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Diamond Offshore Drilling (NYSE:DO)

Q4 2007 Earnings Call

February 7, 2008 10:00 am ET

Executives

Les Van Dyke, Director, Investor Relations

Lawrence R. Dickerson, President and Chief Operating Officer

Gary T. Krenek, Senior Vice President and Chief Financial Officer

John L. Gabriel, Senior Vice President, Contracts and Marketing

Analysts

Ian Macpherson - Simmons & Company

Rob MacKenzie - FBR

Collin Gerry - Raymond James

Jeff Tillery - Tudor Pickering

David Smith - JPMorgan

Robin Shoemaker - Bear Stearns

Geoff Kieburtz – Citi

Alan Laws - Merrill Lynch

Operator

At this time, I would like to welcome everyone to Diamond Offshore Drilling Fourth Quarter 2007 Results Conference Call. (Operator Instructions)

It is now my pleasure to turn the floor over to your host, Mr. Les Van Dyke.

Les Van Dyke

Good morning. Thank you for joining us. With me on the call today are Larry Dickerson, President and Chief Operating Officer; Gary Krenek, Senior Vice President and Chief Financial Officer; and John Gabriel, Senior Vice President of Contracts and Marketing.

Before Larry begins his remarks, I should remind you that statements made during this conference call may constitute forward-looking statements that are inherently subject to a variety of risks and uncertainties that could cause actual results to differ materially from those projected.

Forward-looking statements include, but are not limited to discussions about future revenues and earnings, capital expenditures, industry conditions and competition, dates that drilling rigs will enter service, as well as management’s plans and objectives for the future.

A discussion of the risk factors that could impact these areas and the company’s overall business and financial performance can be found in the company’s reports filed with the Securities and Exchange Commission.

Given these concerns, investors and analysts should not place undue reliance on forward-looking statements. The company expressly disclaims any obligation to release publicly any updates to any forward-looking statements to reflect any change in the company’s expectations or any changes in advanced conditions or circumstances on which any forward-looking statement is based.

With that, I will turn the meeting over to Larry.

Lawrence R. Dickerson

Thank you, Les. I’m going to make some comments this morning. First, I’ll talk about the year that just passed and talk a little bit about the state of the market as we go into the year 2008. I’m going to comment next on our tax charge that occurred in the quarter. And then I’ll get into the fourth quarter and what were the factors that were impacting the results that we had for that period of time.

And I’ll turn it over to Gary Krenek, who will give you some guidance on costs going forward into 2008. John Gabriel, our head of Marketing will be here, won’t make an opening statement but will respond to your questions about the markets.

First of all, as we complete 2007, we are very pleased with the $11 billion of backlog that we achieved in the company. The latest big addition to that occurred in December, when we signed several contracts in Brazil stretching on into 2014 roughly.

Although, we’ve seen oil prices declined a bit from flirting with $100 a barrel to right around $90 a barrel, we still see a very strong market. Our customers are just as excited at this $90 level, as they were when we first hit $90 on the way up.

Particularly in floater markets, very, very strong interest. We’re still in discussions all the time about availability of some of our rigs. We do have some rigs that will be available at the end of 2008 and those are drawing keen interest from just about every market in which we operate in.

Although, we’re primarily a floater company, we do have enough jack-ups to have some important data points. And as I think everybody knows, there has been a modest recovery or stabilization of the jack-up market in the US Gulf.

In the fourth quarter, we had very low utilization in a number of idle units. All of those rigs are now back to work. We’re not looking at situations where our rigs are working or they’re coming down next week or two weeks before which was the case in the fourth quarter.

We’ve seen that rate stabilize and in some cases, begin to move up. And I think this is due to a number of factors but the number one thing would be to look at the active number of jack-up rigs that are available in the Gulf of Mexico versus where they were even a year ago.

There’s been a substantial reduction and I think as we get out of hurricane season and got into fourth quarter and are now looking at 2008 budget money, we’re seeing some pretty strong interest in the Gulf of Mexico jack-up market. We’ll need some more data points before we can begin to say what the overall impact will be in 2008, but certainly that looks positive today. So that looks terrific.

Talking about our construction program, the Ocean Monarch, which is our fifth generation upgrade to the Ocean Victory. And a sister unit to the Ocean Endeavor, which was delivered this year, is scheduled to be out and still remains on track to be available in the fourth quarter. We will not begin earning revenue until 2009 after we mobilize it from Singapore to the U.S. Gulf of Mexico.

Our two jack-up rigs that we have, there’s been some slippage in both the Brownsville shipyard and in Singapore and we think we’re seeing this across the board in virtually all rigs in those areas. But they’re still within tolerance and not at a level that is going to materially impact our budgeted costs.

So we’ve got both of those rigs that are available to come on to the payroll right at the end of May now. The one in Singapore will mobilize out of Singapore and head down to Australia. It goes on the payroll when the mobilization begins and we’re still comfortable on that revised schedule.

The one in Brownsville, we do not have a job for at this point in time, although we continue to bid it in the international market. So if we do secure a job in an international market although it will be available in May, there will obviously be a mobilization period.

But at this time, although we continue to bid that there is an increasing likelihood that we may work in the U.S. Gulf of Mexico for at least a couple of wells. And really, when you look at the number of new construction jack-ups and how few of them are actually headed into the U.S. Gulf, we’re not displeased with that particular use of that rig.

Now let me move on to the tax charge, which was obviously very large in the quarter. And what happened was that during the fourth quarter, the company made a one-time distribution of $850 million from a foreign subsidiary to its U.S. parent. And this transaction provides Diamond with unrestricted access to capital, which otherwise may have been limited as to use. And there was a unique pattern that made this the most advantageous point of time to affix this transaction.

The distribution was made at a very low incremental U.S. tax cost, which was less than 7% of the amount distributed. So accordingly, a one-time charge to tax expense of $59 million, which works out to $0.42 cents per share was incurred in the fourth quarter.

Talking about the overall impact of the fourth quarter and I think when you adjust for that, we were still down sequentially from the quarter previously. And down on maybe, some of the guidance had been and this remains very much a top line driven business, so the number one impact on us was greater than anticipated downtime in the fourth quarter. And I’ll go through those in particular, in order of the number of days that cost us.

We had 36 days over and above the normal type of downtime that we project on a particular big rig operating in the U.S. Gulf of Mexico and this was some equipment issues. We had a stack full and we had some other things that went wrong. We were very disappointed in this as was our customers. We’ve been working very diligently to try to anticipate these types of problems and make sure that they don’t carry forward in 2008 but it is a risk of the business.

And then the next biggest item, we had 32 days of delays in acceptance testing of rigs that have relocated to international markets. And this is not any particular market but a variety of markets. That we get to that market and we find either customer acceptance testing takes longer than we had projected, or that there’s regulatory issues in the locale. Where regulatory authorities delay getting to the rig and then find things that they don’t believe are acceptable that we have to remedy.

And we go through an intense program to make sure that our rigs are ready. And in most cases, rigs that are going international are down for modifications. And we anticipate that in evaluating the overall job, but this has been beyond what we would have normally experienced. And we don’t think that’s good for either us, or the customer, but it is a fact of life. So we had those 32 days delay.

And then the third big item, 23 days, so that the combined total of days that we’re talking about here is 91 days, occurred on the Ocean Patriot. And this is probably a new issue for us. We were completing drilling in New Zealand. We drilled for a number of customers there, had a job back in Australia.

Our intention in our design was to be fully on the contract during the mobilization and during our time in New Zealand. However, we found when we were getting ready to leave that an invasive species, an Asian green-lipped mussel, had attached itself to the hull of the rig.

This is a mussel that was brought in for food raising purposes from Asia into New Zealand. New Zealand is pleased with this particular mussel but the government in Victoria and I assume other states in Eastern Australia did not want this in place, and we had to remove this.

And occurring at almost the last moment, we incurred costs to mobilize divers and blasters and prepare for that. And that’s about $5 million of our overall cost overrun for the quarter. But the bigger impact was the 23 days of missed contract time as we removed these mussels from the lower hulls. That rig is now in Australia. We completed that effort and we’re doing a special survey right now. And then we will go to work on our existing contracts. So, that was the biggest item.

On the cost side, really, if you look at, I think we’ve guided towards operating expenses being similar to what we had in Q3. And if you look at that, there was the mussel cost that we had. And then we had some additional costs, on the rig that we had equipment problems on, throughout the fleet of about $6 million. That’s $11 million, which is more than the $9 million increase in drilling expense that were obviously the offsets across the board going both ways. But those were the biggest single items.

In the G&A area, our costs were increased due to retention programs that we had put in place. And in addition to that, the number of rigs that we had in shipyards, we did 12 in the past year. And they’re planned throughout the year, but of course, we don’t really control that whenever wells come to an end and shipyard space is available.

It turned out that we had a lot going simultaneously all in the U.S. Gulf of Mexico. So we had to hire greater than budgeted amount outside consulting engineers to try to expedite and make sure that we could cover all that work and not have further delays. So, that was money well spent but that’s an additional cost. So, that’s pretty much what drove the results during Q4.

Gary is going to give you some guidance for overall 2008. 2008 is another year where we have a large number of rigs scheduled to be in shipyards. So we’ve got that exposed to us. We continue to have rigs that are scheduled to relocate to international markets.

So we’re continuing to be exposed to acceptance, testing delays, although again we’re working that very difficult. I do not believe that we are exposed to mussel issues, and certainly, we will work in the future to make sure that we’re contractually protected for invasive species. But we have many contracts that are in place that don’t particularly address that.

Before, I let Gary talk in detail about where 2008 will be, I think in general I’m going to make some comments on what the overall cost trend is. Our belief is that industry inflation will run about 10%. It’s about what we’ve seen this year.

And that’s sort of at the low end of guidance that we’ve said that we may run as much between 10% and 15%. If you listen into the NOV conference call, I think they’ll more than likely give you all the support that you would need for a lot of the stuff that we buy and how that’s increased.

And then the other component is certainly labor, cost increases in labor. And all we can do is guess on what the trend has been in 2008, 2009 if, as more rigs are delivered, particularly on the floaters side, there is a greater competition for personnel, and that number could be higher.

But in addition to that 10% core inflation rate in the oil field, we’ll see about another 9% roughly of costs that increase year-over-year. And these are costs though that are matched by higher revenues. And then the two factors are more rigs. We’ll have two new build jack-ups at midyear, which will add costs that we did not incur, that we’ve been capitalized in the shipyard in 2007. So that will be a component.

And then we’ll have the Endeavor operating for a full year where it arrived and incurred cost in 2007 for just about a half year. And then the other half of the non-core inflation component, about 4% is due to rigs working international versus domestic.

So, if we take a rig in Mexico to Brazil into the Middle East, any of these locales, our operating expenses are higher. But that should be compensated for either higher day rates or it’s a cost that we’re willing to take because of the extended horizon that we have with terms that match that.

So that concludes my opening remarks. And I’ll now let Gary Krenek talk for a while.

Gary T. Krenek

Thanks, Larry. Larry has already commented on some of the larger items that affected this past quarter such as the tax transaction, our rig operating cost, and G&A. So I would just like to fill in around some of the smaller items that also impacted this past quarter’s financial statements.

Looking at the other lines on the income statement, depreciation expense increased $6 million quarter-over-quarter. This was due to our normal year end accounting adjustment to depreciation. It reflects our policy of taking one half year of depreciation on all fixed assets acquired during the year and truing the number for depreciation up at year-end.

And one final item on Q4 is the tax rate for the quarter. Excluding the one-time tax transaction, our tax rate for the quarter was 24.5%. This is lower than the prior three quarters and also was due primarily to normal year end true ups. Still, it resulted in a total tax rate of 27.4% for the entire year of 2007, which was within our guidance of 27% to 29%.

Now looking forward to this year 2008, we’ve included on our rig status report that was published this morning we expect a number of down days by rig for 2008, along with expected daily operating costs by class of rig and by geographic location. Therefore, I’m not going to repeat that information here, but would refer you to that status report which can be found on our website.

One comment though, the rig operating costs are estimates for the entire year. As we continue to experience increasing costs in the industry, as Larry talked about, we would expect that actual daily cost be slightly lower than our published numbers in the first part of the year and slightly higher in the latter part of the year, averaging out to the amounts that we’ve listed on that rig status report.

All rigs that are scheduled for surveys during the year will incur their normal daily operating costs while undergoing their survey and will also incur additional costs for mobes, inspection related fees, deferred repairs, etc.

We expect an additional $5 million to be incurred by the jack-up Ocean Drake during its inspection period; $5 to $6 million each for the Bounty, General, Rover, Clipper, Guardian, and Victory; an additional $8 to $10 million each for the Valiant, Nomad, Princess, and Patriot. And finally an additional $11 to $13 million for the Ambassador as we will have to mobe it back to the US Gulf of Mexico from offshore Mexico for its survey.

The Ocean Yorktown, which will be continuing its life extension work in the shipyard for the first part of this year before heading to Brazil to begin its five-year contract with Petrobras, will only incur its normal second generation operating costs while in the shipyard, as much of its additional costs are being capitalized.

We also expect to incur $2 to $3 million each on each of the two new jack-ups, the Ocean Shield and Scepter, which will be expensed rather than capitalized prior to them beginning their initial contracts in midyear.

And one final note regarding 2008’s rig operating expense, we’ll incur approximately $5 million each quarter during 2008 for amortized mobe expense that had previously been deferred. This expense, however, will be offset by amortized mobe revenue, which has also been deferred. And if you do the math on all of this, it should result in anticipated rig operating costs from ‘07 to ‘08 of the 18% to 19% that Larry just talked about.

Looking at a few other cost areas for 2008, we expect depreciation expense to run $66 to $67 million in the first two quarters of the year and then go to $69 to $70 million in the final two quarters. The increase in the second half being attributable to our two new jack-ups that will be delivered midyear.

G&A expense is expected to run $15 to $16 million per quarter during 2008 and interest expense net of capitalized interest should be approximately $8 million for the entire year. You can assume that that $8 million will be spread equally through the four quarters of the year.

Our tax rate for 2008 is expected to be between 28% and 29%. As always, the actual rate will depend on the ultimate breakdown between US and international income and where that international income is earned.

And finally, capital expenditures for the coming year, we’re expecting our CapEx to be approximately $680 million in 2008 broken down as follows.

continuing work on the upgrade of the Monarch and completion of the two jack-ups, $180 million

required upgrades to rigs to comply with our Brazil contracts, $130 million

CapEx spent on our 12 rigs undergoing surveys as they do additional work while they’re in the shipyard, $160 million

additional spare equipment that we’re going to buy as part of our revenue preservation plan, $50 million

and then other just general maintenance CapEx, $160 million.

If you add all of that up, it should come to $680 million.

And with that, I’ll turn it back over to Larry.

Lawrence R. Dickerson

I think that covers just about everything. We did make an announcement also today on our special dividend, but I don’t know that I have anything additionally to say on that. So, we’ll open it up now for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is coming from Rob MacKenzie - FBR.

Rob MacKenzie - FBR

I guess my first question is where the conference call left off. And that’s to do with the special dividend. I know historically you all have tended to pay out most of your excess cash in special dividends and didn’t this quarter. I presume, was that related somewhat to the unexpected tax payment and could we perhaps see those special dividends rise going forward?

Lawrence R. Dickerson

All I can do is we fall back on our statement, which is that the Board will, at each quarter, consider a special dividend. And then it lists all the factors that we will include in there, earnings and cash flow position in company and the tax payment would have been one of those issues that would have computed into that.

But we don’t give guidance as to how that future is going to look. I think, though I would just have everybody look at the pattern that we’ve exhibited in the past. I think there’s probably some good clues there as to our thought process.

Rob MacKenzie - FBR

And a follow up to that, is this distribution of the foreign earnings, is that all you have kind of stranded overseas?

Gary T. Krenek

At this point, yes. We brought all the foreign earnings back in. So, that’s it as of December 31.

Rob MacKenzie - FBR

And then on the deepwater rig market, it appears that at least one of your competitors has been rather undisciplined in signing some long term contracts and some new bills that’s of fairly low day rates or returns on capital that seem suboptimal. How do you see that affecting the market for existing rigs, particularly yours?

Lawrence R. Dickerson

Well, I’ll let John talk about the way things have been. But I mean we’ve seen that where the new build market is pretty much puts a cap on what you can get for your existing fleet. And it has been right around $500,000. It moves up and down a little bit from there. So, it’s no surprise to us. John?

John Gabriel

Really, the only comment I would add to that is we just see this deepwater market globally as continuing in a very robust manner and I think that the real driver to that is going to be the response to the tenders that Petrobras has out right now in particular for their deepwater requirements. So, we don’t see any negative impact on the market at all.

Lawrence R. Dickerson

But we’ve known for some time that for whatever reason, we’re not participating in that little sector of the market so we’re not necessarily the best person to ask. But that new builds, except on very rare instances, for normal type equipment don’t really exceed $500,000 a day. And sometimes a little bit less depending upon market conditions or how bad somebody really wants to get a contract.

Operator

Thank you. Our next question is coming from Ian Macpherson - Simmons & Company.

Ian Macpherson - Simmons & Company

I see on the updated status sheet a pretty extensive upgrade plan for the Bounty next year and I was just wondering if you could elaborate on what that entails. And is that pursuant to a customer request or what’s behind the work and the downtime on that rig?

John Gabriel

Basically what we’re going to do in 2009 is to re-power the rig. So, I guess our plans right now are to take the rig up to Singapore and to put new engine generator sets and an SCR system on it. So, that’s basically what the plan is for the Bounty next year.

Lawrence R. Dickerson

And we will be doing a minor water depth upgrade, and we do have contract prospects, but the key driver is to just get the rig re-powered. The engines are worn out and the pollution levels that we are seeing from those units are not what we want to be on a go-forward basis.

Ian Macpherson - Simmons & Company

I guess my other question would be on the jack-ups side you have the Ocean Spur, looks like a short-term day rate in the mid $130s. And I’m just curious if that’s, sort of, where you see rates heading for that type of rig or if there’s something unique about that day rate? Seems a little bit lower than what we were expecting anyway.

John Gabriel

I don’t think it’s terribly inconsistent with a couple other short term fixtures in the Mediterranean. That market, in general, there’s work there and we anticipate the rig to stay busy, consistent with the market rates in the area. I guess that’s about $135,000 a day job. Those rigs, in general, depending on term are somewhere in the $130 to $150 range.

Ian Macpherson - Simmons & Company

As it relates to the new build, the Scepter, that isn’t committed yet, do you think that the market still supports multi-year contract opportunities at, call it $180 or so for that class of rig, or is that perhaps too optimistic at this stage?

John Gabriel

Well, I think it depends on the operating theater, but I would certainly say yes, the term opportunities are out there. We’ve got outstanding tenders for terms anywhere from one to three years, and depending on the area, yes, the $180,000 a day rate level is certainly achievable.

Lawrence R. Dickerson

Yes, and there’s clearly a difference between the Ocean Spur class of rig, which is now a 25-year-old rig with more limited capabilities than the new builds. The new build jack-ups are a whole different beast in terms of capability and that’s been reflected and continues to be reflected in a day rate premium over your more limited capable 300-footers.

Operator

Our next question is coming from Collin Gerry - Raymond James.

Collin Gerry - Raymond James

I wanted to follow up a little bit on the mid-water market in the Gulf of Mexico, specifically with the Saratoga and the Ambassador moving back there now; not a lot of capability in that region on those levels left. What’s demand like for the low mid-water range for those type of assets? Should we see them re-priced here in the Gulf?

John Gabriel

The demand for the rigs is pretty good. We’re not seeing the extended term in the Gulf of Mexico as we’re seeing internationally, but the demand is there and we’re looking at pricing these rigs consistent with the market for short term work in the Gulf of Mexico.

Collin Gerry - Raymond James

On the Ambassador specifically, you talked a little bit about that but is that rig moving back to the Gulf of Mexico permanently or are you in discussions with renewing it for the Mexican Gulf of Mexico market?

John Gabriel

When we finish the PEMEX contract, at this stage, we don’t have any indication from PEMEX that they are talking about long-term extension. We’ve actually got commitments and are in discussions with respect to further commitments on the rig once it gets back in here. So it looks like it’s going to be in the Gulf of Mexico up until the survey and probably for some period after the survey at least.

Collin Gerry - Raymond James

That actually brings up a good point as it relates to PEMEX. There seems to be some confusion as to how their tendering is going to spell out here especially on the jack-up side going into 2008. With your discussions there, could you just give us a little color of what you’re seeing out of PEMEX as we go through to 2008, particularly on the jack-up side, but also on the floater side?

John Gabriel

We attended a meeting down there back in January with all of the other contractors that are working there and I guess those that want to work there. And they put forth some general formal plans for 2008.

At this stage, there was no mention of incremental floater demand. I think it’s still fluid, but there was nothing formal in the presentation they made. They did focus on jack-ups. And I think the primary things we were able to digest from the presentation was that there may be a bit of a shift on their part towards fleet mix from jack-up wires towards the deeper water independent-leg cantilever rigs.

And that there is a thought process where they will be looking at picking up additional rigs, but under some new form of tender. We have not seen that form of tender. It has been suggested that it may contain a purchase right. But again we haven’t seen it. And I think we will reserve comment on where it might be headed until we see what the documents look like.

Collin Gerry - Raymond James

How do you think should it contain such a purchase right, how would that affect bidding activity? Would that make some of the contractors a little more gun-shy about going to Mexico?

Lawrence R. Dickerson

I don’t think we know.

John Gabriel

The devil’s in the details and we haven’t seen them yet. That’s about as simple as I can say it.

Operator

The next question is coming from Jeff Tillery - Tudor Pickering.

Jeff Tillery - Tudor Pickering

I wanted to ask a little bit around the operating cost guidance. You’ve got shipyard days ‘08 versus ‘07 coming down 35% to 40%. The base industry inflation I understand with increased costs, but what is a like shipyard stay cost in ‘08 versus ’07? It would imply that it costs quite a bit more and I’m just trying to understand some of the details around that.

Gary T. Krenek

The number of days in the shipyard does not necessarily drive the dollar cost of the survey. We’re going to spend extra money for the mobe. Regardless of how many days we’re in the shipyard, the mobe is exactly the same. The daily operating costs continue while we’re in the shipyard, so that’s going to be consistent. Whether we’re operating or in the shipyard, the costs overall are going to be the same.

So, the cost on the survey this year may be slightly higher, more driven from the fact that we have more international surveys to do. Most of our surveys in 2007 were domestic.

And the best guidance I can give you is what we supplied. Which is using normal daily operating costs that we’ve given you in the rig status report this morning and those additional costs that I laid out earlier in the conference call.

Jeff Tillery - Tudor Pickering

And you guys provided pretty detailed guidance on ‘09 shipyard stays. How large is the air bar around that? Because that would imply shipyard time comes down quite a bit in ‘09. I’m just trying to understand on the utilization side, is there a big air bar around that? Are you pretty comfortable with what you see today? These are the major shipyard stays?

Gary T. Krenek

We are comfortable with these are the rigs that will be in the shipyard in ‘09 for doing their surveys. The number of days that is an estimate on our part. We won’t know for certain a closer estimate of those days until we go through our budget at the end of this year.

But what we tried to do is look at what it normally takes us to do a shipyard in this day and age, which is longer than it had been previously due to a number of factors. Lay that out, and then for a rig such as the Bounty which we know already that we’re going to be doing additional work on, laying those days out also.

So, while they are estimates, we are at this point in time not expecting anything greatly in excess of what we’ve laid out in the rig status report.

Jeff Tillery - Tudor Pickering

And the last question is just on the CapEx. As you get past the rest of the new build costs, your ‘08 CapEx of 680 includes 180 of new builds. Is $400 to $500 million a reasonable range to expect go forward post new builds and that gives you some room for contract driven upgrades?

Lawrence R. Dickerson

That’s difficult to say because we haven’t really grappled with it. We would expect because we have fewer rigs in the shipyard, we don’t have the time available to install stuff on the rigs. So, we would expect it to come down but that’s offset by costs continuing to go up.

And we will have another year’s worth of data in front of us. And if we discover a tool or an enhancement or an upgrade that will provide us with additional uptime, limiting downtime, any kind of redundancy protection, or any of that kind of stuff, you can bet we will do that. Certainly at that point in time that we will go to shipyard.

So, there are a bunch of factors going back and forth, but the biggest single one will be a decline in shipyards. What did we have in ‘09, five rigs, six rigs?

Gary T. Krenek

Yes, five.

Lawrence R. Dickerson

Five. I expect netting out everything else that it will trend down. I just can’t tell you how far down it will go.

Operator

Our next question is coming from David Smith - JPMorgan.

David Smith - JPMorgan

If I could follow up on the PEMEX issue, you mentioned they might be looking to hydrate their jack-up fleet. I’m wondering if they gave any indication about the reasoning for that, whether it’s performance issues within that or safety concerns given the Usumacinta tragedy, maybe a combination of things.

John Gabriel

I don’t think they really went into a lot of detail as to why. I would suspect that just simple versatility in terms of watered up capability and deficiencies would be the driver.

Lawrence R. Dickerson

What we see in the Gulf of Mexico, it depends on the needs as people move into deeper water and this is all being driven by geological things within the jack-up realm and that the mass becomes less of a tool that you need for jack-ups, and if you’re working on the platforms or any of these other factors that we don’t always get privy to.

David Smith - JPMorgan

On your Brownsville new build, the Scepter, but that rig is pretty suitable for the deep shelf requirements. Is that correct?

Lawrence R. Dickerson

Yes.

John Gabriel

Yes.

David Smith - JPMorgan

Do you see much interest there for work in the Gulf? You mentioned it might work there initially.

John Gabriel

We have seen a little bit of interest. We’re in discussions, very early stages of discussions with a couple of customers about the potential for the rig here in the Gulf. Again, I think our focus really has been international, based on the term that we can probably achieve in the international market versus the Gulf of Mexico market. But there has been a little bit of discussion about the rig for here in the Gulf of Mexico.

David Smith - JPMorgan

If it were for deep shelf requirements, any reason that you wouldn’t get the premium international rates for that kind of specific Gulf of Mexico requirement, deep shelf requirement?

John Gabriel

I really don’t see any reason why not.

David Smith - JPMorgan

But the Ocean Spur, I think currently the last announcement on that was in the $130s, down from the prior rate in the $190s. And I’m just wondering if that’s pure supply/demand dynamics or if maybe there was something special about the last $190 rate?

John Gabriel

I think it’s more that the $190, it was more of an anomaly than the $135 is, not to say that that market is basically at $135,000 a day. But I think the $190 rate was more of an opportunistic situation. And I think that again, that class of rig is not the new build, 350 to 400 foot, 2 million pound derrick type of rig. So we’re looking at a class distinction in rates really.

Operator

Our next question is coming from Robin Shoemaker - Bear Stearns.

Robin Shoemaker - Bear Stearns

I wanted to pursue a little bit on this mobe/demobe expenses and inspection fees, delays, and acceptance testing. You’re getting, I think, mobe and demobe fees on virtually all of your contracts. But I’m sure that some of these extended transitional costs are not getting reimbursed. Can you explain exactly how that works and whether you’re trying to perhaps strengthen the terms of those expenses that you incur when moving a rig from one region to another and anticipating all of the start-up costs in the new location?

Lawrence R. Dickerson

There is an accounting for mobe where the cost and the mobe fees are deferred and go to zero and are amortized over the life of the contract in general. But the impact that we talked about was that if a rig doesn’t go to work for 30 days, then we are losing 30 days’ worth of revenue that we would have otherwise expected and maybe had guided to in our previous rig status reports. So it’s the loss of revenue rather than accounting that deals with it.

So far as strengthening contracts, yes, we’d like to have stronger contracts. But almost every contract says that the customer has to buy off and accept the rig. And what we’ve just found in these international markets with the customers that they and the regulatory authorities have been more stringent. I won’t characterize whether we think it’s too much or too little, but more stringent than we had expected or that we would normally see in acceptance testing here in the Gulf of Mexico.

Robin Shoemaker - Bear Stearns

You’ve got a consensus estimate of $11.50 a share this year. And you’ve given us some pretty good cost guidance and it does seem that you’re incurring a little bit of extra cost and somewhat delays in starting up rigs. If you would, my question is simply do you think that number is a stretch based on what you’re seeing and the guidance you’ve provided here on costs.

Lawrence R. Dickerson

I think we give pretty complete guidance with our rig status reports. And people do the math, they can test that, I understand. But we don’t get into the business of making those comments. I just tell everybody to do the math and again, with a lot of focus on costs and costs are important. I think costs are relatively under control, and this remains a top line driven business. So people need to make sure they calculate the top line appropriately.

Operator

Our next question is coming from Geoff Kieburtz - Citi.

Geoff Kieburtz - Citi

On the Scepter, what kind of rate would you need to get in the Gulf of Mexico to make it at least indifferent versus taking the rig internationally?

Lawrence R. Dickerson

Well, we would like to cover our cost and then I think in some markets we would like to have a premium as well, to go there. But in other cases, such as the Brazil announcements, I think everybody understood that the ability to book term, we were willing to take discounts from what otherwise would be available on the short term.

So we do an analysis and we estimate what all the transition costs and make sure that those are covered to the best of our ability. And I think that even though we’ve mentioned these two markets or a couple of markets where we’ve had to accept some testing delays, and that’s revenue that we didn’t anticipate, that still didn’t imperil the economics, these are still good deals for us to take going internationally.

So I think we have time for one final question.

Operator

Our final question is coming from Alan Laws - Merrill Lynch.

Alan Laws - Merrill Lynch

I have more of a theoretical question surrounding your cash return policy. You guys have been pretty tax savvy and we’re in an election year and where there have been some murmurs about removing the favorable dividend tax rate. Would a material increase in the dividend tax rate, I guess, really affect your decision to use the special dividend vehicle to return in capital to shareholders?

Lawrence R. Dickerson

Yes. I’m going to stick to our dividend response as to how we may calculate that. I think that’s one of the factors that should be covered in the list, but I can’t really comment further.

Alan Laws - Merrill Lynch

What I’m really asking is, there is a choice out there, you can return the cash that way, repurchase stock, or maybe even change your thoughts on that and go after M&A. Are you in any way inclined to pivot on any of those given dramatic changes?

Lawrence R. Dickerson

The statement, I’m getting some hypothetical questions, but the statement is that the Board will consider all of these factors in May. So, I think there is enough latitude in our statement to indicate that we will consider the appropriate factors that we believe work best.

Alan Laws - Merrill Lynch

Some of your peers have talked up M&A again recently. Could you give us an update on your thinking on the M&A side, and opportunities that are in the market and your thoughts?

Lawrence R. Dickerson

We don’t see any change in the M&A environment. Again, there is not a lot of cost savings to be had from a change and any combination between players that reduces the number of bidders, it benefits accrue to everybody. So, we are pleased to operate in an environment we think we can operate and are not driven to go out and buy someone just to do a deal. We’ve always been driven to seek value and the definition of value changes in the market based on equipment, but we will continue to remain value focused.

Alan Laws - Merrill Lynch

And rather than corporate deals, I was more referring to the availability of call them spec rates in the market that don’t have crews or don’t have an operating base. Are you interested in that?

Lawrence R. Dickerson

There maybe some value there. There might be something that we could move on.

Alan Laws - Merrill Lynch

How often does these invasive species, mussels issue come up?

Lawrence R. Dickerson

This is the first time we’ve ever seen it. And I think it’s indicative of more focus on the environment. I know invasive species have been issues primarily for vessels that actually come into port. We typically have been offshore.

I don’t know whether it was to deal with the fact that were coming in the port to do a special survey or the fact that there was recognition that the species themselves could transition from us to the supply boats. It will be a factor in countries that are more focused on this and certainly be a factor in us making sure that we know this in advance and don’t have to deal with it at the last minute.

Alan Laws - Merrill Lynch

This is going into your contracts from this point forward?

Lawrence R. Dickerson

Well, I mean apart from the contracts just if we had known three months before we were set to leave that this was an issue we were facing, we could have perhaps done the blasting while we were working. It all depends on the particular operations, and therefore we wouldn’t have missed contractual days.

Lawrence R. Dickerson

Thank you everybody. We’ll join you again later in the year and we appreciate your attention.

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Source: Diamond Offshore Drilling Q4 2007 Earnings Call Transcript
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