, 2005, or an increase of $64.4 million compared
to the same period in 2004.

Average operating revenue per day earned by our jack-up fleet during the
first nine months of 2005 increased 40%, compared to the first nine months of
2004. For the first nine months of 2005, our operating revenue per day averaged
$52,800 as compared to an average of $37,600 for the comparable period in 2004.
Excluding the Ocean Warwick, higher dayrates contributed $52.4 million to the
overall increase in revenues generated by our jack-up fleet.

Continuing improvements in the jack-up market were responsible for the
increase in overall utilization (excluding the Ocean Warwick) for our jack-up
fleet which rose to 89% during the nine months ended September 30, 2005 from 79%
during the same period in 2004. This increase in utilization for our rigs
generated an additional $8.8 million in revenues during the first nine months of
2005 compared to the prior year period. Primary factors causing the improvement
in utilization included the reactivation of the Ocean Champion from cold-stack
status in the third quarter of 2004 and the nearly full utilization of both the
Ocean Columbia and the Ocean Nugget during the first nine months of 2005, which
were in shipyards for all or part of the same period of 2004 for inspections and
related repairs. Favorable utilization trends during the first nine months of
2005 were partially offset by lower utilization for the Ocean Heritage, which
experienced unpaid downtime for leg repairs and contract preparation work during
the second quarter of 2005, and the Ocean Spur, which was stacked in a shipyard
for nearly two months during the third quarter of 2005 for leg repairs.

In late August 2005, the Ocean Warwick was declared a constructive total
loss by our insurers as a result of damage sustained during Hurricane Katrina.
During the nine months ended September 30, 2005, this drilling unit generated
$11.8 million in revenues compared to $9.0 million in the same period of 2004
primarily due to a higher average operating dayrate earned during 2005, as
compared to the first nine months of 2004. Prior to its destruction, average
utilization for the Ocean Warwick during 2005 was 76% compared to 98% during the
same period in 2004. Lower utilization in 2005 resulted from downtime in the
first quarter of 2005 for repairs to damages sustained during Hurricane Ivan in
September 2004. See " - Overview - Impact of 2005 Hurricanes."

Contract Drilling Expense. Contract drilling expenses for our jack-up fleet
for the nine months ended September 30, 2005 increased $4.2 million compared to
the same period in 2004, primarily due to:

- normal operating costs during the first nine months of 2005 for the
Ocean Champion following its reactivation in August 2004;

- higher normal operating costs for our jack-up fleet operating in the
GOM due to the 2005 increase in average utilization compared to the
same period in 2004, including the effect of December 2004 and
September 2005 salary increases; and

- normal repair and maintenance, travel, and shore-based costs during
the first nine months of 2005 for the Ocean Heritage and Ocean
Sovereign, both of which mobilized to new locations during the same
period in 2004. We also incurred $1.0 million in uninsured costs for
leg repairs to the Ocean Heritage during the second quarter of 2005.

Partially offsetting these higher contract drilling expenses were lower
mobilization costs during the first nine months of 2005 for the Ocean Heritage
compared to the same period in 2004 when the rig incurred additional costs

to mobilize to Ecuador. In addition, during the first nine months of 2004, we
recorded a $3.0 million insurance deductible as operating expense related to
damage sustained by the Ocean Warwick during Hurricane Ivan.

Reimbursable expenses, net.

Revenues related to reimbursable items, offset by the related expenditures
for these items, were $4.7 million and $2.4 million for the nine months ended
September 30, 2005 and 2004, respectively. Reimbursable expenses include items
that we purchase, and/or services we perform, at the request of our customers.
We charge our customers for purchases and/or services performed on their behalf
at cost, plus a mark-up where applicable. Therefore, net reimbursables fluctuate
based on customer requirements, which vary.

Depreciation.

Depreciation expense increased $3.8 million to $137.9 million in the nine
months ended September 30, 2005 compared to $134.1 million in the same period of
2004 primarily due to depreciation recorded in 2005 associated with capital
additions in 2004 and the first nine months of 2005. Partially offsetting this
increase was a reduction in depreciation for the Ocean Liberator, which we
removed from our actively-marketed fleet in December 2004 and subsequently sold
in June 2005.

General and Administrative Expense.

We incurred general and administrative expense of $27.6 million during the
nine months ended September 30, 2005 compared to $24.3 million for the same
period in 2004. The $3.3 million increase in overhead costs between the periods
was primarily due to higher compensation expense related to our management bonus
plan and fees paid to our external auditors in the 2005 period. Partially
offsetting these higher expenses were lower legal fees for the nine months ended
September 30, 2005 compared to the same period in 2004, primarily due to the
settlement of litigation in December 2004.

Gain on Sale of Assets.

We recognized a net gain of $8.8 million on the sale of assets during the
nine months ended September 30, 2005 compared to a net loss of $1.3 million
during the same period of 2004. Net gains recognized for the first nine months
of 2005 include a pre-tax gain of $8.0 million from the June 2005 sale of the
Ocean Liberator and gains on the sale of used drill pipe during the period,
partly offset by a $1.4 million loss due to the retirement of equipment lost or
damaged during Hurricanes Katrina and Rita. The loss on sale of assets for the
comparable period in 2004 relates primarily to the retirement of equipment lost
in Hurricane Ivan.

Casualty Gain on Ocean Warwick.

We recorded a $33.6 million casualty gain during the nine months ended
September 30, 2005 as a result of the constructive total loss of one of our
jack-up rigs, the Ocean Warwick, resulting from damages sustained during
Hurricane Katrina in August 2005. See "- Overview - Impact of 2005 Hurricanes."

Interest Income.

We earned interest income of $18.0 million during the nine months ended
September 30, 2005 compared to $7.6 million in the same period of 2004. The
$10.4 million increase in interest income is primarily the result of the
combined effect of slightly higher interest rates earned on higher average cash
and investment balances in the first nine months of 2005, as compared to the
same period in 2004. See "- Liquidity and Capital Requirements" and "-
Historical Cash Flows."

Interest Expense.

Interest expense of $33.7 million for the nine months ended September 30,
2005 increased $13.3 million from interest expense of $20.4 million for the same
period in 2004. This increase was primarily attributable to interest related to
our 4.875% Senior Notes Due July 1, 2015, or 4.875% Senior Notes, and our 5.15%
Senior Notes Due September 1, 2014, or 5.15% Senior Notes, which were issued in
June 2005 and August 2004, respectively. In addition, interest expense for the
nine months ended September 30, 2005 included a write-off of $6.9 million in
debt issuance costs associated with our June 2005 repurchase of approximately
96% of our then outstanding Zero Coupon Convertible Debentures due 2020, or Zero
Coupon Debentures. This increase in interest cost was partially

offset by lower interest expense on our Zero Coupon Debentures as a result of
the partial repurchase in June 2005. See "- Liquidity and Capital Requirements -
Contractual Cash Obligations."

Income Tax (Expense) Benefit.

We recognized income tax expense of $65.1 million on pre-tax income of
$218.6 million during the nine months ended September 30, 2005 compared to an
income tax benefit of $5.9 million on a pre-tax loss of $24.4 million for the
nine months ended September 30, 2004. Our net income tax expense or benefit is a
function of the mix between our domestic and international pre-tax earnings or
losses, respectively, as well as the mix of international tax jurisdictions in
which we operate. Different combinations of pre-tax earnings and losses among
jurisdictions resulted in an estimated annual effective tax rate of 29.5% at
September 30, 2005 compared to 27.7% at September 30, 2004.

OPERATIONS OUTSIDE THE UNITED STATES

Our non-U.S. operations are subject to certain political, economic and
other uncertainties not normally encountered in U.S. operations, including risks
of war and civil disturbances (or other risks that may limit or disrupt
markets), expropriation and the general hazards associated with the assertion of
national sovereignty over certain areas in which operations are conducted. No
prediction can be made as to what governmental regulations may be enacted in the
future that could adversely affect our non-U.S. operations or the international
offshore contract drilling industry. Our operations outside the United States
may also face the additional risk of fluctuating currency values, hard currency
shortages, controls of currency exchange and repatriation of income or capital.

We operate four of our semisubmersible rigs offshore Mexico for
Pemex-Exploracion y Produccion, the national oil company of Mexico. The terms of
these contracts expose us to greater risks than we normally assume, such as
exposure to greater environmental liability. While we believe that the financial
terms of the contracts and our operating safeguards in place mitigate these
risks, there can be no assurance that our increased risk exposure will not have
a negative impact on our future operations or financial results.

SOURCES OF LIQUIDITY AND CAPITAL RESOURCES

Our principal sources of liquidity and capital resources are our cash flows
from operations, proceeds from the issuance of debt securities and our cash
reserves. At September 30, 2005 we had $486.7 million in "Cash and cash
equivalents" and $302.4 million in "Investments and marketable securities"
representing our investment of cash available for current operations, which also
included $300.0 million in marketable securities purchased under repurchase
agreements.

In September 2005, we received $44.1 million in net insurance proceeds from
the casualty loss of the Ocean Warwick; see "- Overview - Impact of 2005
Hurricanes."

Cash Flows from Operations. We operate in an industry that has been, and is
expected to continue to be, extremely competitive and highly cyclical. Our cash
flows from operations are a function of the dayrates we receive for our drilling
rigs, as well as the utilization of these rigs. These factors are not within our
control and are difficult to predict with any degree of specificity. For a
description of other factors that could affect our cash flows from operations,
see "- Overview-Industry Conditions" and " - Forward-Looking Statements."

Shelf Registration. We have the ability to issue an aggregate of
approximately $117.5 million in debt, equity and other securities under a shelf
registration statement. In addition, we may issue, from time to time, up to
eight

million shares of common stock, shares which are registered under an acquisition
shelf registration statement (upon effectiveness of any required amendment
thereto), in connection with one or more acquisitions by us of securities or
assets of other businesses.

LIQUIDITY AND CAPITAL REQUIREMENTS

Our liquidity and capital requirements are primarily a function of our
working capital needs, capital expenditures and debt service requirements. Cash
required to meet our capital commitments is determined by evaluating the need to
upgrade rigs to meet specific customer requirements and by evaluating our
ongoing rig equipment replacement and enhancement programs, including water
depth and drilling capability upgrades. It is the opinion of our management that
our operating cash flows and cash reserves will be sufficient to meet these
capital commitments; however, we will continue to make periodic assessments
based on industry conditions. In addition, we may, from time to time, issue debt
or equity securities, or a combination thereof, to finance capital expenditures,
the acquisition of assets and businesses or for general corporate purposes. Our
ability to effect any such issuance will be dependent on the results of our
operations, our current financial condition, current market conditions and other
factors which are beyond our control.

We believe that we have the financial resources needed to meet our business
requirements in the foreseeable future, including capital expenditures for rig
upgrades and continuing rig enhancements and working capital requirements.

Contractual Cash Obligations.

Purchase Obligations and Capital Commitments. As of September 30, 2005, we
had purchase obligations aggregating approximately $200 million and $227 million
related to the major upgrade of the Ocean Endeavor and construction of two new
jack-up rigs, respectively. We had no other purchase obligations for major rig
upgrades or any other significant obligations at September 30, 2005, except for
those that arise during the normal course of business and are related to our
direct rig operations.

4.875% Senior Notes. On June 14, 2005, we issued $250.0 million aggregate
principal amount of 4.875% Senior Notes at an offering price of 99.785% of the
principal amount, resulting in net proceeds to us of $247.7 million, exclusive
of accrued issuance costs.

Our 4.875% Senior Notes bear interest at 4.875% per year, payable
semiannually in arrears on January 1 and July 1 of each year, beginning January
1, 2006, and mature on July 1, 2015. The 4.875% Senior Notes are unsecured and
unsubordinated obligations of Diamond Offshore Drilling, Inc., and they rank
equal in right of payment to our existing and future unsecured and
unsubordinated indebtedness, although the 4.875% Senior Notes will be
effectively subordinated to all existing and future obligations of our
subsidiaries. We have the right to redeem all or a portion of these notes for
cash at any time or from time to time on at least 15 days but not more than 60
days prior written notice, at the redemption price specified in the governing
indenture plus accrued and unpaid interest to the date of redemption.

Zero Coupon Debentures. On June 7, 2005, we repurchased $460.0 million
accreted value, or $774.1 million in aggregate principal amount at maturity, of
our Zero Coupon Debentures at a purchase price of $594.25 per $1,000 principal
amount at maturity, which represents approximately 96% of our then outstanding
Zero Coupon Debentures. The holders of our remaining outstanding Zero Coupon
Debentures have the right to require us to repurchase the Zero Coupon Debentures
on June 6, 2010 and June 6, 2015 at the accreted value through the date of
repurchase. We may pay such repurchase price with either cash or shares of our
common stock or a combination of cash and shares of common stock.

As of September 30, 2005, the aggregate accreted value of our Zero Coupon
Debentures then outstanding of $18.6 million is classified as long-term debt in
our Consolidated Balance Sheets. The aggregate principal amount at maturity will
be $30.9 million assuming no additional conversions or redemptions occur prior
to the maturity date.

Dividends.

In October 2005, we declared a cash dividend of $0.125 per share of our
common stock payable on December 1, 2005 to stockholders of record on November
1, 2005.

Our Board of Directors has stated that it will consider declaring a special
cash dividend in the first quarter of 2006. The amount of the special cash
dividend, if any, will be determined by our Board. Any future determination as
to the payment of dividends will be made at the discretion of our Board of
Directors and will depend upon our operating results, financial condition,
capital requirements, general business conditions and such other factors that
our Board of Directors deems relevant.

Letters of Credit.

We are contingently liable as of September 30, 2005 in the amount of $48.0
million under certain performance, bid, supersedeas and custom bonds and letters
of credit. Agreements related to approximately $34.0 million of multi-year
performance bonds can require cash collateral for the full line at any time for
any reason. Holders of agreements related to another $0.5 million currently have
the option to require cash collateral due to the lowering of our credit rating
in 2004. As of September 30, 2005 we have not been required to make any cash
collateral deposits with respect to these agreements. The remaining agreements
cannot require cash collateral except in events of default. On our behalf, banks
have issued letters of credit securing certain of these bonds.

Capital Expenditures.

In the second quarter of 2005, we entered into agreements with Keppel FELS
Limited to construct two high-performance, premium jack-up rigs. The two new
drilling units, the Ocean Scepter and the Ocean Shield, will be constructed in
Brownsville, Texas and in Singapore, respectively, at an aggregate expected cost
of approximately $300 million. We paid shipyard deposits totaling $56.8 million
in the second quarter of 2005 related to the new construction. We expect
delivery of both units in the first quarter of 2008.

In May 2005, we began a major upgrade of the Ocean Endeavor for
ultra-deepwater service. The modernized rig is being designed to operate in up
to 10,000 feet of water at an estimated upgrade cost of approximately $250
million, of which approximately $25.9 million had been spent as of September 30,
2005 and an additional $78 million is anticipated to be spent in the remainder
of 2005. We estimate that the project is approximately 19% complete and delivery
of the upgraded rig is expected in mid-2007.

We estimate that capital expenditures in 2005 associated with our ongoing
rig equipment replacement and enhancement programs and other corporate
requirements will be approximately $122 million. As of September 30, 2005, we
had spent approximately $81 million for capital additions, excluding upgrade
costs for the Ocean Endeavor, construction of the two new jack-up rigs and the
reactivation of the Ocean New Era. See " - Reactivation Costs."

In August 2005, we concluded the purchase the Garden Banks, a Victory-class
semisubmersible drilling rig, and related equipment for $20.0 million.

We expect to finance the balance of our 2005 capital expenditures through
the use of existing cash balances or internally generated funds.

Reactivation Costs.

In the third quarter of 2005, we began the process of reactivating our
cold-stacked rig, the Ocean New Era. We expect the reactivation of this rig to
be completed in the fourth quarter of 2005 and to cost approximately $15.4
million, of which approximately $5.1 will be expensed in the second half of 2005
as contract drilling expense and $10.3 million will be capitalized and amortized
to expense over the estimated life of the rig. As of September 30, 2005, we had
spent $6.2 million on the reactivation project.

Off-Balance Sheet Arrangements.

At September 30, 2005 and December 31, 2004, we had no off-balance sheet
debt or other arrangements.

HISTORICAL CASH FLOWS

The following is a discussion of our historical cash flows from operating,
investing and financing activities for the nine months ended September 30, 2005
compared to the same period in 2004.

Net Cash Provided by Operating Activities.

NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
2005 2004 CHANGE
-------- -------- ---------
(IN THOUSANDS)

Net income (loss) ................................. $153,439 $(18,526) $ 171,965
Net changes in operating assets and liabilities ... (98,805) 6,209 (105,014)
Casualty gain on Ocean Warwick .................... (33,605) -- (33,605)
Loss (gain) on sale of marketable securities ...... 1,209 (231) 1,440
Depreciation and other non-cash items, net ........ 192,288 145,006 47,282
-------- -------- ---------
$214,526 $132,458 $ 82,068
======== ======== =========

Cash flow from our operations in the first nine months of 2005 increased
$82.1 million or 62%, as compared to the same period in 2004. The increase in
cash flow from our operations in the first nine months of 2005 is the result of
higher utilization and higher average dayrates earned by our offshore drilling
units as a result of an increase in overall demand for our offshore contract
drilling services, as compared to the same period of 2004. Depreciation and
other non-cash adjustments to net income increased $47.3 million, primarily due
to $54.1 million in deferred income tax expense recognized during the nine
months ended September 30, 2005. These favorable trends were negatively impacted
by an increase in cash required to satisfy our working capital requirements,
including a temporary increase in our trade receivables, which will generate
cash as the billing cycle is completed, and $11.9 million in additional
insurance receivables related to hurricane damage in 2005. See " - Overview
-Impact of 2005 Hurricanes."

Net Cash Provided by (Used in) Investing Activities.

NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
2005 2004 CHANGE
----------- ----------- -----------
(IN THOUSANDS)

Purchase of marketable securities ........................ $(4,511,361) $(2,913,971) $(1,597,390)
Proceeds from sales and maturities of
marketable securities ................................. 4,863,752 2,773,630 2,090,122
Capital expenditures ..................................... (187,066) (69,719) (117,347)
Insurance proceeds from casualty loss of Ocean Warwick ... 44,088 -- 44,088
Proceeds from sale of assets ............................. 19,551 1,521 18,030
Proceeds from maturities of Australian dollar
time deposits ......................................... 11,761 19,846 (8,085)
Purchase of Australian dollar time deposits .............. -- (42,073) 42,073
Proceeds from settlement of forward contracts ............ 939 -- 939
----------- ----------- -----------
$ 241,664 $ (230,766) $ 472,430
=========== =========== ===========

Our investing activities generated $241.7 million in the nine months ended
September 30, 2005, compared to a usage of $230.8 million in the same period in
2004. In the first nine months of 2005, we sold marketable securities, net of
purchases, of $352.4 million compared to net purchases of $140.3 million during
the same period of 2004. This increase in net sales activity is primarily the
result of increased cash requirements in 2005 to partially fund the repurchase
of $460.0 million accreted value of our Zero Coupon Debentures in June 2005 and
capital additions. Our investment portfolio at September 30, 2005 also included
$300.0 million in marketable securities purchased under repurchase agreements.

In the first nine months of 2005, we spent $84.4 million on projects
associated with our ongoing rig equipment replacement and enhancement programs,
the reactivation of the Ocean New Era and other corporate requirements. Also
during the nine months ended September 30, 2005, we spent an additional $82.7
million in connection with the Ocean Endeavor upgrade and the Ocean Scepter and
Ocean Shield construction projects and $20.0 million for the purchase of the
Garden Banks and its related equipment. In the same period in 2004, we spent
$56.3 million on

various projects in connection with our ongoing replacement and enhancement
programs and other corporate requirements and an additional $13.4 million to
complete a two-year enhancement program for six of our jack-up rigs and an
upgrade of the Ocean America. In June 2005, we sold one of our cold-stacked
semisubmersible rigs, the Ocean Liberator, for net cash proceeds of $13.6
million. Proceeds from the sale of miscellaneous assets in the first nine months
of 2004 were not significant.

During September 2005, we collected $44.1 million in insurance proceeds
related to the loss of the Ocean Warwick. We received the remaining $6.4 million
owed to us by insurers in connection with this claim in October 2005.

In the second quarter of 2004, based on the expectation that higher
interest rates could be achieved by investing in Australian dollar-based
securities, we invested $42.1 million in Australian dollar time deposits
(equivalent of 60 million Australian dollars) with expirations ranging from May
2004 to March 2005. $11.8 million and $19.8 million of these investments matured
in the nine months ended September 30, 2005 and 2004, respectively. From time to
time, we may utilize forward exchange contracts to hedge our exposure to changes
in exchange rates between U.S. dollars and the local currencies of the countries
in which we operate. During the first nine months of 2005, we entered into
various foreign currency forward exchange contracts which resulted in net
realized gains totaling $0.9 million.

As of September 30, 2005, we had foreign currency forward exchange
contracts outstanding requiring us to purchase the equivalent of $3.0 million in
Mexican pesos in October and November 2005, the equivalent of $3.0 million in
Australian dollars in October 2005 and the equivalent of $7.0 million in British
pounds sterling in November 2005. Subsequent to September 30, 2005, we entered
into additional contracts to purchase the equivalent of $3.8 million in
Australian dollars in November 2005 and the equivalent of $7.0 million in
British pounds sterling in December 2005 based on our estimated foreign currency
cash requirements through the remainder of 2005.

Net Cash (Used in) Provided by Financing Activities.

NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
2005 2004 CHANGE
--------- -------- ---------
(IN THOUSANDS)

Proceeds from issuance of senior notes ... $ 249,462 $249,397 $ 65
Payment of debt issuance costs ........... (1,866) (1,565) (301)
Redemption of Zero Coupon Debentures ..... (460,015) -- (460,015)
Payment of dividends ..................... (32,159) (24,249) (7,910)
Acquisition of treasury stock ............ -- (18,077) 18,077
Proceeds from stock options exercised .... 9,565 -- 9,565
--------- -------- ---------
$(235,013) $205,506 $(440,519)
========= ======== =========

In June 2005 and August 2004, we issued $250.0 million principal amount of
our 4.875% Senior Notes and our 5.15% Senior Notes, respectively, for net cash
proceeds of $247.6 million and $247.8 million, respectively. We repurchased
$460.0 million accreted value, or approximately 96%, of our then outstanding
Zero Coupon Debentures for cash in June 2005.

During the nine months ended September 30, 2005, we received $9.6 million
in proceeds from the exercise of stock options to purchase shares of our common
stock. There were no stock option exercises during the nine months ended
September 30, 2004.

We paid dividends of $32.2 million during the first nine months of 2005,
compared to $24.2 million in the first nine months of 2004. Our dividend payment
on September 1, 2005 reflected a $0.0625 per share increase over dividends paid
in previous quarters in 2004 and 2005.

Depending on market conditions, we may, from time to time, purchase shares
of our common stock or issue put options in the open market or otherwise. During
the nine months ended September 30, 2004, we purchased 782,200 shares of our
outstanding common stock at an aggregate cost of $18.1 million, or at an average
cost of $23.11 per share. We did not repurchase any shares of our outstanding
common stock or issue any put options during the nine months ended September 30,
2005.

OTHER

Currency Risk. Certain of our subsidiaries use the local currency in the
country where they conduct operations as their functional currency. Currency
environments in which we have material business operations include Mexico,
Brazil, the U.K., Australia, Indonesia and Malaysia. When possible, we attempt
to minimize our currency exchange risk by seeking international contracts
payable in local currency in amounts equal to our estimated operating costs
payable in local currency with the balance of the contract payable in U.S.
dollars. At present, however, only a limited number of our contracts are payable
both in U.S. dollars and the local currency.

Currency translation adjustments are generally accumulated in a separate
section of stockholders' equity. If we were to cease our operations in a
currency environment, the accumulated adjustments would be recognized currently
in our results of operations. The effect on our results of operations from these
translation gains and losses has not been material and we do not expect them to
have a significant effect in the future.

RECENT ACCOUNTING PRONOUNCEMENTS

In June 2005 the Financial Accounting Standards Board, or FASB, issued SFAS
No. 154, "Accounting Changes and Error Corrections," or SFAS 154, a replacement
of Accounting Principles Board Opinion No. 20 and SFAS No. 3. SFAS 154 provides
guidance on the accounting for and reporting of accounting changes and error
corrections and is effective for accounting changes and corrections of errors
made in fiscal years beginning after December 15, 2005. We do not expect
adoption of SFAS 154 to have a material impact on our consolidated results of
operations, financial position or cash flows.

In December 2004 the FASB revised SFAS No. 123, "Accounting for Stock-Based
Compensation," or SFAS 123 (R). This statement supersedes Accounting Principles
Board Opinion No. 25 and its related implementation guidance. This statement
requires that the compensation cost relating to share-based payment transactions
be recognized in financial statements. That cost will be measured based on the
fair value of the equity or liability instruments issued. SFAS 123 (R) was
originally effective as of the first interim or annual reporting period
beginning after June 15, 2005. In April 2005, however, the Securities and
Exchange Commission adopted a rule that defers the required effective date of
SFAS 123 (R) for registrants such as us until the beginning of the first fiscal
year beginning after June 15, 2005. This statement applies to all awards granted
after the required effective date and to awards modified, repurchased or
cancelled after that date, as well as the unvested portion of awards granted
prior to the effective date of SFAS 123(R). We do not expect our adoption of
SFAS 123 (R) to have a material impact on our consolidated results of
operations, financial position or cash flows.

FORWARD-LOOKING STATEMENTS

We or our representatives may, from time to time, make or incorporate by
reference certain written or oral statements that are "forward-looking
statements" within the meaning of Section 27A of the Securities Act of 1933, as
amended, or the Securities Act, and Section 21E of the Securities Exchange Act
of 1934, as amended, or the Exchange Act. All statements other than statements
of historical fact are, or may be deemed to be, forward-looking statements.
Forward-looking statements include, without limitation, any statement that may
project, indicate or imply future results, events, performance or achievements,
and may contain or be identified by the words "expect," "intend," "plan,"
"predict," "anticipate," "estimate," "believe," "should," "could," "may,"
"might," "will," "will be," "will continue," "will likely result," "project,"
"forecast," "budget" and similar expressions. Statements made by us in this
report that contain forward-looking statements include, but are not limited to,
information concerning our possible or assumed future results of operations and
statements about the following subjects:

- future market conditions and the effect of such conditions on our
future results of operations (see "- Overview - Industry Conditions");

- future uses of and requirements for financial resources (see "-
Liquidity and Capital Requirements" and "- Sources of Liquidity and
Capital Resources");

- interest rate and foreign exchange risk (see "Quantitative and
Qualitative Disclosures About Market Risk");

- future contractual obligations (see "--Overview--Industry Conditions"
and "- Liquidity and Capital Requirements");

- future operations outside the United States including, without
limitation, our operations in Mexico (see "--Overview--Industry
Conditions");

- future effect on operating results of 2005 hurricanes (see
"--Overview--Impact of 2005 Hurricanes");

- business strategy;

- growth opportunities;

- competitive position;

- expected financial position;

- future cash flows;

- future quarterly or special dividends;

- financing plans;

- tax planning (See "--Overview--Critical Accounting Estimates--Income
Taxes," "--Three Months Ended September 30, 2005 and 2004" and "--Nine
Months Ended September 30, 2005 and 2004");

- budgets for capital and other expenditures (see "- Liquidity and
Capital Requirements");

- timing and cost of completion of rig upgrades and other capital
projects (see "- Liquidity and Capital Requirements");

- delivery dates and drilling contracts related to rig conversion and
upgrade projects (see "--Liquidity and Capital Requirements");

- plans and objectives of management;

- performance of contracts (see "--Overview--Industry Conditions");

- outcomes of legal proceedings;

- compliance with applicable laws; and

- adequacy of insurance or indemnification.

These types of statements inherently are subject to a variety of risks and
uncertainties that could cause actual results to differ materially from those
expected, projected or expressed in forward-looking statements. These risks and
uncertainties include, among others, the following:

- general economic and business conditions;

- worldwide demand for oil and natural gas;

- changes in foreign and domestic oil and gas exploration, development
and production activity;

- oil and natural gas price fluctuations and related market
expectations;

- the ability of the Organization of Petroleum Exporting Countries,
commonly called OPEC, to set and maintain production levels and
pricing, and the level of production in non-OPEC countries;

- policies of the various governments regarding exploration and
development of oil and gas reserves;

- advances in exploration and development technology;

- the political environment of oil-producing regions;

- casualty losses;

- operating hazards inherent in drilling for oil and gas offshore;

- industry fleet capacity;

- market conditions in the offshore contract drilling industry,
including dayrates and utilization levels;

- competition;

- changes in foreign, political, social and economic conditions;

- risks of international operations, compliance with foreign laws and
taxation policies and expropriation or nationalization of equipment
and assets;

- risks of potential contractual liabilities pursuant to our various
drilling contracts in effect from time to time;

- foreign exchange and currency fluctuations and regulations, and the
inability to repatriate income or capital;

- risks of war, military operations, other armed hostilities, terrorist
acts and embargoes;

- changes in offshore drilling technology, which could require
significant capital expenditures in order to maintain competitiveness;

- regulatory initiatives and compliance with governmental regulations;

- compliance with environmental laws and regulations;

- customer preferences;

- effects of litigation;

- cost, availability and adequacy of insurance;

- adequacy of our sources of liquidity;

- the availability of qualified personnel to operate and service our
drilling rigs; and

- various other matters, many of which are beyond our control.

The risks included here are not exhaustive. Other sections of this report
and our other filings with the Securities and Exchange Commission include
additional factors that could adversely affect our business, results of
operations and financial performance. Given these risks and uncertainties,
investors should not place undue reliance on forward-looking statements.
Forward-looking statements included in this report speak only as of the date of
this report. We expressly disclaim any obligation or undertaking to release
publicly any updates or revisions to any forward-looking statement to reflect
any change in our expectations with regard to the statement or any change in
events, conditions or circumstances on which any forward-looking statement is
based.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

The information included in this Item 3 is considered to constitute
"forward-looking statements" for purposes of the statutory safe harbor provided
in Section 27A of the Securities Act and Section 21E of the Exchange Act. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Forward-Looking Statements" in Item 2 of Part I of this report.

Our measure of market risk exposure represents an estimate of the change in
fair value of our financial instruments. Market risk exposure is presented for
each class of financial instrument held by us at September 30, 2005 and December
31, 2004 assuming immediate adverse market movements of the magnitude described
below. We believe that the various rates of adverse market movements represent a
measure of exposure to loss under hypothetically assumed adverse conditions. The
estimated market risk exposure represents the hypothetical loss to future
earnings and does not represent the maximum possible loss or any expected actual
loss, even under adverse conditions, because actual adverse fluctuations would
likely differ. In addition, since our investment portfolio is subject to change
based on our portfolio management strategy as well as in response to changes in
the market, these estimates are not necessarily indicative of the actual results
which may occur.

Exposure to market risk is managed and monitored by senior management.
Senior management approves the overall investment strategy that we employ and
has responsibility to ensure that the investment positions are consistent with
that strategy and the level of risk acceptable to us. We may manage risk by
buying or selling instruments or entering into offsetting positions.

Interest Rate Risk

We have exposure to interest rate risks arising from changes in the level
or volatility of interest rates. Our investments in marketable securities are
primarily in fixed maturity securities. We monitor our sensitivity to interest
rate risk by evaluating the change in the value of our financial assets and
liabilities due to fluctuations in interest rates. The evaluation is performed
by applying an instantaneous change in interest rates by varying magnitudes on a
static balance sheet to determine the effect such a change in rates would have
on the recorded market value of our investments and the resulting effect on
stockholders' equity. The analysis presents the sensitivity of the market value
of our financial instruments to selected changes in market rates and prices
which we believe are reasonably possible over a one-year period.

The sensitivity analysis estimates the change in the market value of our
interest sensitive assets and liabilities that were held on September 30, 2005
and December 31, 2004, due to instantaneous parallel shifts in the yield curve
of 100 basis points, with all other variables held constant.

The interest rates on certain types of assets and liabilities may fluctuate
in advance of changes in market interest rates, while interest rates on other
types may lag behind changes in market rates. Accordingly the analysis may not
be indicative of, is not intended to provide, and does not provide a precise
forecast of the effect of changes of market interest rates on our earnings or
stockholders' equity. Further, the computations do not contemplate any actions
we could undertake in response to changes in interest rates.

Our long-term debt as of September 30, 2005 and December 31, 2004 is
denominated in U.S. dollars. Our debt has been primarily issued at fixed rates,
and as such, interest expense would not be impacted by interest rate shifts. The
impact of a 100-basis point increase in interest rates on fixed rate debt would
result in a decrease in market value of $134.8 million and $149.2 million,
respectively. A 100 basis point decrease would result in an increase in market
value of $165.4 million and $184.4 million, respectively.

Foreign Exchange Risk

Foreign exchange risk arises from the possibility that changes in foreign
currency exchange rates will impact the value of financial instruments. During
2004, we invested in Australian dollar time deposits and at December 31, 2004,
15.0 million Australian dollars (equivalent to $11.6 million) of time deposits
were included in "Investments and marketable securities" in our Consolidated
Balance Sheets at December 31, 2004. These time deposits matured during the
first quarter of 2005.

During the nine months ended September 30, 2005, we entered into various
forward exchange contracts requiring us to purchase predetermined amounts of
foreign currencies at predetermined dates. As of September 30, 2005, we had
foreign currency forward exchange contracts outstanding requiring us to purchase
the equivalent of

$3.0 million in Mexican pesos in October and November 2005, the equivalent of
$3.0 million in Australian dollars in October 2005 and the equivalent of $7.0
million in British pounds sterling in November 2005. Subsequent to September 30,
2005, we entered into additional contracts to purchase the equivalent of $3.8
million in Australian dollars in November 2005 and the equivalent of $7.0
million in British pounds sterling in December 2005 based on our estimated
foreign currency cash requirements through the remainder of 2005. These forward
exchange contracts were included in "Other assets" in our Consolidated Balance
Sheets at September 30, 2005 at fair value in accordance with SFAS No. 133,
"Accounting for Derivatives and Hedging Activities."

The sensitivity analysis below assumes an instantaneous 20% change in
foreign currency exchange rates versus the U.S. dollar from their levels at
September 30, 2005 and December 31, 2004.

The following table presents our market risk by category (interest rates
and foreign currency exchange rates):

FAIR VALUE ASSET (LIABILITY) MARKET RISK
---------------------------- ----------------------------
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30, DECEMBER 31,
CATEGORY OF RISK EXPOSURE: 2005 2004 2005 2004
------------------------------------- ------------- ------------ ------------- ------------
(IN THOUSANDS)

Interest rate:
Marketable securities ............ $ 2,414(a) $ 650,247(a) $ 200(c) $2,100(c)
Long-term debt ................... 1,036,548(b) (1,213,820)(b) -- --
Foreign Exchange:
Australian dollar time deposits .. -- 11,602(d) -- 2,300(d)
Forward exchange contracts ....... 130(d) -- 2,900(d) --

(a) The fair market value of our investment in marketable securities, excluding
repurchase agreements, is based on the quoted closing market prices on
September 30, 2005 and December 31, 2004.

(b) The fair values of our 4.875% Senior Notes, 5.15% Senior Notes, 1.5%
convertible senior debentures due 2031 and Zero Coupon Debentures are based
on the quoted closing market prices on September 30, 2005 and December 31,
2004. The fair value of our Ocean Alliance lease-leaseback agreement is
based on the present value of estimated future cash flows using a discount
rate of 5.16% for September 30, 2005 and 4.27% for December 31, 2004.

(c) The calculation of estimated market risk exposure is based on assumed
adverse changes in the underlying reference price or index of an increase
in interest rates of 100 basis points at September 30, 2005 and December
31, 2004.

(d) The calculation of estimated foreign exchange risk is based on assumed
adverse changes in the underlying reference price or index of an increase
in foreign exchange rates of 20% at September 30, 2005 and a decrease in
foreign exchange rates of 20% at December 31, 2004.

ITEM 4. CONTROLS AND PROCEDURES.

Our Chief Executive Officer, or CEO, and Chief Financial Officer, or CFO,
participated in an evaluation by our management of the effectiveness of our
disclosure controls and procedures as of the end of our last fiscal quarter that
ended on September 30, 2005. Based on their participation in that evaluation,
our CEO and CFO concluded that our disclosure controls and procedures were
effective as of September 30, 2005 to ensure that required information is
disclosed on a timely basis in our reports filed or furnished under the Exchange
Act.

There was no change in our internal control over financial reporting that
occurred during the third fiscal quarter of 2005 that has materially affected,
or is reasonably likely to materially affect, our internal control over
financial reporting.

PART II. OTHER INFORMATION

ITEM 6. EXHIBITS.

See the Exhibit Index for a list of those exhibits filed or furnished
herewith.

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 28-October-2005 By: \s\ Gary T. Krenek
------------------------------------
Gary T. Krenek
Vice President and
Chief Financial Officer

Date 28-October-2005 \s\ Beth G. Gordon
------------------------------------
Beth G. Gordon
Controller (Chief Accounting Officer)

EXHIBIT INDEX

Exhibit No. Description
----------- -----------

3.1 Amended and Restated Certificate of Incorporation of the Company
(incorporated by reference to Exhibit 3.1 to the Company's
Quarterly Report on Form 10-Q for the quarterly period ended June
30, 2003).

3.2 Amended and Restated By-laws of the Company (incorporated by
reference to Exhibit 3.2 to the Company's Quarterly Report on Form
10-Q for the quarterly period ended March 31, 2001).

31.1* Rule 13a-14(a) Certification of the Chief Executive Officer.

31.2* Rule 13a-14(a) Certification of the Chief Financial Officer.

32.1* Section 1350 Certification of the Chief Executive Officer and
Chief Financial Officer.

* Filed or furnished herewith.