Diamond Offshore Drilling Inc (DO) 2006 Q4 法說會逐字稿

Good morning, my name is Melissa and I'll be your conference operator today. At this time I would like to welcome everyone to the Diamond Offshore Drilling Fourth Quarter 2006 results conference call. [OPERATOR INSTRUCTIONS] Thank you, it is now my pleasure to turn the floor over to your host, Les Van Dyke, Director of Investor Relations. Sir, you may begin your conference.

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

Before Larry begins his remarks, I should remind you that statements made during this conference call may constitute forward-looking statements and 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 the 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 events, conditions, or circumstances on which any forward-looking statement is based.

With that, I'll turn the meeting over to Larry.

Thank you very much. And welcome everybody to our end of the year fourth quarter conference call. We were obviously very pleased with the results for the fourth quarter. This is the 10th consecutive quarter of increasing revenues. And of course, in this market we would expect that trend and that was certainly no surprise. When you look forward at all the revenue we've got booked as rates continue to roll higher from previous commitments, we would expect revenues to continue to rise quarter to quarter, at least through the point in time that we have everything booked.

The quarterly results, I think were driven by the increase in the top line major component of that. And then we were very successful in keeping our cost in line. The industry is under tremendous cost pressures, we're not immune to that. When Gary Krenek goes through our budget for next year and gives you some guidance on what sort of rates used, you'll get into some of that detail. I'll revisit that here in just a minute, on some of those factors.

For the quarter, we are certainly did a decent job. And I think the top line is going to continue to move significantly more than we have cost escalation quarter to quarter. So we would continue to see that trend going forward. We had a decent amount of down time in the quarter, 598 days, which included rigs in the shipyards, some special surveys, and some idle time on our Gulf of Mexico jack-up fleets and we'll go through that in some period of time. Even with that, we achieved a record result.

I'd like to also comment just for a moment on the dividend, which we previously announced. That's a $4 special dividend, which will be payable to shareholders of record early next week. And combined with our regular dividends that we paid for the year of $0.50, $4.50 represents slightly under 88% of our earnings for the year that we've returned to shareholders. And in the previous year, we returned 105% when we paid a combined $2 dividend. So we've announced well in advance that it is our intention to look towards special dividends as the means to return and utilize excess cash. It's not that we're not investing cash in the business, but as you know the cash flows are so strong right now that we're easily able to do that.

And I also think at this Company, we made many of our commitments to upgrade early. The Ocean Endeavor is in its final stages in Singapore, has left the shipyard and awaiting it's heavy list vessel doing some last-minute testing. We announced that we would do that upgrade in December of 2004. It took some time to get the rig over there. But two years, roughly from announcement to completion. We still have to bring the rig back to the Gulf of Mexico. But that was an example of us committing capital early, $250 million to that upgrade, and we're going to be able to realize higher day rates really starting this year and I'll come back here to the Endeavor for just a second.

In general, the market continues very strong. In our release we talked about the Ocean Confidence and its four year commitment at $500,000 a day here in the U.S. Gulf of Mexico, we're not announcing the customer at this juncture. We'll do this shortly, but we need to clear that with him before we make that announcement, but we're very pleased with that.

Don't have any other specific data points, but we're seeing strong markets in all floater markets, deep water, mid water, I think as you've noted we've announced a couple of short-term jobs or a short-term job in the Gulf of Mexico in the low 300s and that's certainly where we're bidding some of the work. I think that's evidence of that. We've got very strong rates going internationally for mid water rates, international jack-ups continue to provide us with opportunities potentially to bring some rigs out of the U.S. gulf, which is the only weak market that we see presently.

We have two jack-ups idle today. We've got 7 working and 2 stacked. One of those has a commitment to go to work early next week so it'll be a brief period of stack time. And as I indicated earlier in the fourth quarter, we did take a significant amount of idle time on one of our jack-ups as it was down. There's about 60 rigs working in the U.S. gulf. The industry has done a great job of moving rigs out of the gulf for a variety of reasons, but it shrunk supply. Gas prices, frankly are fairly strong, yet we're seeing some hesitation on operators to commit, and there's not presently a demand for that many rigs. There's roughly 8 to 10 rigs that are idle, either ready-stacked, waiting on weather, between jobs, so there is more rigs available even with the reduction in supply in the U.S. Gulf of Mexico.

So I think that covers everything on a looking on what's happened in the past, looking forward, as I indicated Gary Krenek will go through greater detail on what our revised costs are. But essentially over 2006 OpEx, we're looking at, which was about $812 million, we're looking at roughly $150 million increase for the year going forward.

And that number consists of several factors. Some of those factors are offset easily by revenue, for instance we now have the Endeavor scheduled to go to work. And so we will be taking in revenue, but we'll be taking in cost, and that is a component of the cost increase. We have rigs that have gone international. We've taken a jack-up that worked in 2006 down to Mexico. We've got a floater working in Egypt. There's higher cost in international markets. So that's another component of that, but that's also offset by revenue. And about 30% of that increase, though is related to increases in wages and benefits as we seek to remain competitive and ensure we've got competent personnel operating our rigs.

We've seen increases in what our vendors charge us for costs, which is another factor, maybe 20% of the increase that we're looking at. And then another one I would characterize is our need to do more maintenance next year. So not just necessarily the price, but the quantity that we're doing and that's driven by the number of surveys and rigs that are scheduled to go in the shipyard. We've got 12 surveys scheduled in '07 versus 6 in the previous year. And that is a about 25% of the overall cost increase.

And then the only other thing I will comment on the future is that we have seen delays in shipyards. We've tried to ensure that we budget increased time because of labor issues that exist in some of the shipyards around the world. Presently, we have the Whittington and Saratoga, which are two semi-submersibles undergoing life extension projects and those rigs are running, each of those rigs is at least 30 days late on its schedule to come out.

And finally, I said we'd come back into the Endeavor. The Endeavor is ready, will be ready shortly for load out to come back to the U.S. Gulf of Mexico, but our heavy lift vendor suffered the loss of one of his vessels. And he has reshuffled his rig carrying assignments, we have fallen out a little bit on the short end. And so we're looking at delays on getting the Endeavor here, operating in the Gulf of Mexico, which will probably put us in mid June rather than earlier in the year we were hoping for a late March start. That's impacted us, but it's still quicker to go that route than load to the rig itself. We're really kind of caught on that particular issue.

So that concludes my opening statement. Again, an excellent quarter. I'll let Gary Krenek give you some more guidance for the future.

Thanks, Larry. I'd like to do two things. First of all I'll add just a little bit more color to the fourth quarter operating results and then spend some time discussing what we see coming forward in 2007.

With respect to fourth quarter, we did have a couple of, or three items, adjustments in the fourth quarter that affected operating costs. The first was a approximately $9 million adjustment to our claims cost accrual. This was a result of us accruing expenses in excess of what we needed to do. This is a reflection, we believe mostly of our excellent safety record, not only in a reduction in number of incidents, but also on a reduction in severity of incidents. So that was a $9 million pick up to income decrease in operating expense in Q4.

In addition, we've got two unrelated and nonrecurring adjustments that we booked in the quarter. Both of these adjustments again were to operating expense for about $4 million each, but went in opposite directions. One increase in cost and one decrease in cost and thus in effect, kind of canceling each other out. The effect, however, can be seen in the break down of operating costs by rig class. First adjustment caused jack-up costs to increase by 4 million, and second caused our mid water, semi-submersible operating costs to decrease by 4 million in Q4. We don't see either of these re-occuring this the future.

Other than these three items, most of the other fluctuations and operating costs in the quarter were a result of normal operations or items that we'd forewarn and talked about in our previous conference call. If anyone would like any further details on these fluctuations, I'd be happy to answer them during the Q&A session afterwards.

During the fourth quarter, we also reported approximately $5.5 million pretax gain in our other income and expense line. These gains were primarily made up of two items. First, there were gains that we recorded on foreign currency fluctuations during the quarter and then second, there were gains that we recorded as a result of reimbursements that we received related to equipment loss during the 2005 hurricanes. And finally, our tax rate for the entire year of 2006 ended up at 26.9%. Because we had recorded a slightly higher rate through the end of the third quarter, we booked a true-up in the fourth quarter to get back to this 26.9%. This resulted in effective rate in the fourth quarter of just under 25%.

Looking forward to 2007, we've given a pretty detailed guidance on expected down time and Larry's talked about that this morning. And we've given more guidance on our rig status reports. So rather than going over that today, I'll let you refer back to those reports. Suffice to say, keep in mind, we do have the 12 rigs that are coming in for their five year surveys in '07, as Larry said, as well as two additional rigs that will complete their surveys and related work that will begun in 2006, as opposed to the 7 rigs that began their surveys in '06.

Larry, went through a general increase in cost, operating cost for '07. What I'd like to do in order to assist analysis with -- analysts with their models, continue our tradition of giving estimated rig operating cost by category as part of our February conference call. So on a per day rig basis, here they are.

For jack-ups, we expect Gulf of Mexico jack-up operating costs to be somewhere in the lower $30,000 range per day. Indonesian jack-ups in the mid 30s. Mexico and Katar jack-ups, upper 30s. Tunisian and Egypt jack-ups working in the mid 40s.

Looking at floaters in the Gulf of Mexico, we expect second generation floaters to incur operating costs in the day rates in the low 40s. Our fourth generation Victory class upgrade in the upper 40s, as built fourth gen rigs in the low 50s. Our 5th generation Victory upgrades in the Gulf of Mexico in the low 60s. And finally, 5th generation DP semis, which is Confidence, in the upper 80s.

Looking internationally at our floaters, we expect our Mexican rigs to incur costs in the upper 40s, down in Brazil, mid water, conventionally moored, upper 60s. The Brazil mid water DP rig in the mid 80s and our DP rig in -- deep water DP rig in Brazil slightly over $100,000 per day. Both Egypt and U.K. mid water rigs we expect costs in the mid 60s. And in Norway our -- the Vanguard at approximately $120,000 a day. Indonesia mid water semi-submersibles would expect costs in the low 50s. Australia and new Zealand in the upper 70s. Finally our Malaysian 5th generation Victory upgrade in the low 70s. We'll also incur costs somewhere in the mid 40s per day for both repair of spare equipment that can't be attributed to specific rigs and also for training costs for our crews.

As in past years, experience has shown us that we can expect these costs that I've just given you to be slightly lower in the first half of the year and conversely slightly higher in the second half of '07, but averaging out to the numbers I've just talked about.

We always get a question on how much it'll cost for us to do our surveys. During '07, in addition to the normal operating costs that I just mentioned, we expect to record an additional expense of $3 million to $4 million per jack-up when they're in the process of doing their surveys and $5 million to $6 million each for the floaters. There are 3 exceptions to the floater number and that is for the Worker, Yorktown, and Baroness, where due to various factors, including increased maintenance work, we expect to spend $12 million to 13 million each for these three rigs, again, in addition to their normal operating costs.

Taking a look at the other line items on the income statement, you can expect to see depreciation expense increase to approximately $55 million in the first quarter of this year to reflect our capital program. And then additional $2 million per quarter for the remainder of the year as a result of bringing the Endeavor online. As for G&A expense, we expect to see an 8 to10% increase from our year-to-date 2006 number which was about $41.5 million. As a result of the majority of our 1.5% convertible debentures being converted here in the first quarter, we expect normal interest expense, net of capitalized interest to decrease to about $6 million in Q1, and then be right at $5 million in the final three quarters of the year. In addition to the $6 million interest expense in the first quarter, you can expect an additional $9 million non-cash charge as we write off unamortized debt issuance cost that was related to the 1.5% debentures being converted. This $9 million additional non-cash charge will be reported interest expense in the first quarter. And finally, the effective tax rate for the year is expected to be somewhere between 28 and 29%. And as always, we'll depend on the ultimate break down on U.S. and international income and also where that international income is earned.

Final item I have to talk to you about is projection of capital expenditures for the year. We're estimating that we'll spend about $220 million on our new build jack-ups, on the Monarch and also on the completion of the Endeavor. That's in total for those four items. In addition to the $220 million worth of upgrade in new build capital costs, we're going to spend about $50 million for a rig-like enhancement projects with the Yorktown, and also the completion of the Whittington and the Saratoga, which will complete their work in the first quarter of this year. We'll spend an additional $30 million on the new era in Voyager which are contract requirements for their work for the PEMEX jobs that we begin mid '07. And we also have $40 million that we're going to spend in spare capital equipment, which is part of our revenue preservation program that Larry talked about. And finally, we'll spend another $195 million of just maintenance capital maintaining our rigs. If you add up all those numbers I just gave you, you'll see that comes out to 535 million for CapEx in '07, which is flat with what we spent in 2006.

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

Okay. I think we're ready for questions and we'll try to grab through those so everyone can move on to hear the natural gas numbers in 10 minutes.

[OPERATOR INSTRUCTIONS] Your first question is coming from Daniel Boyd with Goldman Sachs.

Hi, guy, good quarter on costs there. Costs were still well below our estimate, I think even if adjusting for some of the items you mentioned there. It appears you're doing better than some of your peers at managing your shipyard projects. Can you talk a little bit about what's driving this?

Well, as I indicated, we're in an environment where you're seeing cost pressures. If you look at shipyards, they're full, so they raise their prices and they have trouble getting adequate labor to perform these kind of repair issues you've got. You've got vendors raising prices on you. Your cost of services, all of that goes up, and the only thing that we have found is that as much advance planning as you probably can do will help you with that. We've tried, we've moved on to a two-year budgeting cycle recognizing the long lead times to have things delivered. So hopefully that cuts down costs and pre-commits. I think everything you can do and knowing what you're doing early can help you achieve good numbers. As we go through the coming year, though, it's going to be a continual struggle, but that's where we're faced for focused on making sure that those costs are in line. But those are a component of the numbers that Gary revealed and we think they will go up despite our efforts.

Okay. And then an unrelated question. What are your expectations for the Whittington? Do you still expect to get the 295 a day you talked about on the Q2 call?

Well, we think that's a strong market. And we have noted that we have placed some short-term items in the low 300s. So I think we're very comfortable with achieving that earlier 295 or greater. John, you have anything to say on that?

Well, in general, we're just, we remain enthusiastic about this segment of the market globally. We're continuing to see term opportunities internationally, particularly in Mexico, Brazil, West Africa, the Mediterranean, and we expect these to mature to the formal bid stage throughout calendar year '07. And we're also seeing continued interest in the U.S. Gulf of Mexico, again albeit for shorter term commitments.

And to get back to your first question, I did concentrate on the expense nature, that's what we look at, but I think it's just as important to look at the capital commitments and the capital budget this Company has engaged in. The Endeavor was completed as I indicated $250 million. The Monarch is beginning, we've pre-committed to many of those costs, estimated to be right at $300 million. Those are significant saving, as well as our new jack-ups were fairly committed fairly early in jack-up construction cycles. So all of those things have been good news for us. And we've delivered all of those class upgrades on budget.

Right and when do you think we'll hear something on the Whittington?

We have a standard that we -- before we release, we will release on letter of intent if there's not. We just have to get to that stage.

All right. Thanks.

Thank you. Your next question is coming from Ian Macpherson with Simmons and Company.

Hey, good morning, guys.

Morning.

Interested in the prospects for the Gulf of Mexico jack-up market. And I gather that you're still entertaining prospects to move one or two of your rigs out of the Gulf of Mexico. Is that getting to be more difficult now with the persisting softness there? Is it a more competitive market for Gulf of Mexico jack-ups that are looking at maybe that's going to be a more crowded space for domestic rigs looking for international contracts, particularly when you have this influx new of new builds coming out of the eastern shipyards this year?

I guess that's company by company specific. Many of the rigs that are operating in the U.S. gulf rigs, the Mat rigs, don't have a lot of opportunities to go overseas. We have three Mat rigs. It really depends upon rigs, specific. We've got a couple rigs that we've been bidding internationally. And we would expect, you would think there would be more competitive. But at the moment, both between us and what other people are doing, we're still able to look at stepping up the rates that we're able to achieve and going internationally.

But at leading edge bid level basis, you're not seeing really any erosion and international jack-up rates relative to 6 months ago?

No, not at all.

Okay.

Still very strong.

If I could have a quick follow-up. I guess on the deep water side, your next rig to come available will be the America in a little over a year. In deep water terms, that's relatively soon. If you could provide any color on the marketing prospects for that rig, what sort of term you're looking at on that rig's next contract would be interesting.

I -- we just don't really have anything to report. We are -- we've got a number of rigs out there that we get interest in. We get a lot of interest from overseas venues to see if we'd be interested in moving one of our fourth gen rigs internationally. So we look at that and then we look at U.S. gulf. We tend to see more term internationally, longer term than we do in the U.S. gulf.

Okay. Thanks, Larry.

Thank you. Your next question is coming from Pierre Connor with Capital One Company.

Good morning, everybody.

Morning.

I'd like to ask the question about the top line number there. And maybe Gary could tell us. If you could -- is there a way to break out what of that came from performance bonuses on the Brazil contracts in the quarter? Is there any?

A small portion, very small portion as a percentage of the total revenue. But nothing unusual that we have not recorded in prior quarters.

So pretty standard?

Yes. Wasn't anything unusual in there.

That's good. Also let me ask you on your available contracted time, stripping out yard time and down time, what kind of performance, and we typically model the 95-97. What kind of performance, maybe it's a question for John, did you have during the quarter in terms of sort of available days up time?

I guess you're asking utilization or --

Yeah, utilization, but stripping out yard time and idle non-contracted time.

We had in Q4 -- we had 91 days of idle time, almost all of that on a jack-up. And then we had 76 days of down time related to equipment failures or repair time, that kind of stuff. To look at the previous quarter, we only had 20 days roughly of stack time. And we had 46 days of equipment down time.

Okay. That's helpful to understand the differences. Okay. And then last one also, Larry or John. What sort of timing do we, or how do we think about how it unfolds with contract negotiations on the Ambassador and the Yorktown. When should we expect to -- how does that work?

The Yorktown right now the current contract, I believe expires either in June or July and we've got an extended shipyard plan for the Yorktown, which basically takes it into the --

to the end of the year.

-- the end of the year, early in '08. There's nothing eminent right now on the Yorktown other than its consideration for some of these opportunities outside of the Gulf of Mexico. And I don't want to limit it to outside of the Gulf of Mexico, but it's certainly a rig that we've got some good vision on.

With respect to the Ambassador, the Ambassador contract, I believe runs through almost the end of the year, October. We are going through the process now of evaluating an opportunity to extend it in Mexico. That's something that probably matures over the next 30 days or so. I guess our preference would probably be to keep that rig down there.

Okay. Okay so working on that extension currently?

Yes. And those bids all are public information once they're filed.

Yes. Okay. Very good and I appreciate the laying out of the down time the way you've done that recently and the fleet status. So thank you very much.

Sure.

I'll turn it back, guys. Thanks.

Thank you, your next question is coming from Doug Becker with Banc of America.

Thanks. I wanted to follow up on Pierre's question about the revenues. At least in our numbers, the high spec revenues did come in higher than we were expecting. Is there anything in those revenue numbers that wasn't captured in the fleet statuses?

There shouldn't have been. We said the Brazil bonuses were comparable to prior quarters. We didn't record anything really that was an unusual item in the quarter.

Anything that we have cost escalators?

Slight amounts in there. But again, nothing that was unique to the fourth quarter or that really changed from the third quarter.

Okay.

One thing I might comment. We do have various short periods of down time on these rigs for equipment repair during the quarter as all drilling contractors do. And if you take 3 or 4 days worth of down time, which we caution everybody to use 97 or 98% utilization. If we take that 97, that down time on a rig that's earning $450,000 a day versus one that's working on old contract at 200,000, that can cause a fairly big swing in those revenue numbers. So that may be one item out there.

Okay. Switching gears to the heavy lift vessel market. I guess you're being hurt by it for the upgrade. But how about getting rigs out of the Gulf of Mexico? If you wanted to move a rig out of the Gulf today, how long would the wait be?

It all depends on the timing. Obviously they're tight supply now. I think there's additional supply coming later in the year. So I just -- I can't give you a general answer on that. John, have you any out recently?

Well, as we evaluate opportunities and put bids together, we survey the heavy-lift market, which effectively is the coal, the one player in it right now. And there are scheduling opportunities that pop up in the just kind of out of the blue. There are also opportunities where someone has committed to a heavy lift vessel that has the -- actually has the capacity to carry two jack-ups as opposed to the one it's committed for, so those things are there. To be definitive about -- about the lag time between securing an opportunity and when we can actually effectively move the rig, we just can't do it without talking to the people on a daily basis.

We're talking several months at a minimum.

I think that's fair, yes.

Okay. Thank you very much.

Thank you. Your next question is coming from Waqar Syed with Tri-Stone Capital.

Hi. You mentioned, Larry, that one of the jack-ups that's idle is going to have a contract in about a week 10 days time. Is this the Ocean Titan?

No, it's the Ocean Spartan.

And what kind of rate should we expect for that rig?

We will disclose that on our rig status report. I don't mean to be that way yet, but we need to cross a couple more hoops before we're ready to announce that. I think it will be in line with kind of the trends you've seen where rates on jack-ups in the Gulf of Mexico have been going down as a result to the competitive nature of the market.

Okay. And then Gary, the $9 million adjustment as you talked about in operating cost side. Can that be broken down for the high spec and mid water and jack-up segments?

Right at $2 million were attributal to the high spec rigs. Let's say right at 3- 3.5 million to the other semi-submersibles. Right at 3 to the jack-ups, and then we think booked about a half a million dollars for the other cost line. Those were all credits to expense. So decreased our expense.

Right. Right. Okay. And these are you believe totally nonrecurring?

Well, we would hope that our continued safety efforts and we believe that our continued safety efforts will be effective that over the long-term will reduce that. But essentially this is like an actuarial determined number that you make estimates and you don't have enough facts to regauge your numbers for quite a ways down the way. So for modeling purposes, we'd say this is a one-time event.

That's correct. We've reduced what we expect and what we will book as an expense in the go forward time period in '07 and that's already reflected in those per day numbers that I gave you for rig operating costs.

Okay. Great. Great. Thank you very much. Great quarter.

Thank you.

Thank you. Your next question is coming from Judd Bailey with Jeffries and Company.

Thank you, good morning. Question -- follow-up to an earlier question on some cost pass through provisions in your contracts. You mentioned operating costs will likely be up roughly 150 million in 2007. Can you remind us what you have in the way of cost pass through provisions in some of your contracts for this year?

Well, most of our cost pass throughs are labor related. There are some rigs that have other costs related. There's some rigs that have no cost escalations in there. And there were some contracts that the customer, when we negotiated, said I don't want to be exposed to that. And we said okay, fine, we'll raise the day rate 10-15 grand going in. That all gets lost in that measure. But there will be some cost relief on there. And I don't -- I don't know that we particularly budgeted that. We're giving you the gross costs that are going up.

You can give us a rough idea of contracts will have some sort of labor cost pass through?

We did a review about -- I don't know 4-5 months ago one of our competitors in the conference call announced what percentage of their contracts had some cost protection in there. And so we calculated that same sort of number and that was based upon not rigs, but future revenue, but how much the future revenue was covered with some cost protection. And I believe the number we came up with was about 62-64% of future revenues had some cost protection in there. That doesn't mean 62% of our costs are covered because not all of them had things outside of labor. And then even the effectiveness of that labor rolled forward. There's sometimes an annual or semiannual date that you make the adjustment on.

That's fair, thank you.

The cost escalations are in excess when your costs go up in excess of 3% or 5% or something like that. So it varies by contract.

Okay. All right. Well, thank you. That's good.

And my next question is on future growth opportunities, you're taking delivery the Endeavor. You've got two more jack-ups. Can you maybe give some insight, as you're thinking about the fleet any more, and would that be on the jack-up or the semi side or new builds or other upgrade opportunities if there's any hulls out there that could potentially be acquired to do the similar types of upgrades you've done in the past?

Short answer is yes.

Okay.

We -- we look at -- look at everything -- we frankly try to be a little counter-cyclical in the way we approach fleet capacity additions. And conditions today where the shipyards are really fully priced and you're looking way out there and you're bidding against all your competitors who have lots of money, as well tend to drive returns down on pure new builds. So all I can say is we will constantly look at that as a part of where we deploy capital. But we've got to look at that, how does that serve our shareholders, vis a vis, the special dividends that were going on. I don't think they're mutually exclusive. I think we'll be making moves on both sides of the equation.

Great. Thanks. I'll turn it back. Thanks.

Thank you. Your next question is coming from with Alan Laws with Merrill Lynch.

Good morning.

Morning.

Morning.

On the competence, the competence LOI or contracted looked pretty great to us. You appear kind of in the driver's seat with respect to near term floating rate capacity or availability in kind of a tight market. How long do you think it's going to be before most of those available rig days for 2008 are gone for the mid water fleet?

Mid water or deep water?

Well, either.

Okay.

Or both, actually.

I would -- I would -- with the state of the present market, then we would expect those to be committed here during 2007. It would surprise me that we exit 2007 with any significant future commitment with a market where it is today, future uncommitted days.

Are you seeing any acceleration in the bidding for the equipment now? Or just the same high level?

I think it's been the same level for the past two years. Within that, there'll be a time frame when all of a sudden there's three people that simultaneously want a class of rig. And other times it's a little more measured. But it's no real change in the market.

All right. Second question was on your majority shareholder and how they're thinking about their investment in Diamond, has there been any change to their view of the offshore drilling sector? And I guess more specifically is there any interest or talk of consolidating the Company?

I haven't -- you're specific question of what buying out the minority shareholders and making it 100% owned sub?

Yes.

I'm sure 10-K rules would require uniform disclosure of that. I don't believe there's been any change in view of the business in their view of this industry, really in the 15 years that they've been involved in this, that they recognized that it's a cyclical business, there's lots of opportunities to make money for all shareholders. They've been very focused on value and I don't see any change in that overall perspective today in these really great times versus 2003 when we were out buying rigs and down time.

All right. And sort of follow-up to that, what are your thoughts overall on sector consolidation?

Well, we've been involved in sector consolidation much earlier. And I think the fact that there are fewer players today than they were 15 years ago is beneficial to the industry participants, for a variety of reasons. Obviously the street may be interested in our pricing power and fewer people to bid, but you have a more, you just need to be of a certain size to get the job done. Now there's been all these new Norwegian entrants in here. I think the basic problem with looking for consolidation in this industry is there's no readily available value enhancements by doing a merger, there's not enough costs to be saved to justify paying a premium, nor has there been a significant size multiple advantage by being larger. Without those two factors what you've always needed is a large-selling shareholder to effect most of the mergers that have occurred. And I don't see a lot of that present.

Okay. Thanks, guys.

Welcome.

Turn it back.

Thank you. Your next question is coming from Zack Schreiber with Duquesne Capital.

Hi. Can you hear me?

Yes.

Just the question on the operating costs and I didn't get all the details on the call, but was there some deferred activity in the quarter such that some of the operating costs are going to come back to us later on in the year? You guys actually just had a great quarter on the execution side? Or some combination of the two?

Well, there were no deferred costs that you can expect to roll forward. The only thing is what I mentioned the $9 million reduction to the claims accrual. You're right, after, even after you factor that out, we believe we watch our costs closely and we believe as Larry said did a good job during the quarter.

If you back up, you can't run this business right down to the last penny or the last $2 million with any kind of certainty. In Q3, our costs were up. And the tone of the conference call was costs were, we didn't do a good job controlling. I'll admit they were up in that quarter, we had events. But we had the same programs and policies in there and we would expect that we'll have some quarters where we're a little bit on the high side, some quarters we're on the low side. But I think if you look at it averaged over time, I think this company's doing an excellent job on managing the costs and the biggest value creation still remains driving that top line, get that top line to roll and to get that top line to price in larger numbers. That's going to by and large take care of the cost increases.

And then, I got cut off a second ago. In terms of just the value return and special dividends. I think you said that it's not mutually exclusive. Are you talking about now buying back stock and doing special dividends?

I'm talking about investing in the fleet or buying rigs, upgrading rigs, some of those type things.

Got it.

We're not ruling out stock buybacks as a potential, but I think we've made a pretty fairly strong signal by our track record that we see significant advantages in special dividends.

And going forward, how should we think about the special dividend next year? There was a fair amount of speculation and maybe a little bit of confusion around the special dividend this year. Should we think about that it's always going to be this, 80% or so of the previous year's operating earnings, irrespective of the operating cash flow?

No, we've tried to go through pains to indicate that there's not a guaranty that that's why we're making it a special dividend and we will, the Board will sit down and after reviewing the results for the year, look at our investment opportunities, look at our capital spending programs, and make that choice, or when I said they're not mutually exclusive -- multiple choices, that best serve the interest of the shareholders. And the only thing I would say on the past history is you can see that obviously we've given strong weight to special dividends as being one of those significant components.

Last question. On cost recovery clauses within your contracts, is there any way to say sort of what percentage of your backlog has cost recovery clauses in it or what percentage of your contracts have cost recovery clauses in it?

We said that of our future revenue as when we did this calculation 3 or 4 months ago, like 63% of that future revenue had some form of cost escalation built into it.

Relatively consistent over time or is it --

We haven't measured -- I don't know what that data measures. I would say that we've been more successful in the stronger market adapting those type of clauses. And I just caution everybody that doesn't mean 62% of our costs are going to be --

Sure.

--100% protected, but there's some form, primarily labor.

Thanks guys. Congratulations.

Let's take one more call.

Thank you. Your last question is coming from Benjamin Dell with Bernstein.

Hi, guys.

Morning.

I had a couple of questions. The first on your Gulf of Mexico comments. Is it, let's say the the Gulf of Mexico market sort of rebounding before sort of the '07 hurricane season?

Well, it's difficult for us to see when the actual rebound. For a long period last year as things turned down, we talked about the fourth quarter, we the industry, and we talked about first quarter this year. And so now, I think people were talking second quarter before hurricane and all that. It's difficult to say. But clearly, there's not that many rigs there that need to go to work to and not that much marginal demand. If you look back historically, there's always been just to keep the Gulf of Mexico going, there's been a certain level of activity. And we're looking today at roughly 60 jack-ups going, which is fairly all time low. So when all that comes together, I don't know. But we're still comfortable with Gulf of Mexico rigs and even with the reduced rates, we're still earning decent cash out of that segment of our overall fleet.

Sure. And when you look further out sort of to the broader jack-up market the '08 '09 time frame. How do you sort of view that market out there? Do you have a feel on whether it's going to be as tight, stronger or weaker, and have you seen increments of demand for that rig? A willingness upon a term contract?

We are -- we are marketing the Scepter, of our two jack-ups, the Shield. We have a term contract on it. And we have -- we don't have anything yet on the Scepter. Obviously, as you indicated, '08, '09 you're going to look at new jack-ups being delivered. But I think the market and the rates that are being paid for those are giving you a fairly good signal that there's going to be adequate jobs for those rigs.

I was looking just the other day at some data coming out of the Asia Pacific that shows the number of jack-ups active in that theater. And it's climbed significantly. And is expected to continue to climb through '07. So then you look at the demand that's going on in the Far East, an incremental demand taking rigs into India's been significant. There's just a whole lot of coastlines around the world that at these price levels are being opened up to jack-up activity and not all the gas as in the U.S. Gulf of Mexico. There's a lot of strength internationally.

And are there going to be too many rigs delivered? I frankly don't know. All I can do is look at what the future commitment rates are and see what the market is telling you.

Just lastly, the you have a time frame for when you expect to have a contract signed on that rig?

John?

Before it's delivered.

Okay. I guess, that's all I can ask.

Okay.

Right. It's not like we're going to turn one down now because we want to wait and see where prices are. But that rig is a year out from delivery, at least. And it's -- I just, that may be too soon for a commitment of a rig coming out of the U.S. Gulf of Mexico, but as we get closer, it'll be more real. I think we've seen on our discussions that we've had with people that they're very excited about such a big rig and of all the rigs being constructed, not out of all the rigs, but it is one that's operated by a jack-up experienced mainstream contractor and I think that has value that should be delivered in terms of the contract we get for it.

Okay. That's great. Thanks for your time.

All right. Thanks, everybody for joining us. And we will see you next quarter. And at various other venues in between.

Thank you. This concludes today's Diamond Offshore Drilling Inc. conference call. You may now disconnect.