DIAMOND OFFSHORE DRILLING, INC. - Quarter Report: 2013 September (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended September 30, 2013

OR

For the transition period from                      to                     

Commission file number 1-13926

DIAMOND OFFSHORE DRILLING, INC.

(Exact name of registrant as specified in its charter)

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).      Yes   x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

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.

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DIAMOND OFFSHORE DRILLING, INC.

TABLE OF CONTENTS FOR FORM 10-Q

QUARTER ENDED SEPTEMBER 30, 2013

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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)

The accompanying notes are an integral part of the consolidated financial statements.

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DIAMOND OFFSHORE DRILLING, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(In thousands, except per share data)

The accompanying notes are an integral part of the consolidated financial statements.

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DIAMOND OFFSHORE DRILLING, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

(In thousands)

The accompanying notes are an integral part of the consolidated financial statements.

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DIAMOND OFFSHORE DRILLING, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)

The accompanying notes are an integral part of the consolidated financial statements.

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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, 2012 (File No. 1-13926).

As of October 25, 2013, Loews Corporation owned 50.4% of the outstanding shares of our common stock.

Interim Financial Information

The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the U.S., or GAAP, for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange Commission. Accordingly, pursuant to such rules and regulations, they do not include all disclosures required by GAAP 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, statements of comprehensive income and statements of cash flows at the dates and for the periods indicated. Results of operations for interim periods are not necessarily indicative of results of operations for the respective full years.

Use of Estimates in the Preparation of Financial Statements

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

Reclassifications

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

Cash and Cash Equivalents

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.

The effect of exchange rate changes on cash balances held in foreign currencies was not material for each of the three and nine-month periods ended September 30, 2013 and 2012.

Marketable Securities

We classify our investments in marketable securities as available for sale and they are stated at fair value in our Consolidated Balance Sheets. Accordingly, any unrealized gains and losses, net of taxes, are reported in our Consolidated Balance Sheets in “Accumulated other comprehensive gain (loss),” or AOCGL, 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 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, as well as any declines in value that are judged to be other than temporary, are reported in our Consolidated Statements of Operations in “Other income (expense) – Other, net.” See Note 4.

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Provision for Bad Debts

We record a provision for bad debts on a case-by-case basis when facts and circumstances indicate that a customer receivable may not be collectible. In establishing these reserves, we consider historical and other factors that predict collectability, including write-offs, recoveries and the monitoring of credit quality. Such provision is reported as a component of “Operating expenses” in our Consolidated Statements of Operations. See Note 2.

Derivative Financial Instruments

Our derivative financial instruments consist of foreign currency forward exchange, or FOREX, contracts which we may designate as cash flow hedges. In accordance with GAAP, each derivative contract is stated in the balance sheet at its fair value with gains and losses reflected in the income statement except that, to the extent the derivative qualifies for and is designated as an accounting hedge, the gains and losses are reflected in income in the same period as offsetting gains and losses on the qualifying hedged positions. Designated hedges are expected to be highly effective, and therefore, adjustments to record the carrying value of the effective portion of our derivative financial instruments to their fair value are recorded as a component of AOCGL in our Consolidated Balance Sheets. The effective portion of the cash flow hedge will remain in AOCGL until it is reclassified into earnings in the period or periods during which the hedged transaction affects earnings or it is determined that the hedged transaction will not occur. We report such realized gains and losses as a component of “Contract drilling, excluding depreciation” expense in our Consolidated Statements of Operations to offset the impact of foreign currency fluctuations in our expenditures in local foreign currencies in the countries in which we operate. See Note 9.

Adjustments to record the carrying value of the ineffective portion of our derivative financial instruments to fair value and realized gains or losses upon settlement of derivative contracts not designated as cash flow hedges are reported as “Foreign currency transaction gain (loss)” in our Consolidated Statements of Operations. See Notes 5 and 6.

Assets Held For Sale

In 2012, our management adopted a plan to actively market for sale three cold-stacked mid-water semisubmersibles (the Ocean Epoch, the Ocean New Era and the Ocean Whittington) and one cold-stacked jack-up rig (the Ocean Spartan). In connection with the reclassification of these rigs to “Assets held for sale,” we measured the fair value of each rig in the disposal group using a probability-weighted cash flow analysis that utilized significant unobservable inputs, representing a Level 3 fair value measurement, which included assumptions for estimated proceeds that may be received upon disposition of the rig and estimated costs to sell. For our three mid-water semisubmersibles in the disposal group, we determined that, due to the expected resale market for rigs of this type and age, the highest and best use of these rigs would be for sale as scrap. Based on our analyses, we determined that the carrying values of the mid-water semisubmersible rigs in the disposal group were impaired, as the carrying value for each exceeded its aggregate fair value, and recognized an impairment loss in the fourth quarter of 2012. We determined that the carrying value of the Ocean Spartan was not impaired. At both September 30, 2013 and December 31, 2012, we reported “Assets held for sale” aggregating $11.6 million in our Consolidated Balance Sheets. See Note 6.

Drilling and Other Property and Equipment

We carry our drilling and other property and equipment at cost. Maintenance and routine repairs are charged to income currently while replacements and betterments, which upgrade or increase the functionality of our existing equipment and that significantly extend the useful life of an existing asset, are capitalized. Significant judgments, assumptions and estimates may be required in determining whether or not such replacements and betterments meet the criteria for capitalization and in determining useful lives and salvage values of such assets. Changes in these judgments, assumptions and estimates could produce results that differ from those reported. Historically, the amount of capital additions requiring significant judgments, assumptions or estimates has not been significant. During the nine months ended September 30, 2013 and the year ended December 31, 2012, we capitalized $189.2 million and $220.3 million, respectively, in replacements and betterments of our drilling fleet, resulting from numerous projects ranging from $25,000 to $60 million per project.

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Costs incurred for major rig upgrades and/or the construction of rigs are accumulated in construction work-in-progress, with no depreciation recorded on the additions, until the month the upgrade or newbuild is completed and the rig is placed in service. Upon retirement or sale of a rig, the cost and related accumulated depreciation are removed from the respective accounts and any gains or losses are included in our results of operations as “Gain on disposition of assets.” Depreciation is recognized up to applicable salvage values by applying the straight-line method over the remaining estimated useful lives from the year the asset is placed in service. Drilling rigs and equipment are depreciated over their estimated useful lives ranging from three to 30 years.

Capitalized Interest

We capitalize interest cost for qualifying construction and upgrade projects. See Note 7. A reconciliation of our total interest cost to “Interest expense” as reported in our Consolidated Statements of Operations is as follows:

Impairment of Long-Lived Assets

We evaluate our property and equipment for impairment whenever changes in circumstances indicate that the carrying amount of an asset may not be recoverable, such as cold stacking a rig or excess spending over budget on a newbuild, construction project or major rig upgrade. There were no cold-stacked rigs at September 30, 2013 that were not being marketed for sale.

Current Portion of Long-Term Debt

Our 5.15% Senior Notes due September 1, 2014, or 5.15% Senior Notes, in the aggregate principal amount of $250.0 million will mature on September 1, 2014. Accordingly, the aggregate $249.9 million accreted value of our 5.15% Senior Notes has been presented as “Current portion of long-term debt” in our Consolidated Balance Sheets at September 30, 2013.

Foreign Currency

Our functional currency is the U.S. dollar. Foreign currency transaction gains and losses are reported as “Foreign currency transaction gain (loss)” in our Consolidated Statements of Operations and include, when applicable, unrealized gains and losses to record the carrying value of our FOREX contracts not designated as accounting hedges, as well as realized gains and losses from the settlement of such contracts. For the three-month and nine-month periods ended September 30, 2013, we recognized net foreign currency transaction (losses) of $(4.6) million and $(3.9) million, respectively. For the three-month and nine-month periods ended September 30, 2012, we recognized net foreign currency transaction (losses) of $(1.9) million and $(0.9) million, respectively. See Note 5.

Revenue Recognition

We recognize revenue from dayrate drilling contracts as services are performed. In connection with such drilling contracts, we may receive fees (either lump-sum or dayrate) for the mobilization of equipment. We earn these fees as services are performed over the initial term of the related drilling contracts. We defer mobilization fees received, as well as direct and incremental mobilization costs incurred, and amortize each, on a straight-line basis, over the term of the related drilling contracts (which is the period we estimate 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. Absent a contract, mobilization costs are recognized currently.

Some of our drilling contracts require downtime before the start of the contract to prepare the rig to meet customer requirements. At times, we may be compensated by the customer for such work (either lump-sum or dayrate). These fees are generally earned as services are performed over the initial term of the related drilling contracts. We defer contract preparation fees received as well as direct and incremental costs associated with the

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contract preparation activities and amortize each, on a straight-line basis, over the term of the related drilling contracts (which we estimate to be benefited from the contract preparation activity).

From time to time, we may receive fees from our customers for capital improvements to our rigs (either lump-sum or dayrate). We defer such fees received in “Accrued liabilities” and “Other liabilities” in our Consolidated Balance Sheets and recognize these fees into income on a straight-line basis over the period of the related drilling contract. We capitalize the costs of such capital improvements and depreciate them over the estimated useful life of the improvement.

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.

Recent Accounting Pronouncements

In July 2013, the Financial Accounting Standards Board issued Accounting Standards Update 2013-11, or ASU 2013-11, which eliminates diversity in practice for the presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss or a tax credit carryforward is available to reduce the taxable income or tax payable that would result from disallowance of a tax position. ASU 2013-11 affects only the presentation of such amounts in an entity’s balance sheet and is effective for fiscal years beginning after December 15, 2013 and interim periods within those years. Early adoption is permitted. We are evaluating the impact, if any, of the adoption of ASU 2013-11 on our consolidated balance sheets.

2. Supplemental Financial Information

Consolidated Balance Sheets Information

Accounts receivable, net of allowance for bad debts, consists of the following:

We recorded $22.6 million in bad debt expense during the three-month and nine-month periods ended September 30, 2013, to reserve the outstanding accounts receivable balance for two of our customers. See Note 6.

Prepaid expenses and other current assets consist of the following:

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Accrued liabilities consist of the following:

Consolidated Statements of Cash Flows Information

Noncash investing activities excluded from the Consolidated Statements of Cash Flows and other supplemental cash flow information is as follows:

3. Earnings Per Share

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

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The following table sets forth the share effects of stock options and the number of stock appreciation rights excluded from our computations of diluted earnings per share, or EPS, as the inclusion of such potentially dilutive shares would have been antidilutive for the periods presented:

4. Marketable Securities

We report our investments as current assets in our Consolidated Balance Sheets in “Marketable securities,” representing the investment of cash available for current operations. See Note 6.

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

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

5. Derivative Financial Instruments

Foreign Currency Forward Exchange Contracts

Our international operations expose us to foreign exchange risk associated with our costs payable in foreign currencies for employee compensation, foreign income tax payments and purchases from foreign suppliers. We may utilize FOREX contracts to manage our foreign exchange risk. Our FOREX contracts generally require us to net settle the spread between the contracted foreign currency exchange rate and the spot rate on the contract settlement date, which, for most of our contracts, is the average spot rate for the contract period.

We enter into FOREX contracts when we believe market conditions are favorable to purchase contracts for future settlement with the expectation that such contracts, when settled, will reduce our exposure to foreign currency

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gains and losses on future foreign currency expenditures. The amount and duration of such contracts are based on our monthly forecast of expenditures in the significant currencies in which we do business and for which there is a financial market (i.e., Australian dollars, Brazilian reais, British pounds sterling, Mexican pesos and Norwegian kroner). These forward contracts are derivatives as defined by GAAP.

During the nine months ended September 30, 2013 and 2012, we settled FOREX contracts with aggregate notional values of approximately $233.9 million and $236.3 million, respectively, of which the entire aggregate amounts were designated as a cash flow accounting hedge. During the nine-month periods ended September 30, 2013 and 2012, we did not enter into or settle any FOREX contracts that were not designated as accounting hedges.

The following table presents the aggregate amount of loss recognized in our Consolidated Statements of Operations related to our FOREX contracts designated as accounting hedges for the three-month and nine-month periods ended September 30, 2013 and 2012.

As of September 30, 2013, we had FOREX contracts outstanding in the aggregate notional amount of $151.6 million, consisting of $20.7 million in Australian dollars, $86.7 million in Brazilian reais, $20.5 million in British pounds sterling, $11.7 million in Mexican pesos and $12.0 million in Norwegian kroner. These contracts generally settle monthly through June 2014. As of September 30, 2013, all outstanding derivative contracts had been designated as cash flow hedges. See Note 6.

We have International Swap Dealers Association, or ISDA, contracts, which are standardized master legal arrangements that establish key terms and conditions, which govern certain derivative transactions. At September 30, 2013, all of our FOREX contracts were with two counterparties and were governed under such ISDA contracts. There are no requirements to post collateral under these contracts; however, they do contain credit-risk related contingent provisions including credit support provisions and the net settlement of amounts owed in the event of early terminations. Additionally, should our credit rating fall below a specified rating immediately following the merger of the company with another entity, the counterparty may require all outstanding derivatives under the ISDA contract to be settled immediately at current market value. Our ISDA arrangements also include master netting agreements to further manage counterparty credit risk associated with our FOREX contracts. We have elected not to offset the fair value amounts recorded for our FOREX contracts under these agreements in our Consolidated Balance Sheets as of September 30, 2013 and December 31, 2012; however, there would have been no significant difference in our Consolidated Balance Sheets if the estimated fair values were presented on a net basis for these periods.

The following table presents the fair values of our derivative FOREX contracts designated as hedging instruments at September 30, 2013 and December 31, 2012.

The following table presents the amounts recognized in our Consolidated Balance Sheets and Consolidated Statements of Operations related to our FOREX contracts designated as cash flow hedges for the three-month and nine-month periods ended September 30, 2013 and 2012.

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As of September 30, 2013, the estimated amount of net unrealized losses associated with our FOREX contracts that will be reclassified to earnings during the next twelve months was $1.0 million. The net unrealized losses associated with these derivative financial instruments will be reclassified to contract drilling expense. During the three-month and nine-month periods ended September 30, 2013 and 2012, we did not reclassify any amounts from AOCGL due to the probability of an underlying forecasted transaction not occurring.

6. Financial Instruments and Fair Value Disclosures

Financial instruments which potentially subject us to significant concentrations of credit or market risk consist primarily of periodic temporary investments of excess cash, trade accounts receivable and investments in debt securities, including residential mortgage-backed securities. We generally place our excess cash investments in U.S. government-backed short-term money market instruments through several financial institutions. At times, such investments may be in excess of the insurable limit. We periodically evaluate the relative credit standing of these financial institutions as part of our investment strategy.

Most of our investments in debt securities are U.S. government securities with minimal credit risk. However, we are exposed to market risk due to price volatility associated with interest rate fluctuations.

Concentrations of credit risk with respect to our trade accounts receivable are limited primarily due to the entities comprising our customer base. Since the market for our services is the offshore oil and gas industry, this customer base consists primarily of major and independent oil and gas companies and government-owned oil companies. At September 30, 2013 and December 31, 2012, our largest customer in Brazil, Petróleo Brasileiro S.A. (a Brazilian multinational energy company that is majority-owned by the Brazilian government) accounted for $120.4 million and $116.4 million, or 28% and 24%, respectively, of our total consolidated gross accounts receivable balance. Our second largest customer in Brazil, OGX Petróleo e Gás Ltda. (a privately owned Brazilian oil and natural gas company), or OGX, accounted for $80.3 million or 17% of our total consolidated gross accounts receivable balance at December 31, 2012. Our accounts receivable balance from OGX was fully reserved at September 30, 2013.

In general, before working for a customer with whom we have not had a prior business relationship and/or whose financial stability may be uncertain to us, we perform a credit review on that company. Based on that analysis, we may require that the customer present a letter of credit, prepay or provide other credit enhancements. We record a provision for bad debts on a case-by-case basis when facts and circumstances indicate that a customer receivable may not be collectible and, historically, losses on our trade receivables have been infrequent occurrences.

During the third quarter of 2013, based on our assessment of the financial condition of two customers, OGX and Niko Resources Ltd., and our expectations regarding the probability of collection of amounts due to us, we recorded $22.6 million in bad debt expense, to reserve the outstanding receivable balances from these customers. All

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outstanding receivables from these two customers have been fully reserved at September 30, 2013. Our allowance for bad debts was $28.2 million and $5.5 million at September 30, 2013 and December 31, 2012, respectively. We have not recognized any revenue associated with these two customers in the third quarter of 2013. See Note 2.

At December 31, 2012, $17.2 million in trade accounts receivable was payable to us from a 27% net profits interest, or NPI, in certain developmental oil-and-gas producing properties, which we believe is a real property interest. Our drilling program related to the NPI arrangement was completed in 2011, and the balance of the trade receivable due to us under the NPI arrangement was received in 2013. However, the customer who conveyed the NPI to us filed a voluntary petition for reorganization under Chapter 11 of the Bankruptcy Code on August 17, 2012. Certain parties (including the debtor) in the bankruptcy proceedings have questioned whether our NPI, and certain amounts we have received under it since the filing of the bankruptcy, should be included in the debtor’s estate under the bankruptcy proceeding. We have filed a declaratory judgment action in the bankruptcy court seeking a declaration that our NPI, and payments that we have received from it since the filing of the bankruptcy, are not part of the bankruptcy estate, and we will vigorously defend our rights and pursue our interests in this matter.

Fair Values

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The fair value hierarchy prescribed by GAAP requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. There are three levels of inputs that may be used to measure fair value:

Market conditions could cause an instrument to be reclassified among Levels 1, 2 and 3. Our policy regarding fair value measurements of financial instruments transferred into and out of levels is to reflect the transfers as having occurred at the beginning of the reporting period. There were no transfers between fair value levels during the nine-month periods ended September 30, 2013 and 2012.

Certain of our assets and liabilities are required to be measured at fair value on a recurring basis in accordance with GAAP. In addition, certain assets and liabilities may be recorded at fair value on a nonrecurring basis. Generally, we record assets at fair value on a nonrecurring basis as a result of impairment charges. We did not

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record any impairment charges related to assets measured at fair value on a nonrecurring basis during the three-month and nine-month periods ended September 30, 2013 and 2012.

Assets and liabilities measured at fair value are summarized below:

We believe that the carrying amounts of our other financial assets and liabilities (excluding long-term debt), which are not measured at fair value in our Consolidated Balance Sheets, approximate fair value based on the following assumptions:

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We consider our long-term debt, including current maturities, to be Level 2 liabilities under the GAAP fair value hierarchy and, accordingly, the fair value of our 5.70% Senior Notes due 2039, 5.875% Senior Notes due 2019, 4.875% Senior Notes due July 1, 2015, and 5.15% Senior Notes due September 1, 2014 was derived using a third-party pricing service at September 30, 2013 and December 31, 2012. We perform control procedures over information we obtain from pricing services and brokers to test whether prices received represent a reasonable estimate of fair value. These procedures include the review of pricing service or broker pricing methodologies and comparing fair value estimates to actual trade activity executed in the market for these instruments occurring around the report date. Fair values and related carrying values of our long-term debt instruments are shown below.

We have estimated the fair value amounts by using appropriate valuation methodologies and information available to management. Considerable judgment is required in developing these estimates, and accordingly, no assurance can be given that the estimated values are indicative of the amounts that would be realized in a free market exchange.

7. Drilling and Other Property and Equipment

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

Construction work-in-progress, including capitalized interest, at September 30, 2013 and December 31, 2012 is summarized as follows:

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. With respect to each claim or exposure, we have made an assessment, in accordance with GAAP, of the probability that the resolution of the matter would ultimately result in a loss. When we determine that an unfavorable resolution of a matter is probable and such amount of loss can be determined, we record a liability for the amount of the estimated loss at the time that both of these criteria are met. Our management believes that we have recorded adequate accruals for any liabilities that may reasonably be expected to result from these claims.

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Litigation. We are one of several unrelated defendants in lawsuits filed in state courts alleging that defendants manufactured, distributed or utilized drilling mud containing asbestos and, in our case, allowed such drilling mud to have been utilized aboard our offshore drilling rigs. The plaintiffs seek, among other things, an award of unspecified compensatory and punitive damages. The manufacture and use of asbestos-containing drilling mud had already ceased before we acquired any of the drilling rigs addressed in these lawsuits. We believe that we are not liable for the damages asserted and we expect to receive complete defense and indemnity with respect to a majority of the lawsuits from Murphy Exploration & Production Company pursuant to the terms of our 1992 asset purchase agreement with them. We also believe that we are not liable for the damages asserted in the remaining lawsuits pursuant to the terms of our 1989 asset purchase agreement with Diamond M Corporation, and we filed a declaratory judgment action in Texas state court against NuStar Energy LP, or NuStar, the successor to Diamond M Corporation, seeking a judicial determination that we did not assume liability for these claims. We obtained summary judgment on our claims in the declaratory judgment action, but NuStar appealed the trial court’s decision, and the appellate court has remanded the case to trial. 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 effect on our consolidated financial condition, results of operations and 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 and cash flows.

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 deductibles for marine liability insurance coverage, including personal injury claims, which primarily result from Jones Act liability in the Gulf of Mexico, are currently $10.0 million for the first occurrence, with no aggregate deductible, and vary in amounts ranging between $5.0 million and, if aggregate claims exceed certain thresholds, up to $100.0 million for each subsequent occurrence, depending on the nature, severity and frequency of claims which might arise during the policy year. The Jones Act is a federal law that permits seamen to seek compensation for certain injuries during the course of their employment on a vessel and governs the liability of vessel operators and marine employers for the work-related injury or death of an employee. We engage outside consultants to assist us in estimating our aggregate liability for personal injury claims based on our historical losses and utilizing various actuarial models. We allocate a portion of the aggregate liability to “Accrued liabilities” based on an estimate of claims expected to be paid within the next twelve months with the residual recorded as “Other liabilities.” At September 30, 2013, our estimated liability for personal injury claims was $35.5 million, of which $8.1 million and $27.4 million were recorded in “Accrued liabilities” and “Other liabilities,” respectively, in our Consolidated Balance Sheets. At December 31, 2012, our estimated liability for personal injury claims was $36.1 million, of which $9.9 million and $26.2 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:

Purchase Obligations

Ultra-Deepwater Floater Construction. In May 2013, we entered into an agreement with Hyundai Heavy Industries, Co., Ltd., or Hyundai, for the construction of a 10,000 foot dynamically positioned, harsh environment semisubmersible drilling rig. The Ocean GreatWhite is under construction in South Korea at an estimated cost of $755 million, including capital spares, commissioning and shipyard supervision. The contracted price to Hyundai totaling $628.5 million is payable in two installments, of which the first installment of $188.6 million has been paid. The final installment of $439.9 million is due upon delivery of the rig, which is expected to occur in the first quarter of 2016.

Drillship Construction. We are financially obligated under four separate turnkey construction contracts with Hyundai for the construction of four ultra-deepwater drillships. We expect the aggregate cost of the construction of our drillships, including commissioning, capital spares and project management costs, to be approximately $2.6

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billion. The contracted price of each drillship is payable to Hyundai in two installments, with final payment due on delivery of each drillship. We have paid the first installment for each of the four drillships, aggregating $647.6 million. The Ocean BlackHawk and Ocean BlackHornet are expected to be delivered in the fourth quarter of 2013 and in the first quarter of 2014, respectively, and, at those times, the second installment of approximately $394 million will be payable to Hyundai for each rig. The Ocean BlackRhino and Ocean BlackLion are expected to be delivered in the second and fourth quarters of 2014, respectively, at which times approximately $395 million will be payable to Hyundai for each rig.

Ocean Onyx Construction. We are obligated under a vessel modification agreement with Keppel AmFELS, L.L.C., or Keppel, for the construction of the Ocean Onyx, a moored semisubmersible deepwater rig, which is expected to be delivered in the fourth quarter of 2013. We estimate the aggregate cost for the construction of the Ocean Onyx to be approximately $335.0 million, including commissioning, capital spares and project management costs. The contracted price due to Keppel is payable in 11 installments based on the occurrence of certain events as detailed in the vessel modification agreement. To date, we have paid the first nine installments, of which $58.4 million and $65.7 million was paid in 2013 and 2012, respectively. The balance payable to Keppel under the construction agreement of $21.9 million is payable in the fourth quarter of 2013.

Ocean Apex Construction. We are obligated under a vessel modification agreement with Jurong Shipyard Pte Ltd, or Jurong, for the construction of the Ocean Apex, a moored semisubmersible deepwater rig, which is expected to be delivered in the third quarter of 2014 at an aggregate cost of approximately $370.0 million, including commissioning, capital spares and project management costs. The contracted price due to Jurong is payable in 12 installments based on the occurrence of certain events as detailed in the vessel modification agreement. We have paid the first five installments, of which $33.8 million and $27.0 million was paid in 2013 and 2012, respectively. The remaining $74.3 million in aggregate milestone payments are payable to Jurong during the remainder of 2013 and in 2014 as construction milestones are met.

Ocean Patriot Enhancements. In February 2013, we entered into a vessel modification agreement with Keppel FELS Limited, or Keppel Singapore, for enhancements to the Ocean Patriot that will enable the rig to work in the North Sea. We estimate the cost of the enhancement project to be approximately $120.0 million, including shipyard costs, owner-furnished equipment and labor, commissioning and capital spares. Construction work is expected to begin in Singapore in the fourth quarter of 2013 and to be completed in the second quarter of 2014. The contracted price due Keppel Singapore is approximately $29.0 million, payable in seven installments based on the occurrence of certain events as detailed in the vessel modification agreement. We paid the first two installments due to Keppel Singapore aggregating $10.1 million in 2013. The remaining $18.8 million in aggregate milestone payments are payable to Keppel Singapore during the remainder of 2013 and in 2014 as construction milestones are met.

At September 30, 2013 and December 31, 2012, we had no other purchase obligations for major rig upgrades or any other significant obligations, except for those related to our direct rig operations, which arise during the normal course of business.

Letters of Credit and Other. We were contingently liable as of September 30, 2013 in the amount of $70.2 million under certain performance, bid, supersedeas and custom bonds and letters of credit. Agreements relating to approximately $58.2 million of performance, supersedeas and customs bonds can require collateral at any time. As of September 30, 2013, we had not been required to make any collateral deposits with respect to these agreements. The remaining agreements cannot require collateral except in events of default. On our behalf, banks have issued letters of credit securing certain of these bonds.

9. Accumulated Other Comprehensive Gain (Loss)

The components of our AOCGL and related changes thereto are as follows:

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The following table presents the line items in our Consolidated Statements of Operations affected by reclassification adjustments out of AOCGL.

10. Segments and Geographic Area Analysis

Although we provide contract drilling services with different types of offshore drilling rigs and also provide such services in many geographic locations, we have aggregated these operations into one reportable segment based on the similarity of economic characteristics due to the nature of the revenue earnings process as it relates to the offshore drilling industry over the operating lives of our drilling rigs.

Revenues from contract drilling services by equipment type are listed below:

Geographic Areas

Our drilling rigs are highly mobile and may be moved to other markets throughout the world in response to market conditions or customer needs. At September 30, 2013, our actively-marketed drilling rigs were en route to or located offshore 13 countries in addition to the United States. Revenues by geographic area are presented by attributing revenues to the individual country or areas where the services were performed.

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11. Income Taxes

Our income tax expense is a function of the mix between our domestic and international pre-tax earnings or losses, as well as the mix of international tax jurisdictions in which we operate. Certain of our international rigs are owned and operated, directly or indirectly, by one of our wholly owned foreign subsidiaries. It is our intention to indefinitely reinvest future earnings of this subsidiary to finance foreign activities. Accordingly, we have not made a provision for U.S. income taxes on such earnings except to the extent that such earnings were immediately subject to U.S. income taxes.

During the first quarter of 2013, our tax expense was reduced by $27.5 million as a result of the American Taxpayer Relief Act of 2012, or the Act, which was signed into law on January 2, 2013. The Act extends through 2013 several expired temporary business provisions, commonly referred to as “extenders,” which were retroactively extended to the beginning of 2012. As required by GAAP, we recorded the retroactive effect of the extenders when the Act was signed into law.

Tax Returns and Examinations. We file income tax returns in the U.S. federal jurisdiction, various state jurisdictions and various foreign jurisdictions. Tax years that remain subject to examination by these jurisdictions include years 2003 to 2012. We are currently under audit in several of these jurisdictions. We do not anticipate that any adjustments resulting from the tax audit of any of these years will have a material impact on our consolidated results of operations, financial condition and cash flows.

Mexico Tax Jurisdiction. The tax authorities in Mexico previously audited our income tax returns for the years 2004 and 2006 and had issued assessments for tax years 2004 and 2006 of approximately $22.9 million and $24.4 million, respectively, including interest and penalties, which we had appealed. In 2013 the Mexican tax authorities initiated a tax amnesty program whereby income tax assessments, including penalties and interest, could be partially or completely waived. Under the tax amnesty we were able to settle our tax liabilities for the years 2004 and 2006 for a net cash cost of $3.7 million. As a result of increases in uncertain tax positions for later years, we recorded an additional $13.2 million of expense, including $5.0 million of interest and $2.7 million of penalties.

Due to the expiration of the statute of limitations in Mexico for the 2007 tax year at the end of June 2013, during the second quarter of 2013, we reversed our $4.3 million accrual for this uncertain tax position, of which $1.5 million was interest and $0.6 million was penalty.

On June 13, 2013 we received official notification that the Mexican tax authorities will be auditing the 2008 income tax return of one of our Mexican subsidiaries.

U.S. Tax Jurisdiction. In May 2013, we were notified by the Department of the Treasury that the Internal Revenue Service audit of our 2010 corporate tax return was completed without adjustment.

Brazil Tax Jurisdiction. In March 2013, the Brazilian tax authorities began an audit of our income tax returns for the years 2009 and 2010. We are continuing to defend tax assessments by the Brazilian tax authorities for the years 2000, 2004, 2005 and 2007.

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

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

We are a leader in offshore drilling, providing contract drilling services to the energy industry around the globe with a total fleet of 45 offshore drilling rigs, including seven rigs under construction. Our fleet consists of 33 semisubmersibles, three of which are under construction and an additional three of which are held for sale, seven jack-ups, one of which is held for sale, and five dynamically positioned drillships, four of which are under construction.

Several of our construction projects are nearing completion, and we expect delivery of our first new drillship, the Ocean BlackHawk, and the deepwater floater Ocean Onyx in the final quarter of 2013. During 2014, we expect delivery of our remaining three drillships, the Ocean BlackHornet, the Ocean BlackRhino and the Ocean BlackLion in the first, second and fourth quarters, respectively, and the deepwater floater Ocean Apex in the third quarter of the year. Our most recently announced project, construction of the Ocean GreatWhite, an ultra-deepwater harsh environment semisubmersible rig, is underway and is expected to be completed in the first quarter of 2016. The Ocean Onyx, Ocean BlackHawk and Ocean BlackHornet are expected to be operating under contracts in the GOM in the first, second and third quarters of 2014, respectively. The Ocean Apex has recently received a letter of intent, or LOI, for a two-well program, plus one-well option, in the Southeast Asia market beginning in the third quarter of 2014. The LOI is subject to customary conditions, including execution of a definitive agreement. The Ocean GreatWhite is contracted for future operations offshore the coast of southern Australia commencing in the second half of 2016. The Ocean BlackRhino and Ocean BlackLion are not yet contracted.

Construction work pursuant to the North Sea rig enhancement project for the Ocean Patriot is expected to commence in the final quarter of 2013 in Singapore. Upon completion, the rig will then mobilize to the United Kingdom, or U.K., sector of the North Sea, for a contract commencing in the second quarter of 2014.

Market Overview

Floater Markets

Ultra-Deepwater and Deepwater Floaters. The ultra-deepwater and deepwater floater markets are generally firm. Regionally, the Golden Triangle, defined by the offshore drilling industry as the offshore basins of West Africa, Brazil and the Gulf of Mexico, continues to be an area of significant ultra-deepwater and deepwater activity. Demand currently remains strong for ultra-deepwater rigs offshore West Africa, primarily in Angola and Nigeria, where discoveries in the pre-salt formations have led to increased interest in the region. On the Outer Continental Shelf of the United States, or U.S., Gulf of Mexico, or GOM, drilling activity has surpassed pre-Macondo levels, and industry analysts predict that the market will remain strong in the near term, particularly in the ultra-deepwater market. Demand for ultra-deepwater and deepwater rigs offshore Brazil currently remains strong.

However, we believe that the offshore drilling industry will be challenged in the future by expected newbuild rig deliveries, which are expected to increase competition and could result in downward pressure on dayrates if demand does not remain balanced with expected supply. Since 2010, the outlook for the ultra-deepwater and deepwater markets has led to a significant number of orders for newbuild floaters by established drilling contractors as well as new entrants to the industry. As of the date of this report, the total number of announced newbuild floaters exceeds 100 rigs, including an estimated 28 rigs potentially to be built on behalf of Petróleo Brasileiro S.A. Excluding these customer-ordered rigs, 38 of the 62 newbuilds scheduled for delivery in 2014 through 2016 are not yet contracted for future work, including two of our four rigs expected to be delivered in 2014.

In addition, we believe that the offshore drilling industry will continue to be challenged by growing regulatory demands and more complex customer specifications, which could disadvantage the marketability of some lower specification rigs. Customer requirements in certain markets could result in the migration of some ultra-deepwater rigs to work in deepwater, and likewise, some deepwater rigs to displace mid-water units.

Mid-Water Floaters. Strength in the mid-water market varies significantly by region, but overall remains balanced. In both the U.K. and Norway sectors of the North Sea, the mid-water market continues to be quite

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strong. Increasing operator interest in frontier markets across Southeast Asia and South America, including Myanmar, Peru, Nicaragua, Trinidad and Tobago, and Colombia indicates possible future strengthening in those regions. In the GOM, demand for mid-water units is limited, while in Brazil, demand is moderating.

Jack-up Market

We are a small participant in the jack-up market and have a limited view of overall market conditions. We have four jack-up rigs working under long-term contracts in the Mexican waters of the Gulf of Mexico, where contract renewals indicate strong demand. Our sole marketed jack-up rig in the U.S. Gulf of Mexico works well-to-well for smaller operators under short-term commitments.

See “– Contract Drilling Backlog” for future commitments of our rigs during the remainder of 2013 through 2019.

Contract Drilling Backlog

The following table reflects our contract drilling backlog as of October 23, 2013, February 1, 2013 (the date reported in our Annual Report on Form 10-K for the year ended December 31, 2012), and October 17, 2012 (the date reported in our Quarterly Report on Form 10-Q for the quarter ended September 30, 2012). Contract drilling backlog as presented below includes only firm commitments (typically represented by signed contracts) and is calculated by multiplying the contracted operating dayrate by the firm contract period and adding one-half of any potential rig performance bonuses. Our calculation also assumes full utilization of our drilling equipment for the contract period (excluding scheduled shipyard and survey days); however, the amount of actual revenue earned and the actual periods during which revenues are earned will be different than the amounts and periods shown in the tables below due to various factors. Utilization rates, which generally approach 92-98% during contracted periods, can be adversely impacted by downtime due to various operating factors including, but not limited to, weather conditions and unscheduled repairs and maintenance. Contract drilling backlog excludes revenues for mobilization, demobilization, contract preparation and customer reimbursables. No revenue is generally earned during periods of downtime for regulatory surveys. Changes in our contract drilling backlog between periods are a function of the performance of work on term contracts, as well as the extension or modification of existing term contracts and the execution of additional contracts.

Our contract drilling backlog, as of October 23, 2013, was $7.4 billion and no longer includes an aggregate approximately $531.0 million in previously reported contracted backlog, for the fourth quarter of 2013 through 2016, associated with certain contracts for four of our rigs due to uncertainty associated with realizing this backlog.

Contract drilling backlog for our mid-water and ultra-deepwater floaters no longer includes approximately $47.0 million and $434.0 million of previously reported backlog attributable to future work for the Ocean Lexington and the Ocean Monarch, respectively, for Niko Resources Ltd., or Niko. As of the date of this report, $0.7 million and $34.2 million owed to us at September 30, 2013 by Niko in respect of the Ocean Lexington and the Ocean Monarch, respectively, was past due and has been fully reserved. We have notified Niko that it is delinquent in its payment obligations under the contract for the Ocean Monarch. We are in discussions with Niko regarding payment and their obligations under the contracts for these rigs. The Ocean Lexington is currently working in Trinidad for a consortium of companies, including Niko. Expected utilization of the rig by Niko over the term of this agreement has been excluded from contracted backlog as of October 23, 2013. The Ocean Monarch is currently idle while we attempt to negotiate a repayment plan for amounts owed to us and determine Niko’s future commitment to the rig, which may include subletting to another customer or termination to allow newly contracted work for another customer. We do not believe that it is likely that the Ocean Monarch would be back on dayrate before the second quarter of 2014 due to the amount of customer lead time typically required for rigs with these specifications.

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Contract drilling backlog for our mid-water and deepwater floaters no longer includes approximately $22.0 million and $28.0 million in previously reported backlog for the Ocean Quest and the Ocean Star, respectively. As of the date of this report, $57.9 million owed to us at September 30, 2013 by OGX Petróleo e Gás Ltda., or OGX, was past due. The Ocean Quest contract has been terminated, and the rig has been released and is mobilizing to Singapore. The Ocean Star has been sublet to another customer for the remaining duration of the existing contract with OGX for this rig. See “—Results of Operations— Overview—Revenue Not Recognized and Bad Debt Expense.”

The following table reflects the amount of our contract drilling backlog by year as of October 23, 2013.