UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2008

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ________ to ________

DIAMOND OFFSHORE DRILLING, INC.

(Exact name of registrant as specified in its charter)

Delaware		76-0321760
(State or other jurisdiction of incorporation		(I.R.S. Employer
or organization)		Identification No.)

15415 Katy Freeway
Houston, Texas
77094
(Address of principal executive offices)
(Zip Code)
(281) 492-5300
(Registrant’s telephone number, including area code)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ   No o

     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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer þ		Accelerated filer o	Non-accelerated filer o (Do not check if a smaller reporting company)			Smaller reporting company o

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o   No þ

     Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

     As of October 24, 2008     Common stock, $0.01 par value per share                     139,001,050 shares

 

 

DIAMOND OFFSHORE DRILLING, INC.

TABLE OF CONTENTS FOR FORM 10-Q

QUARTER ENDED SEPTEMBER 30, 2008

		PAGE NO.
COVER PAGE			1
TABLE OF CONTENTS			2
PART I. FINANCIAL INFORMATION			3
ITEM 1. Financial Statements (Unaudited)
Consolidated Balance Sheets			3
Consolidated Statements of Operations			4
Consolidated Statements of Cash Flows			5
Notes to Consolidated Financial Statements			6
ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			18
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk			42
ITEM 4. Controls and Procedures			44
PART II. OTHER INFORMATION			45
ITEM 6. Exhibits			45
SIGNATURES			46
EXHIBIT INDEX			47
EX-10.1
EX-31.1
EX-31.2
EX-32.1

PART I. FINANCIAL INFORMATION

ITEM 1. Financial Statements.

DIAMOND OFFSHORE DRILLING, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands, except per share data)

		September 30,				December 31,
		2008				2007
ASSETS
Current assets:
Cash and cash equivalents		$	635,442			$	637,961
Marketable securities			1,138				1,301
Accounts receivable			708,108				522,808
Prepaid expenses and other current assets			137,176				103,120
Total current assets			1,481,864				1,265,190
Drilling and other property and equipment, net of accumulated depreciation			3,321,529				3,040,063
Other assets			43,891				36,212
Total assets		$	4,847,284			$	4,341,465
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current portion of long-term debt		$	—			$	3,563
Accounts payable			76,525				132,243
Accrued liabilities			310,630				235,521
Taxes payable			74,199				81,684
Total current liabilities			461,354				453,011
Long-term debt			503,219				503,071
Deferred tax liability			431,056				397,629
Other liabilities			119,596				110,687
Total liabilities			1,515,225				1,464,398
Commitments and contingencies (Note 10)			—				—
Stockholders’ equity:
Common stock (par value $0.01, 500,000,000 shares authorized, 143,917,850 shares issued and 139,001,050 shares outstanding at September 30, 2008; 143,787,206 shares issued and 138,870,406 shares outstanding at December 31, 2007)			1,439				1,438
Additional paid-in capital			1,843,768				1,831,492
Retained earnings			1,601,248				1,158,535
Accumulated other comprehensive gain			17				15
Treasury stock, at cost (4,916,800 shares at September 30, 2008 and December 31, 2007)			(114,413	)			(114,413	)
Total stockholders’ equity			3,332,059				2,877,067
Total liabilities and stockholders’ equity		$	4,847,284			$	4,341,465

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

DIAMOND OFFSHORE DRILLING, INC. AND SUBSIDIARIES

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

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2008				2007				2008				2007
Revenues:
Contract drilling		$	881,953			$	628,246			$	2,588,919			$	1,854,085
Revenues related to reimbursable expenses			18,423				15,716				51,931				46,936
Total revenues			900,376				643,962				2,640,850				1,901,021
Operating expenses:
Contract drilling			314,273				280,226				872,716				714,624
Reimbursable expenses			18,126				15,458				50,660				45,435
Depreciation			72,014				57,565				211,725				171,605
General and administrative			13,944				13,105				45,434				37,245
Gain on disposition of assets			(228	)			(363	)			(505	)			(5,418	)
Casualty loss			6,281				—				6,281				—
Total operating expenses			424,410				365,991				1,186,311				963,491
Operating income			475,966				277,971				1,454,539				937,530
Other income (expense):
Interest income			3,055				8,735				10,369				26,127
Interest expense			(2,989	)			(2,334	)			(6,226	)			(16,959	)
Gain on sale of marketable securities, net			677				1,763				674				1,755
Other, net			(29,143	)			2,112				(14,947	)			2,517
Income before income tax expense			447,566				288,247				1,444,409				950,970
Income tax expense			(136,916	)			(82,724	)			(426,851	)			(269,370	)
Net income		$	310,650			$	205,523			$	1,017,558			$	681,600
Income per share:
Basic		$	2.23			$	1.48			$	7.32			$	4.96
Diluted		$	2.23			$	1.48			$	7.32			$	4.93
Weighted-average shares outstanding:
Shares of common stock			139,001				138,683				138,945				137,484
Dilutive potential shares of common stock			90				307				131				1,432
Total weighted-average shares outstanding			139,091				138,990				139,076				138,916

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

DIAMOND OFFSHORE DRILLING, INC. AND SUBSIDIARIES

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

		Nine Months Ended
		September 30,
		2008				2007
Operating activities:
Net income		$	1,017,558			$	681,600
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation			211,725				171,605
Gain on disposition of assets			(505	)			(5,418	)
Casualty loss			6,281				—
Gain on sale of marketable securities, net			(674	)			(1,755	)
Deferred tax provision			33,933				10,583
Accretion of discounts on marketable securities			(1,631	)			(9,233	)
Amortization/write-off of debt issuance costs			416				9,231
Amortization of debt discounts			181				178
Stock-based compensation expense			4,570				3,266
Excess tax benefits from stock-based payment arrangements			(1,392	)			(4,280	)
Deferred income, net			11,119				17,041
Deferred expenses, net			(21,842	)			(20,229	)
Other items, net			(4,197	)			2,167
Changes in operating assets and liabilities:
Accounts receivable			(184,300	)			24,905
Prepaid expenses and other current assets			(17,085	)			(33,939	)
Accounts payable and accrued liabilities			(14,772	)			4,994
Taxes payable			(60	)			22,777
Net cash provided by operating activities			1,039,325				873,493
Investing activities:
Capital expenditures			(487,662	)			(451,331	)
Proceeds from disposition of assets, net of disposal costs			2,802				7,658
Proceeds from sale and maturities of marketable securities			1,293,742				2,314,111
Purchases of marketable securities			(1,291,271	)			(2,377,377	)
Proceeds from settlement of forward contracts			11,141				4,889
Net cash used in investing activities			(471,248	)			(502,050	)
Financing activities:
Payment of dividends			(573,917	)			(605,316	)
Proceeds from stock plan exercises			2,002				9,522
Excess tax benefits from stock-based payment arrangements			1,392				4,280
Redemption of 1.5% Debentures			(73	)			—
Net cash used in financing activities			(570,596	)			(591,514	)
Net change in cash and cash equivalents			(2,519	)			(220,071	)
Cash and cash equivalents, beginning of period			637,961				524,698
Cash and cash equivalents, end of period		$	635,442			$	304,627

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

DIAMOND OFFSHORE DRILLING, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1. General Information

     The unaudited consolidated financial statements of Diamond Offshore Drilling, Inc. and subsidiaries, which we refer to as “Diamond Offshore,” “we,” “us” or “our,” should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2007 (File No. 1-13926).

     As of October 24, 2008, Loews Corporation, or Loews, 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, or SEC. 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 and statements of cash flows at the dates and for the periods indicated. Results of operations for interim periods are not necessarily indicative of results of operations for the respective full years.

Cash and Cash Equivalents, Marketable Securities

     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. See Note 5.

     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 gains (losses)” until realized. The cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity and such adjustments are included in our Consolidated Statements of Operations in “Interest income.” The sale and purchase of 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).”

Derivative Financial Instruments

     At September 30, 2008, our derivative financial instruments included foreign currency forward exchange contracts. See Notes 4 and 5.

Supplementary Cash Flow Information

     We paid interest on long-term debt totaling $25.1 million and $25.2 million for the nine months ended September 30, 2008 and 2007, respectively.

     We paid $330.0 million and $224.0 million in U.S. income taxes during the nine months ended September 30, 2008 and 2007, respectively. We paid $86.0 million and $27.5 million in foreign income taxes, net of foreign tax refunds, during the nine months ended September 30, 2008 and 2007, respectively.

     Cash payments for capital expenditures for the nine months ended September 30, 2008, included $43.0 million of capital expenditures that were accrued but unpaid at December 31, 2007. Cash payments for capital expenditures

for the nine months ended September 30, 2007 included $41.4 million of capital expenditures that were accrued but unpaid at December 31, 2006. Capital expenditures that were accrued but not paid as of September 30, 2008, totaled $53.4 million. We have included this amount in “Accrued liabilities” in our Consolidated Balance Sheets at September 30, 2008.

     We recorded income tax benefits of $1.7 million and $5.5 million related to employee stock plan exercises during the nine months ended September 30, 2008 and 2007, respectively.

     During the nine months ended September 30, 2008, the holders of $3.5 million in aggregate principal amount of our 1.5% Senior Convertible Debentures Due 2031, or 1.5% Debentures, and the holders of approximately $33,000 accreted, or carrying, value through the date of conversion of our Zero Coupon Convertible Debentures due 2020, or Zero Coupon Debentures, elected to convert their outstanding debentures into shares of our common stock. See Note 9.

     During the nine months ended September 30, 2007, the holders of $450.5 million in aggregate principal amount of our 1.5% Debentures and the holders of $1.5 million accreted, or carrying, value through the date of conversion of our Zero Coupon Debentures elected to convert their outstanding debentures into shares of our common stock.

Capitalized Interest

     We capitalize interest cost for the construction and upgrade of qualifying assets. During the nine months ended September 30, 2008 and 2007, we capitalized interest on qualifying expenditures related to the upgrade of the Ocean Monarch for ultra-deepwater service and the construction of our two jack-up rigs, the Ocean Scepter (through its completion in August 2008) and the Ocean Shield (through its completion in May 2008). In addition, we capitalized interest costs on qualifying expenditures related to the upgrade of the Ocean Endeavor through completion of the upgrade in March 2007.

     A reconciliation of our total interest cost to “Interest expense” as reported in our Consolidated Statements of Operations is as follows:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2008				2007				2008				2007
						(In thousands)
Total interest cost including amortization of debt issuance costs		$	6,942			$	6,943			$	20,993			$	30,083
Capitalized interest			(3,953	)			(4,609	)			(14,767	)			(13,124	)
Total interest expense as reported		$	2,989			$	2,334			$	6,226			$	16,959

Debt Issuance Costs

     Debt issuance costs are included in our Consolidated Balance Sheets in “Prepaid expenses and other current assets” and “Other assets,” depending on the maturity of the associated debt, and are amortized over the respective terms of the related debt. Interest expense for the nine months ended September 30, 2008 included $84,000 in debt issuance costs that we wrote off in connection with the conversions and final redemption of our 1.5% Debentures during 2008. There were no debt issuance costs written off during the three months ended September 30, 2008. Interest expense for the three and nine months ended September 30, 2007 included $4,000 and $8.9 million, respectively, in debt issuance costs that were written off in connection with conversions of our 1.5% Debentures and Zero Coupon Debentures during the respective periods of 2007.

Treasury Stock

     Depending on market conditions, we may, from time to time, purchase shares of our common stock in the open market or otherwise. We account for the purchase of treasury stock using the cost method, which reports the cost of the shares acquired in “Treasury stock” as a deduction from stockholders’ equity in our Consolidated Balance Sheets. We did not repurchase any shares of our outstanding common stock during the nine months ended September 30, 2008 or 2007.

Comprehensive Income

     A reconciliation of net income to comprehensive income is as follows:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2008				2007				2008				2007
						(In thousands)
Net income		$	310,650			$	205,523			$	1,017,558			$	681,600
Other comprehensive gains (losses), net of tax:
Pension adjustment upon plan termination			—				—				—				4,526
Unrealized holding (loss) gain on investments			(4	)			94				14				179
Reclassification adjustment for gain included in net income			(12	)			—				(12	)			(191	)
Comprehensive income		$	310,634			$	205,617			$	1,017,560			$	686,114

     The tax related to the change in unrealized holding loss on investments for the three months ended September 30, 2008 was approximately $2,000. The tax related to the change in unrealized holding gain on investments for the nine months ended September 30, 2008 was approximately $8,000. The tax effect on the reclassification adjustment for net losses included in net income was approximately $6,000 for the three and nine months ended September 30, 2008.

     The tax related to the change in unrealized holding loss on investments was approximately $50,000 for the three months ended September 30, 2007. The tax related to the change in unrealized holding gains on investments was approximately $96,000 for the nine months ended September 30, 2007. The tax effect on the reclassification adjustment for net gains included in net income was approximately $103,000 for the nine months ended September 30, 2007. The tax related to the pension adjustment upon plan termination for the nine months ended September 30, 2007 was $2.4 million.

Foreign Currency

     Our functional currency is the U.S. dollar. Foreign currency transaction gains and losses, including gains and losses on our foreign currency forward exchange contracts, are reported as “Other income (expense)” in our Consolidated Statements of Operations. For the three and nine months ended September 30, 2008, we recognized net foreign currency exchange losses of $29.0 million and $14.6 million, respectively. For the three and nine months ended September 30, 2007, we recognized net foreign currency exchange gains of $2.1 million and $2.4 million, respectively. See Note 4.

Revenue Recognition

     Revenue from our dayrate drilling contracts is recognized as services are performed. In connection with such drilling contracts, we may receive fees (either lump-sum or dayrate) for the mobilization of equipment. These fees are earned 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 estimated to be benefited from the mobilization activity). Straight line amortization of mobilization revenues and related costs over the initial 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 as incurred.

     From time to time, we may receive fees from our customers for capital improvements to our rigs. 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 asset.

     We record reimbursements received for the purchase of supplies, equipment, personnel services and other services provided at the request of our customers in accordance with a contract or agreement, for the gross amount

billed to the customer, as “Revenues related to reimbursable expenses” in our Consolidated Statements of Operations.

Use of Estimates in the Preparation of Financial Statements

     The preparation of financial statements in conformity with 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.

     Previously reported amounts for “Reimbursable expenses” in our Consolidated Statements of Operations for the three and nine months ended September 30, 2007 have been adjusted to include $1.9 million and $5.2 million, respectively, in reimbursable catering expense to conform to the current year presentation. These amounts were previously reported as “Contract drilling” expense in our Consolidated Statements of Operations. This reclassification had no effect on total operating expenses, operating income or net income for the three and nine months ended September 30, 2007.

Recent Accounting Pronouncements

     In May 2008, the Financial Accounting Standards Board, or FASB, issued FASB Staff Position, or FSP, Accounting Principles Board, or APB, 14-1, “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement),” or FSP APB 14-1. FSP APB 14-1 applies to convertible debt instruments that, by their stated terms, may be settled in cash upon conversion (including partial cash settlement). The FSP requires bifurcation of the instrument into a debt component that is initially valued at fair value and an equity component. The debt component is accreted to par value using the effective yield method, and accretion is reported as a component of interest expense. The equity component is not subsequently revalued as long as it continues to qualify for equity treatment. FSP APB 14-1 is effective for fiscal years beginning after December 15, 2008 and interim periods within those fiscal years on a retrospective basis for all periods presented. We are currently evaluating the impact that adopting FSP APB 14-1 will have on our results of operations and financial position.

     In March 2008, the FASB issued Statement of Financial Accounting Standards, or SFAS, No. 161, “Disclosures about Derivative Instruments and Hedging Activities,” or SFAS 161. SFAS 161 changes the reporting requirements for derivative instruments and hedging activities under SFAS No. 133, “Accounting for Derivatives and Hedging Activities,” or SFAS 133, by requiring enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments are accounted for under SFAS 133 and (c) the effect of derivative instruments and hedging activities on an entity’s financial position, financial performance and cash flows. SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008; however, early application is encouraged. We are in the process of reviewing the enhanced disclosure requirements under SFAS 161.

2. Earnings Per Share

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

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2008				2007				2008				2007
						(In thousands, except per share data)
Net income – basic (numerator):		$	310,650			$	205,523			$	1,017,558			$	681,600
Effect of dilutive potential shares
1.5% Debentures			—				8				15				3,388
Zero Coupon Debentures			9				6				17				45
Net income including conversions – diluted (numerator)		$	310,659			$	205,537			$	1,017,590			$	685,033
Weighted average shares – basic (denominator):			139,001				138,683				138,945				137,484
Effect of dilutive potential shares
1.5% Debentures			—				194				25				1,320
Zero Coupon Debentures			52				52				52				55
Stock options/SARs			38				61				54				57
Weighted average shares including conversions – diluted (denominator)			139,091				138,990				139,076				138,916
Earnings per share:
Basic		$	2.23			$	1.48			$	7.32			$	4.96
Diluted		$	2.23			$	1.48			$	7.32			$	4.93

     Our computation of diluted earnings per share, or EPS, for the three and nine months ended September 30, 2008 excludes 247,042 and 182,037 stock appreciation rights, or SARs, respectively. The inclusion of such potentially dilutive shares in the computation of diluted EPS would have been antidilutive for the periods presented.

     Our computation of diluted EPS for the three months ended September 30, 2007 excludes 172,494 SARs. Our computation of diluted EPS for the nine months ended September 30, 2007 excludes stock options representing 30,666 shares of common stock and 171,878 SARs. The inclusion of such potentially dilutive shares in the computation of diluted EPS would have been antidilutive for the periods presented.

3. 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 5.

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

		September 30, 2008
		Amortized				Unrealized				Market
		Cost				Gain				Value
		(In thousands)
Mortgage-backed securities		$	1,112			$	26			$	1,138

		December 31, 2007
		Amortized				Unrealized				Market
		Cost				Gain				Value
		(In thousands)
Mortgage-backed securities		$	1,277			$	24			$	1,301

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

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2008				2007				2008				2007
						(In thousands)
Proceeds from sales		$	643,720			$	992,392			$	743,742			$	1,689,111
Proceeds from maturities			—				175,000				550,000				625,000
Gross realized gains			680				1,768				680				1,810
Gross realized losses			(3	)			(5	)			(6	)			(55	)

4. 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 and purchases from foreign suppliers. We utilize foreign exchange forward contracts to reduce our forward exchange risk. Our foreign currency forward exchange contracts may obligate us to exchange predetermined amounts of foreign currencies on specified dates or to net settle the spread between the contracted foreign currency exchange rate and the spot rate on the contract settlement date, which for certain contracts is the average spot rate for the contract period.

     During the three and nine months ended September 30, 2008, we settled several of our obligations under various foreign currency forward exchange contracts, which resulted in net realized gains totaling $3.6 million and $11.2 million, respectively. During the three and nine months ended September 30, 2007, we recognized net realized gains of $1.4 million and $4.9 million, respectively, on settlement of foreign currency forward exchange contracts during the period. As of September 30, 2008, we had foreign currency forward exchange contracts outstanding, in the aggregate notional amount of $309.5 million, consisting of $70.7 million in Australian dollars, $88.9 million in Brazilian reais, $104.9 million in British pounds sterling, $25.3 million in Mexican pesos and $19.7 million in Norwegian kroner. These contracts settle at various times through June 2009. See Note 5.

     These forward contracts are derivatives as defined by SFAS 133. SFAS 133 requires that each derivative be 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 hedge accounting, the gains and losses are reflected in income in the same period as offsetting losses and gains on the qualifying hedged positions. We did not seek hedge accounting treatment for these contracts in accordance with SFAS 133. Therefore, we recorded net pre-tax unrealized losses of $28.7 million

and $19.1 million in our Consolidated Statements of Operations for the three and nine months ended September 30, 2008, respectively, as “Other income (expense)” to adjust the carrying value of these derivative financial instruments to their fair value. At September 30, 2008, we have presented the fair value of our outstanding foreign currency forward exchange contracts as a current asset of $0.5 million in “Prepaid expenses and other current assets” and a current liability of $(19.6) million in “Accrued liabilities” in our Consolidated Balance Sheets.

     We recorded a net pre-tax unrealized gain of $0.6 million and a pre-tax net unrealized loss of $12,000 for the three and nine months ended September 30, 2007, respectively, as “Other income (expense)” to adjust the carrying value of our derivative financial instruments held at September 30, 2007 to their fair value.

5. Fair Value Disclosures

     Effective January 1, 2008, we adopted SFAS No. 157, “Fair Value Measurements,” or SFAS 157, which requires additional disclosures about our assets and liabilities that are measured at fair value. SFAS 157 defines fair value 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. SFAS 157 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

Level 1		Quoted prices for identical instruments in active markets. Level 1 assets include short-term investments such as money market funds and U.S. Treasury Bills. Our Level 1 assets at September 30, 2008 included $607.0 million in cash held in money market funds.
Level  2		Quoted market prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets. Level 2 assets and liabilities include over-the-counter foreign currency forward exchange contracts that are valued using model-derived valuation techniques and mortgage-backed securities.
Level 3		Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable. Level 3 assets and liabilities generally include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation or for which there is a lack of transparency as to the inputs used.

Assets and liabilities measured at fair value on a recurring basis are summarized below:

		September 30, 2008
		Fair Value Measurements Using												Assets at Fair
		Level 1				Level 2				Level 3				Value
		(In thousands)
Assets:
Short-term investments		$	606,983			$	—			$	—			$	606,983
Mortgage-backed securities			—				1,138				—				1,138
Forward exchange contracts			—				471				—				471
Total assets		$	606,983			$	1,609			$	—			$	608,592
Liabilities:
Forward exchange contracts		$	—			$	(19,623	)		$	—			$	(19,623	)

6. Prepaid Expenses and Other Current Assets

     Prepaid expenses and other current assets consist of the following:

		September 30,				December 31,
		2008				2007
		(In thousands)
Rig spare parts and supplies		$	51,043			$	50,699
Deferred mobilization costs			34,261				17,295
Prepaid insurance			19,173				11,444
Deferred tax assets			9,006				9,006
Vendor prepayments			6,161				7,296
Deposits			3,935				2,292
Prepaid taxes			8,875				1,681
Foreign currency forward exchange contracts			471				2
Other			4,251				3,405
Total		$	137,176			$	103,120

7. Drilling and Other Property and Equipment

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

		September 30,				December 31,
		2008				2007
		(In thousands)
Drilling rigs and equipment		$	5,181,993			$	4,540,797
Construction work-in-progress			293,362				453,093
Land and buildings			27,529				24,123
Office equipment and other			32,729				29,742
Cost			5,535,613				5,047,755
Less: accumulated depreciation			(2,214,084	)			(2,007,692	)
Drilling and other property and equipment, net		$	3,321,529			$	3,040,063

     Construction work-in-progress at September 30, 2008 consisted of $293.4 million related to the major upgrade of the Ocean Monarch to ultra-deepwater service including accrued capital expenditures aggregating $39.0 million related to this project. We anticipate that the upgrade of the Ocean Monarch will be completed in late 2008. Construction of our two new jack-up rigs Ocean Shield and Ocean Scepter was completed in the second quarter and third quarter of 2008, respectively.

8. Accrued Liabilities

     Accrued liabilities consist of the following:

		September 30,				December 31,
		2008				2007
		(In thousands)
Accrued project/upgrade expenses		$	113,012			$	95,778
Payroll and benefits			72,020				52,975
Deferred revenue			42,445				36,134
Foreign currency forward exchange contracts			19,623				94
Personal injury and other claims			10,180				8,692
Hurricane related expenses			5,080				1,380
Interest payable			4,120				10,413
Other			44,150				30,055
Total		$	310,630			$	235,521

9. Long-Term Debt

     Long-term debt consists of the following:

		September 30,				December 31,
		2008				2007
		(In thousands)
Zero Coupon Debentures (due 2020)		$	4,002			$	3,931
1.5% Debentures (due 2031)			—				3,563
5.15% Senior Notes (due 2014)			249,608				249,566
4.875% Senior Notes (due 2015)			249,609				249,574
							506,634
Less: Current maturities			—				3,563
Total		$	503,219			$	503,071

     The aggregate maturities of long-term debt for each of the five years subsequent to September 30, 2008 are as follows:

(In thousands)
2008		$	—
2009			—
2010			4,002
2011			—
2012			—
Thereafter			499,217
Total		$	503,219

     Debt Conversions. During the period from January 1, 2008 to April 14, 2008, the holders of $3.5 million in aggregate principal amount of our 1.5% Debentures elected to convert their outstanding debentures into shares of our common stock. We issued 71,144 shares of our common stock pursuant to these conversions. On April 15, 2008, we completed the redemption of all of our outstanding 1.5% Debentures, and, as a result, redeemed for cash the remaining $73,000 aggregate principal amount of our 1.5% Debentures.

     During the first nine months of 2008, the holders of approximately $33,000 accreted, or carrying, value through the date of conversion of our Zero Coupon Debentures elected to convert their outstanding debentures into shares of our common stock. We issued 430 shares of our common stock pursuant to these conversions during the first nine months of 2008. The aggregate principal amount at maturity of our Zero Coupon Debentures converted during the nine months ended September 30, 2008 was $50,000.

     At September 30, 2008, there was $6.0 million aggregate principal amount at maturity, or $4.0 million accreted, or carrying, value, of our Zero Coupon Debentures outstanding.

10. Commitments and Contingencies

     Various claims have been filed against us in the ordinary course of business, including claims by offshore workers alleging personal injuries. In accordance with SFAS No. 5, “Accounting for Contingencies,” we have assessed each claim or exposure to determine the likelihood that the resolution of the matter might ultimately result in an adverse effect on our financial condition, results of operations and cash flows. When we determine that an unfavorable resolution of a matter is probable and such amount of loss can be determined, we record a reserve for the estimated loss at the time that both of these criteria are met. Our management believes that we have established adequate reserves for any liabilities that may reasonably be expected to result from these claims.

     Litigation. We are a defendant in a lawsuit filed in January 2005 in the U.S. District Court for the Eastern District of Louisiana on behalf of Total E&P USA, Inc. and several oil companies alleging that our semisubmersible rig, the Ocean America, damaged a natural gas pipeline in the Gulf of Mexico during Hurricane Ivan. The plaintiffs seek damages from us including, but not limited to, loss of revenue, that are currently estimated to be in excess of $100 million, together with interest, attorneys’ fees and costs. We deny any liability for plaintiffs’ alleged loss.

     We are one of several unrelated defendants in lawsuits filed in the Circuit Courts of the State of Mississippi 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. We expect to receive complete defense and indemnity from Murphy Exploration & Production Company pursuant to the terms of our 1992 asset purchase agreement with them.

     Various other claims have been filed against us in the ordinary course of business. In the opinion of our management, the pending or known threatened claims, actions or proceedings against us are not expected to have a material adverse effect on our consolidated financial position, results of operations and cash flows.

     Other. Our operations in Brazil have exposed us to various claims and assessments related to our personnel, customs duties and municipal taxes, among other things, that have arisen in the ordinary course of business. At September 30, 2008, our loss reserves related to our Brazilian operations aggregated $6.3 million, of which $2.0 million and $4.3 million were recorded in “Accrued liabilities” and “Other liabilities,” respectively, in our Consolidated Balance Sheets. Loss reserves related to our Brazilian operations totaled $8.5 million at December 31, 2007, of which $1.9 million was recorded in “Accrued liabilities” and $6.6 million was recorded in “Other liabilities” in our Consolidated Balance Sheets.

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

     Personal Injury Claims. Our deductible for liability coverage for personal injury claims, which primarily results from Jones Act liability in the Gulf of Mexico, is $5.0 million per occurrence, with no aggregate deductible. 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 estimate our aggregate reserve for personal injury claims based on our historical losses and utilizing various actuarial models. At September 30, 2008, our estimated liability for personal injury claims was $29.9 million, of which $9.5 million and $20.4 million were recorded in “Accrued liabilities” and “Other liabilities,” respectively, in our Consolidated Balance Sheets. At December 31, 2007, we had recorded loss reserves for personal injury claims aggregating $32.0 million, of which $8.5 million and $23.5 million were recorded in “Accrued liabilities” and “Other liabilities,” respectively, in our Consolidated Balance Sheets. The eventual settlement or adjudication of these claims could differ materially from our estimated amounts due to uncertainties such as:

	•		the severity of personal injuries claimed;
	•		significant changes in the volume of personal injury claims;
	•		the unpredictability of legal jurisdictions where the claims will ultimately be litigated;
	•		inconsistent court decisions; and
	•		the risks and lack of predictability inherent in personal injury litigation.

     Purchase Obligations. As of September 30, 2008, we had purchase obligations aggregating approximately $61 million related to the major upgrade of the Ocean Monarch. We expect to complete funding of this project in 2008. However, the actual timing of these expenditures will vary based on the completion of various construction milestones, which are beyond our control.

     We had no other purchase obligations for major rig upgrades or any other significant obligations at September 30, 2008, except for those related to our direct rig operations, which arise during the normal course of business.

11. 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 among all divisions and locations, including the nature of services provided and the type of customers of such services, in accordance with SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information.”

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

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2008				2007				2008				2007
						(In thousands)
High Specification Floaters		$	344,024			$	258,679			$	979,313			$	769,087
Intermediate Semisubmersibles			401,891				255,795				1,239,711				725,753
Jack-ups			136,038				113,772				369,895				359,245
Total contract drilling revenues			881,953				628,246				2,588,919				1,854,085
Revenues related to reimbursable expenses			18,423				15,716				51,931				46,936
Total revenues		$	900,376			$	643,962			$	2,640,850			$	1,901,021

Geographic Areas

     At September 30, 2008, our drilling rigs were located offshore eleven countries in addition to the United States. As a result, we are exposed to the risk of changes in social, political and economic conditions inherent in international operations and our results of operations and the value of our international assets are affected by fluctuations in foreign currency exchange rates. Revenues by geographic area are presented by attributing revenues to the individual country or areas where the services were performed.

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2008				2007				2008				2007
		(In thousands)
United States		$	369,410			$	315,626			$	1,088,971			$	1,004,376
International:
Europe/Africa/Mediterranean			166,741				126,741				476,349				346,485
South America			150,711				61,174				436,315				292,352
Australia/Asia/Middle East			131,999				110,610				386,767				165,912
Mexico			81,515				29,811				252,448				91,896
Total revenues		$	900,376			$	643,962			$	2,640,850			$	1,901,021

12. Casualty Loss

     In September 2008, the Ocean Tower sustained significant damage during Hurricane Ike, which impacted the Gulf of Mexico and the upper Texas and Louisiana Gulf coasts. The Ocean Tower lost its derrick, drill floor and drill floor equipment during the hurricane, and we expect the drilling rig to be out of drilling service through the third quarter of 2009. We have not yet made a final assessment of the estimated costs to repair the Ocean Tower nor have we determined whether or not we will have an insurable loss related to this rig. During the third quarter of 2008, we wrote off the net book value of the derrick, drill floor and drill floor equipment for the Ocean Tower of approximately $2.6 million and accrued $3.7 million in estimated salvage costs for the recovery of equipment from the ocean floor. The aggregate of these items is reflected in “Casualty Loss” in our Consolidated Statements of Operations for the three and nine months ended September 30, 2008.

     We are currently assessing damages to our remaining drilling fleet within the impacted areas, as well as our shorebase facilities in Louisiana; however, we do not believe that it is likely that we will have an insurable loss as it relates to this portion of our drilling fleet and shorebase facilities.

13. Income Taxes

     Our net income tax expense or benefit is a function of the mix between our domestic and international pre-tax earnings or losses, respectively, as well as the mix of international tax jurisdictions in which we operate. Certain of our international rigs are owned and operated, directly or indirectly, by Diamond Offshore International Limited, a Cayman Islands subsidiary, which we wholly own. Because it was our intention to indefinitely reinvest the earnings of the subsidiary in foreign activities, no U.S. federal income taxes were provided on these earnings in years subsequent to its formation until December 2007, except to the extent that such earnings were immediately subject to U.S. federal income taxes. In December 2007, this subsidiary made a non-recurring distribution of $850.0 million to its U.S. parent and we recognized U.S. federal income tax on the portion of the earnings of the subsidiary that had not previously been subjected to U.S. federal income tax. As of December 31, 2007, the amount of previously untaxed earnings of this subsidiary was zero. Notwithstanding the non-recurring distribution made in December 2007, it remains our intention to indefinitely reinvest future earnings of this subsidiary to finance foreign activities. Consequently no U.S. federal income taxes were provided in the nine months ended September 30, 2008 on the earnings of this subsidiary except to the extent that such earnings were immediately subject to U.S. federal income taxes.

     We adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” on January 1, 2007. During the three and nine months ended September 30, 2008 we recognized tax expense of $1.6 million and $4.4 million, respectively, for uncertain tax positions related to fiscal 2008. During the three and nine months ended September 30, 2007 we recognized tax expense of $0.8 million and $2.7 million, respectively, for uncertain tax positions related to fiscal 2007. There were no new uncertain tax positions or significant changes in existing uncertain tax positions during the nine months ended September 30, 2008.

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, 2007. References to “Diamond Offshore,” “we,” “us” or “our” mean Diamond Offshore Drilling, Inc., a Delaware corporation, and its subsidiaries.

     We are a leader in deep water drilling with a fleet of 46 offshore drilling rigs. Our fleet currently consists of 30 semisubmersibles, 15 jack-ups and one drillship. During the third quarter of 2008, one of our U.S. Gulf of Mexico jack-ups, the Ocean Tower, was damaged as a result of Hurricane Ike, losing its derrick, drill floor and drill floor equipment. We anticipate that the unit will be out of service for repairs through the third quarter of 2009.

Overview

Industry Conditions

     The growing global economic crisis created an environment of uncertainty during the third quarter of 2008 that has continued in the fourth quarter of 2008. The price of crude oil fell from $142 per barrel at the beginning of the period to $100 per barrel at the close, and was trading in the mid-$60s range near the end of October. At the same time, reported dayrates for offshore rigs continued to rise, setting records for both the current fleet and new-build rigs, as well as U.S. Gulf of Mexico, or GOM, jack-ups. Additionally, we added to our floater backlog during the third quarter. We are unable to predict the impact on our business of a continued decline in commodity prices and the global economy. Possible negative impacts, among others, could include a decline in dayrates for new contracts, and a slowing in the pace of new contract activity.

     Floaters

     The majority of our intermediate and high-specification floater rigs are nearly fully contracted for the remainder of 2008, and 97% of our floater equipment is contracted for 2009. Additionally, contracts for 77% of our floating rigs extend at least until 2010, with 8% of our floating units having contracts extending into the 2014-2015 timeframe. However, during the third quarter of 2008 a customer canceled a letter of intent, or LOI, on the Ocean Star because of infrastructure damage to the customer’s production system caused by hurricanes Gustav and Ike. At the same time, there is currently high customer demand for multi-year contracts for our floater fleet, particularly for those rigs such as the Ocean Star with near-term availability. Although there are a large number of new-build floaters under construction, approximately two-thirds of those units are already under contract and therefore only a limited number of new rigs are available to impact the market.

     International Jack-ups

     The industry’s jack-up market is divided between an international sector and a U.S. sector, with the international sector generally characterized by contracts of longer duration and higher prices, compared to the generally shorter term and lower priced domestic sector. To date in 2008, we have seen relatively steady demand for jack-ups in the international sector with generally static dayrates. However, with less than 20% of the new-build jack-up order book under contract, it is possible that jack-up rig supply could be of concern in the international sector during 2009 and beyond.

     U.S. Gulf of Mexico Jack-ups

     In the domestic jack-up sector, higher natural gas prices and tighter rig supply allowed our domestic jack-up fleet to experience improved utilization and dayrates during the first three quarters of 2008, compared to the same period in 2007. Although natural gas prices have declined from earlier highs, to date, the market remains strong for our active domestic jack-up units, with the Ocean Summit recently signing a one-well contract at a near-record dayrate for 300-ft. GOM units of $140,000. All six of our active GOM jack-up rigs are currently contracted, and two of them are committed into the first quarter of 2009.

Contract Drilling Backlog

     The following table reflects our contract drilling backlog as of October 23, 2008, February 7, 2008 (the date reported in our Annual Report on Form 10-K for the year ended December 31, 2007) and October 25, 2007 (the date reported in our Quarterly Report on Form 10-Q for the quarter ended September 30, 2007) and reflects both firm commitments (typically represented by signed contracts), as well as previously-disclosed LOIs. An LOI is subject to customary conditions, including the execution of a definitive agreement, and as such may not result in a binding contract. Contract drilling backlog 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 95-98% 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 both the performance of work on term contracts, as well as the extension or modification of existing term contracts and the execution of additional contracts.

		October 23,				February 7,				October 25,
		2008				2008				2007
		(In thousands)
Contract Drilling Backlog
High-Specification Floaters (1)		$	4,720,000			$	4,448,000			$	3,657,000
Intermediate Semisubmersibles			6,302,000				5,985,000				4,450,000
Jack-ups			428,000				421,000				432,000
Total		$	11,450,000			$	10,854,000			$	8,539,000

     The following table reflects the amount of our contract drilling backlog by year as of October 23, 2008.

		For the Years Ending December 31,
		Total				2008(1)				2009				2010				2011 - 2015
		(In thousands)
Contract Drilling Backlog
High-Specification Floaters (2)		$	4,720,000			$	333,000			$	1,393,000			$	1,399,000			$	1,595,000
Intermediate Semisubmersibles			6,302,000				412,000				1,836,000				1,588,000				2,466,000
Jack-ups			428,000				127,000				285,000				16,000				—
Total		$	11,450,000			$	872,000			$	3,514,000			$	3,003,000			$	4,061,000

     The following table reflects the percentage of rig days committed by year as of October 23, 2008. The percentage of rig days committed is calculated as the ratio of total days committed under contracts and LOIs, as well as scheduled shipyard, survey and mobilization days for all rigs in our fleet to total available days (number of rigs multiplied by the number of days in a particular year). Total available days have been calculated based on the expected delivery date of the Ocean Monarch.

		For the Years Ending December 31,
		2008(1)				2009				2010				2011 - 2015
Rig Days Committed (2)
High-Specification Floaters			98	%			92	%			77	%			17	%
Intermediate Semisubmersibles			100	%			100	%			77	%			25	%
Jack-ups			86	%			40	%			2	%			—

Casualty Loss

     In September 2008, the Ocean Tower sustained significant damage during Hurricane Ike, which impacted the Gulf of Mexico and the upper Texas and Louisiana Gulf coasts. The Ocean Tower lost its derrick, drill floor and drill floor equipment during the hurricane, and we expect the drilling rig to be out of drilling service through the third quarter of 2009. We have not yet made a final assessment of the estimated costs to repair the Ocean Tower nor have we determined whether or not we will have an insurable loss related to this rig. During the third quarter of 2008, we wrote off the net book value of the derrick, drill floor and drill floor equipment for the Ocean Tower of approximately $2.6 million and accrued $3.7 million in estimated salvage costs for the recovery of equipment from the ocean floor. The aggregate of these items is reflected in “Casualty Loss” in our Consolidated Statements of Operations for the three and nine months ended September 30, 2008.

     We are currently assessing damages to our remaining drilling fleet within the impacted areas, as well as our shorebase facilities in Louisiana; however, we do not believe that it is likely that we will have an insurable loss as it relates to this portion of our drilling fleet and shorebase facilities.

General

     Our revenues vary based on the number of days our fleet is utilized and the dayrates earned. Utilization and dayrates earned are a function of global and regional balance between supply of rigs and demand. When a rig is idle, no dayrate is earned and revenues will decrease as a result. Revenues can also be affected as a result of the acquisition or disposal of rigs, required surveys and shipyard upgrades. In order to improve utilization or realize higher dayrates, we may mobilize our rigs from one market to another. However, during periods of mobilization, revenues may be adversely affected. As a response to changes in the balance of supply and demand, we may withdraw a rig from the market by stacking it or may reactivate a rig stacked previously, which may decrease or increase revenues, respectively.

     The two most significant variables affecting revenues are dayrates for rigs and rig utilization rates, each of which is a function of rig supply and demand in the marketplace. As utilization rates increase, dayrates tend to increase as well, reflecting the lower supply of available rigs, and vice versa. Demand for drilling services is dependent upon the level of expenditures set by oil and gas companies for offshore exploration and development, as well as a variety of political and economic factors. The availability of rigs in a particular geographical region also affects both dayrates and utilization rates. These factors are not within our control and are difficult to predict.

     Operating Income. Our operating income is primarily affected by revenue factors, but is also a function of varying levels of operating expenses. Our operating expenses represent all direct and indirect costs associated with the operation and maintenance of our drilling equipment. The principal components of our operating costs are, among other things, direct and indirect costs of labor and benefits, repairs and maintenance, freight, regulatory inspections, boat and helicopter rentals and insurance. Labor and repair and maintenance costs represent the most significant components of our operating expenses. In general, our labor costs increase primarily due to higher salary levels, rig staffing requirements, and costs associated with labor regulations in the geographic regions in which our rigs operate. We have experienced and continue to experience upward pressure on salaries and wages as a result of

the strengthening offshore drilling market and increased competition for skilled workers. In response to these market conditions we have implemented retention programs, including increases in compensation.

     Costs to repair and maintain our equipment fluctuate depending upon the type of activity the drilling unit is performing, as well as the age and condition of the equipment and the regions in which our rigs are working.

     Operating expenses generally are not affected by changes in dayrates, and short-term reductions in utilization do not necessarily result in lower operating expenses. For instance, if a rig is to be idle for a short period of time, few decreases in operating expenses may actually occur since the rig is typically maintained in a prepared or “ready-stacked” state with a full crew. In addition, when a rig is idle, we are responsible for certain operating expenses such as rig fuel and supply boat costs, which are typically costs of the operator when a rig is under contract. However, if the rig is to be idle for an extended period of time, we may reduce the size of a rig’s crew and take steps to “cold stack” the rig, which lowers expenses and partially offsets the impact on operating income. We recognize, as incurred, operating expenses related to activities such as inspections, painting projects and routine overhauls that meet certain criteria and which maintain rather than upgrade our rigs. These expenses vary from period to period. Costs of rig enhancements are capitalized and depreciated over the expected useful lives of the enhancements. Higher depreciation expense decreases operating income in periods subsequent to capital upgrades.

     Periods of high, sustained utilization may result in cost increases for maintenance and repairs in order to maintain our equipment in proper, working order. In addition, during periods of high activity and dayrates, higher prices generally pervade the entire offshore drilling industry and its support businesses, which cause our costs for goods and services to increase.

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

     In addition, operating income may be negatively impacted by intermediate surveys, which are performed at interim periods between 5-year surveys. Intermediate surveys are generally less extensive in duration and scope than a 5-year survey. Although an intermediate survey may require some downtime for the drilling rig, it normally does not require dry-docking or shipyard time, except for rigs located in the United Kingdom, or U.K., and Norwegian sectors of the North Sea.

     During the last quarter of 2008, we expect that six of our rigs will undergo 5-year regulatory inspections and will be out of service for approximately 266 days in the aggregate, including downtime for planned maintenance projects. We expect to spend an additional approximately 308 days during the remainder of 2008 for an intermediate survey, the mobilization of rigs, completion of contract modifications, extended maintenance projects not performed in conjunction with regulatory surveys and repairs to the Ocean Tower. During 2009, we expect that an additional five of our rigs will undergo 5-year surveys and will be out of service for approximately 280 days in the aggregate. We also expect to spend an additional approximately 921 days during 2009 for intermediate surveys, the mobilization of rigs, contract modifications for international contracts, extended maintenance projects and completion of repairs to the Ocean Tower. In addition, we expect the Ocean Bounty to be taken out of service at some time after the first quarter of 2009 for a water depth upgrade and repowering project. We expect these projects to take approximately one year to complete and will extend to 2010. We can provide no assurance as to the exact timing and/or duration of downtime associated with regulatory inspections, planned rig mobilizations and other shipyard projects. See “ – Overview – Contract Drilling Backlog.”)

     Under our current insurance policy that expires on May 1, 2009, our deductible for physical damage is $75.0 million per occurrence (or lower for some rigs if they are declared a constructive total loss). For physical damage due to named windstorms in the U.S. Gulf of Mexico, there is an annual aggregate limit of $125.0 million.  Accordingly, our insurance coverage for all physical damage to our rigs and equipment caused by named windstorms in the U.S. Gulf of Mexico for the policy period ending May 1, 2009 is limited to $125.0 million.  If named windstorms in the U.S. Gulf of Mexico cause significant damage to our rigs or equipment or to the property of others for which we may be liable, it could have a material adverse effect on our financial position, results of operations and cash flows.

Critical Accounting Estimates

     Our significant accounting policies are discussed in Note 1 of our notes to consolidated financial statements included in Item 1 of Part I of this report and in Note 1 of our notes to audited consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2007. There were no material changes to these policies during the nine months ended September 30, 2008.

Results of Operations

     Although we perform contract drilling services with different types of drilling rigs and in many geographic locations, there is a similarity of economic characteristics among all our divisions and locations, including the nature of services provided and the type of customers for our services. We believe that the combination of our drilling rigs into one reportable segment is the appropriate aggregation in accordance with the Financial Accounting Standards Board, or FASB, Statement of Financial Accounting Standards, or SFAS, No. 131, “Disclosures about Segments of an Enterprise and Related Information.” However, for purposes of this discussion and analysis of our results of operations, we provide greater detail with respect to the types of rigs in our fleet and the geographic regions in which they operate to enhance the reader’s understanding of our financial condition, changes in financial condition and results of operations.

Three Months Ended September 30, 2008 and 2007

     Comparative data relating to our revenue and operating expenses by equipment type are listed below. We have reclassified certain amounts applicable to the prior period to conform to the classifications we currently follow. These reclassifications do not affect earnings.

		Three Months Ended
		September 30,								Favorable/
		2008				2007				(Unfavorable)
						(In thousands)
CONTRACT DRILLING REVENUE
High-Specification Floaters		$	344,024			$	258,679			$	85,345
Intermediate Semisubmersibles			401,891				255,795				146,096
Jack-ups			136,038				113,772				22,266
Total Contract Drilling Revenue		$	881,953			$	628,246			$	253,707
Revenues Related to Reimbursable Expenses		$	18,423			$	15,716			$	2,707
CONTRACT DRILLING EXPENSE
High-Specification Floaters		$	94,713			$	93,069			$	(1,644	)
Intermediate Semisubmersibles			162,011				135,445				(26,566	)
Jack-ups			58,159				47,077				(11,082	)
Other			(610	)			4,635				5,245
Total Contract Drilling Expense		$	314,273			$	280,226			$	(34,047	)
Reimbursable Expenses		$	18,126			$	15,458			$	(2,668	)
OPERATING INCOME
High-Specification Floaters		$	249,311			$	165,610			$	83,701
Intermediate Semisubmersibles			239,880				120,350				119,530
Jack-ups			77,879				66,695				11,184
Other			610				(4,635	)			5,245
Reimbursable expenses, net			297				258				39
Depreciation			(72,014	)			(57,565	)			(14,449	)
General and administrative expense			(13,944	)			(13,105	)			(839	)
Casualty loss			(6,281	)			—				(6,281	)
Gain on disposition of assets			228				363				(135	)
Total Operating Income		$	475,966			$	277,971			$	197,995
Other income (expense):
Interest income			3,055				8,735				(5,680	)
Interest expense			(2,989	)			(2,334	)			(655	)
Gain on sale of marketable securities			677				1,763				(1,086	)
Other, net			(29,143	)			2,112				(31,255	)
Income before income tax expense			447,566				288,247				159,319
Income tax expense			(136,916	)			(82,724	)			(54,192	)
NET INCOME		$	310,650			$	205,523			$	105,127

     Continued high overall utilization and historically high dayrates for our floater fleet contributed to an overall increase in our net income of $105.1 million, or 51%, to $310.6 million in the third quarter of 2008 compared to $205.5 million in the same period of 2007. In many of the floater markets in which we operate, average dayrates increased as our rigs operated under contracts at higher dayrates than those earned during the third quarter of 2007. The market for our jack-up rigs in the GOM improved during the third quarter of 2008 as evidenced by higher utilization compared to the third quarter of 2007; however, our GOM jack-up fleet earned lower average dayrates in the low $80,000 range compared to the third quarter of 2007 when rates for our GOM jack-ups averaged in the high $80,000 range. Total contract drilling revenues in the third quarter of 2008 increased $253.7 million, or 40%, to $881.9 million compared to $628.2 million in the same period a year earlier.

     Total contract drilling expenses increased $34.0 million, or 12%, in the third quarter of 2008, compared to the same period in 2007. Overall cost increases for maintenance and repairs between the 2008 and 2007 periods reflect the impact of high, sustained utilization of our drilling units across our fleet, higher maintenance costs, contract preparation and mobilization costs. Our results for the third quarter of 2008 also include normal operating costs for our newly constructed jack-up rigs, the Ocean Shield and Ocean Scepter, that began operating offshore Malaysia in the second quarter of 2008 and offshore Argentina during the third quarter of 2008, respectively. The increase in overall operating and overhead costs also reflects the impact of higher prices throughout the offshore drilling industry and its support businesses, including higher costs associated with hiring and retaining skilled personnel for our worldwide offshore fleet.

     Depreciation expense increased $14.4 million to $72.0 million during the third quarter of 2008, or 25% compared to the third quarter of 2007, primarily due to a higher depreciable asset base.

     Our results during the third quarter of 2008 were also impacted by a casualty loss of $6.3 million recorded in connection with damages sustained during Hurricane Ike (see “ – Overview – Casualty Loss”) and $25.1 million in net losses on foreign currency forward exchange contracts, primarily from mark-to-market accounting, which is included in “Other, net”.

High-Specification Floaters.

		Three Months Ended
		September 30,								Favorable/
		2008				2007				(Unfavorable)
		(In thousands)
HIGH-SPECIFICATION FLOATERS:
CONTRACT DRILLING REVENUE
GOM		$	269,599			$	207,450			$	62,149
Australia/Asia/Middle East			13,712				16,837				(3,125	)
South America			60,713				34,392				26,321
Total Contract Drilling Revenue		$	344,024			$	258,679			$	85,345
CONTRACT DRILLING EXPENSE
GOM		$	59,557			$	65,791			$	6,234
Australia/Asia/Middle East			10,702				6,701				(4,001	)
South America			24,454				20,577				(3,877	)
Total Contract Drilling Expense		$	94,713			$	93,069			$	(1,644	)
OPERATING INCOME		$	249,311			$	165,610			$	83,701

     GOM. Revenues generated by our high-specification floaters operating in the GOM increased $62.1 million during the third quarter of 2008 compared to the same period in 2007. Average operating revenue per day for our rigs in this market increased to $407,100 during the third quarter of 2008 compared to $354,600 in the third quarter of 2007, resulting in additional revenues of $39.3 million. Seven of our eight high-specification semisubmersible rigs in the GOM are currently contracted at dayrates higher than those earned during the third quarter of 2007.

     Average utilization for our high-specification rigs operating in the GOM increased from 79% in the third quarter of 2007 to 90% in the third quarter of 2008, resulting in a $22.9 million increase in revenues comparing the quarters. The increase in utilization was primarily the result of 57 fewer scheduled downtime days for special surveys and repairs during the third quarter of 2008 compared to the third quarter of 2007. Utilization was also

higher for the Ocean Endeavor during the third quarter of 2008 compared to the same period a year earlier when the rig had 26 days of unscheduled downtime for repairs after being placed in service after completion of its major upgrade.

     Operating costs during the third quarter of 2008 for our high-specification floaters in the GOM decreased $6.2 million compared to the third quarter of 2007 to $59.6 million. The overall reduction in operating costs for the third quarter of 2008 compared to the same quarter of 2007 occurred as higher labor and major maintenance and project costs were offset by lower mobilization and survey costs between the comparable periods.

     Australia/Asia/Middle East. During the third quarter of 2008, our high-specification rig operating offshore Malaysia, the Ocean Rover, incurred 52 days of scheduled downtime for a survey that resulted in a $3.1 million decrease in revenues and a $4.0 million increase in operating costs compared to the same period in 2007.

     South America. Revenues earned by our high-specification floaters operating offshore Brazil increased $26.3 million compared to the third quarter of 2007, primarily due to a higher dayrate earned by the Ocean Alliance. Average operating revenue per day increased from $189,800 during the third quarter of 2007 to $353,100 during the third quarter of 2008 and contributed additional revenues of $28.0 million. The increase in revenue was partially offset by a decline in utilization as a result of 10 days of unpaid downtime during the third quarter of 2008 for repairs on the Ocean Alliance.

     Contract drilling expense for our operations in Brazil increased $3.9 million during the third quarter of 2008 compared to the same period in 2007, primarily due to repair costs for the Ocean Clipper.

Intermediate Semisubmersibles.

		Three Months Ended
		September 30,								Favorable/
		2008				2007				(Unfavorable)
		(In thousands)
INTERMEDIATE SEMISUBMERSIBLES:
CONTRACT DRILLING REVENUE
GOM		$	32,543			$	37,204			$	(4,661	)
Mexico			54,153				13,916				40,237
Australia/Asia/Middle East			90,566				70,369				20,197
Europe/Africa/Mediterranean			135,412				107,523				27,889
South America			89,217				26,783				62,434
Total Contract Drilling Revenue		$	401,891			$	255,795			$	146,096
CONTRACT DRILLING EXPENSE
GOM		$	12,678			$	30,124			$	17,446
Mexico			12,934				17,660				4,726
Australia/Asia/Middle East			41,179				29,324				(11,855	)
Europe/Africa/Mediterranean			49,742				35,809				(13,933	)
South America			45,478				22,528				(22,950	)
Total Contract Drilling Expense		$	162,011			$	135,445			$	(26,566	)
OPERATING INCOME		$	239,880			$	120,350			$	119,530

     GOM. Revenues generated during the third quarter of 2008 by our intermediate semisubmersible fleet operating in the GOM decreased $4.7 million compared to the same period in 2007, primarily as a result of the relocation of three of our rigs (Ocean Voyager and Ocean New Era to Mexico and Ocean Concord to Brazil) from the GOM during the fourth quarter of 2007. These rigs generated revenues of $26.2 million during the third quarter of 2007. The decrease in revenues resulting from the departure of rigs to other geographic locations was partially offset by $15.4 million in additional revenues generated by the Ocean Saratoga due to an increase in its operating dayrate subsequent to the third quarter of 2007 and $6.1 million contributed by the Ocean Ambassador, which we relocated to the GOM from offshore Mexico during the second quarter of 2008.

     Contract drilling expenses in the GOM decreased by $17.4 million during the third quarter of 2008 compared to the third quarter of 2007 primarily due to the absence of operating costs ($19.5 million) for the three rigs that departed the region in the fourth quarter of 2007. In addition, during the third quarter of 2007, we incurred $6.0 million in costs for the Ocean Whittington and Ocean Worker while they were in GOM shipyards during the period. These rigs were subsequently relocated to the South America region. The overall decrease in contract drilling expenses for the third quarter of 2008 was partially offset by the inclusion of normal operating expenses for the Ocean Ambassador.

     Mexico. Transfers of our intermediate semisubmersibles into and out of the Mexico region prior to the third quarter of 2008 resulted in a net reduction of one rig in the region. However, our two intermediate semisubmersible rigs in the region are currently working for PEMEX Exploración Y Producción, or PEMEX, at substantially higher dayrates than those previously earned in the region. The aggregate changes in our offshore fleet in Mexico resulted in a net increase in revenues of $40.2 million during the third quarter of 2008 compared to the same quarter of 2007.

     Australia/Asia/Middle East. Operating revenue for our intermediate semisubmersibles working in the Australia/Asia/Middle East region increased $20.2 million in the third quarter of 2008 compared to the prior year quarter primarily due to an increase in average operating revenue per day from $187,600 during the 2007 quarter to $340,100. The increase in average operating revenue per day generated additional revenues of $32.9 million during the 2008 period and is primarily attributable to higher dayrates earned during the third quarter of 2008 by our three intermediate semisubmersibles operating offshore Australia.

     Average utilization in this region decreased to 71% during the third quarter of 2008 from nearly 100% during the third quarter of 2007, resulting in a $13.1 million reduction in revenues during the 2008 period. The decrease in utilization was primarily the result of 105 days of scheduled downtime for special surveys and repairs during the third quarter of 2008.

     Contract drilling expense for the Australia/Asia/Middle East region increased $11.9 million in the third quarter of 2008 compared to the third quarter of 2007. Contract drilling expenses were higher during the third quarter of 2008 primarily due to survey and related repair costs for the Ocean Bounty and Ocean General and higher labor and personnel-related costs.

     Europe/Africa/Mediterranean. Operating revenue for our intermediate semisubmersibles working in the Europe/Africa/Mediterranean region increased $27.9 million in the third quarter of 2008 compared to the same period in 2007, primarily due to higher dayrates earned by three of our four rigs operating in the North Sea (both U.K. and Norwegian sectors). Average operating revenue per day for our three U.K. semisubmersibles increased from $253,100 in the third quarter of 2007 to $330,600 in the third quarter of 2008, contributing $20.6 million in additional revenue in the 2008 quarter. The Ocean Vanguard operated offshore Norway under a new two-year contract during the third quarter of 2008 at a higher dayrate than previously contracted and contributed $22.4 million in additional revenues.

     A decrease in average utilization in the region comparing the third quarters of 2008 and 2007, reduced revenues by $15.5 million. Utilization in the region during the third quarter of 2008 was negatively impacted by 49 days of scheduled downtime for surveys and repairs and ten days of downtime for the Ocean Lexington as it began its mobilization to Libya for a 120-day contract.

     Contract drilling expense for our intermediate semisubmersible rigs operating in the Europe/Africa/Mediterranean markets increased $13.9 million in the third quarter of 2008 compared to the third quarter of 2007, primarily due to costs associated with scheduled surveys in the third quarter of 2008, including mobilization costs, fuel and survey and related repair costs.

     South America. Revenues generated by our intermediate semisubmersibles working in the South American region increased $62.4 million to $89.2 million in the third quarter of 2008. During the third quarter of 2008, we had six rigs operating in the region compared to three rigs during the same period in 2007. Rig count in this region increased by three due to the relocation of the Ocean Concord (Brazil) and the Ocean Worker (Trinidad and Tobago) in the fourth quarter of 2007 and the Ocean Yorktown (Brazil) in the second quarter of 2008 where they generated aggregate revenues of $46.5 million in the third quarter of 2008. There were no revenues earned by these three rigs in this region during the third quarter of 2007. In addition, the Ocean Whittington operated the entire third quarter of 2008, generating an additional $16.2 million in revenues, compared to operating only a portion of the third quarter of 2007 when the rig had 63 days of unpaid downtime for acceptance testing and repairs.

     Operating expenses for our operations in the South American region increased $22.9 million in the third quarter of 2008, as compared to the third quarter of 2007, primarily due to normal operating costs for the three additional rigs in this region in 2008 ($20.2 million).

Jack-Ups.

		Three Months Ended
		September 30,								Favorable/
		2008				2007				(Unfavorable)
		(In thousands)
JACK-UPS:
CONTRACT DRILLING REVENUE
GOM		$	48,846			$	55,256			$	(6,410	)
Mexico			27,364				15,895				11,469
Australia/Asia/Middle East			27,720				23,403				4,317
Europe/Africa/Mediterranean			31,328				19,218				12,110
South America			780				—				780
Total Contract Drilling Revenue		$	136,038			$	113,772			$	22,266
CONTRACT DRILLING EXPENSE
GOM		$	24,895			$	29,964			$	5,069
Mexico			8,019				4,273				(3,746	)
Australia/Asia/Middle East			12,244				7,251				(4,993	)
Europe/Africa/Mediterranean			10,330				5,589				(4,741	)
South America			2,671				—				(2,671	)
Total Contract Drilling Expense		$	58,159			$	47,077			$	(11,082	)
OPERATING INCOME		$	77,879			$	66,695			$	11,184

     GOM. Revenue generated by our jack-up rigs operating in the GOM decreased $6.4 million during the third quarter of 2008 compared to the third quarter of 2007, primarily due to the relocation of the Ocean Columbia to Mexico in the first quarter of 2008 ($7.6 million). In addition (excluding the Ocean Columbia) average operating revenue per day in the third quarter of 2008 decreased to $84,000 from $91,000 in the third quarter of 2007, resulting in a $3.9 million decrease in revenue compared to the prior year quarter.

     In contrast, average utilization (excluding the Ocean Columbia) increased from 81% during the third quarter of 2007 to 90% during the third quarter of 2008, generating additional revenues of $5.1 million. The increase in utilization was primarily due to an improvement in market conditions in the GOM subsequent to the third quarter of 2007. Our jack-up fleet in the GOM had no ready-stack days during the third quarter of 2008 compared to 97 ready-stack days during the same period in 2007, partially offset by 24 days of scheduled or other unpaid downtime for surveys and unanticipated repairs.

     Contract drilling expense in the GOM decreased $5.1 million during the third quarter of 2008 compared to the same period in 2007. The overall decrease in operating costs during the third quarter of 2008 was primarily attributable to the absence of operating costs in the GOM for the Ocean Columbia, which reduced operating expenses by $4.2 million.

     Mexico. Revenue and contract drilling expense from our jack-up rigs operating in Mexico increased $11.5 million and $3.7 million, respectively, in the third quarter of 2008 compared to the third quarter of 2007 primarily due to the operation of the Ocean Columbia offshore Mexico.

     Australia/Asia/Middle East. Revenue generated by our jack-up rigs operating in the Australia/Asia/Middle East region increased $4.3 million in the third quarter of 2008 compared to the same period in 2007 and included $16.1 million of revenues earned by our recently completed jack-up rig, the Ocean Shield. In addition, an increase in the average operating dayrate for the Ocean Sovereign generated $3.2 million in additional revenue during the third quarter of 2008. These revenue increases were partially offset by the relocation of the Ocean Heritage to Egypt in late June 2008 ($14.9 million).

     Contract drilling expenses in the Australia/Asia/Middle East region increased $5.0 million during the third quarter of 2008 primarily due to the addition of normal operating costs for the Ocean Shield.

     Europe/Africa/Mediterranean. Revenue generated by our jack-up rigs operating in the Europe/Africa/Mediterranean region increased $12.1 million during the third quarter of 2008 compared to the same period in 2007. The Ocean King was relocated to Croatia in the third quarter of 2007, where it generated $10.1 million in revenues working under a bareboat charter, and the Ocean Heritage, which relocated to Egypt in late June 2008, generated $8.9 million in revenues. These revenue increases were partially offset by a $7.0 million reduction in revenues generated by the Ocean Spur during the third quarter of 2008 compared to the prior year quarter, primarily due to the recognition of other operating revenues associated with its contract offshore Tunisia in 2007 and a lower dayrate earned on the rig’s current contract offshore Egypt in 2008.

     The $4.7 million increase in operating expenses in the region is primarily attributable to the inclusion of normal operating costs for the Ocean Heritage.

     South America. Our newly constructed jack-up rig, the Ocean Scepter, began operating offshore Argentina late in the third quarter of 2008, generating $0.8 million in revenues and incurring $2.7 million in contract drilling expenses.

Depreciation.

     Depreciation expense increased $14.4 million to $72.0 million during the third quarter of 2008 compared to $57.6 million during the same period in 2007, primarily due to depreciation associated with capital additions in 2007 and 2008.

Casualty Loss.

     During September 2008, one of our jack-up rigs, the Ocean Tower, sustained significant damage during Hurricane Ike. As a result of this damage during the third quarter of 2008 we wrote off the net book value of the Ocean Tower’s derrick, drill floor and related equipment lost in the storm of approximately $2.6 million and accrued $3.7 million in estimated salvage costs for recovery of equipment from the ocean floor.

Other Income and Expense (Other, net).

     Included in “Other, net” are foreign currency transaction gains and losses and other income and expense items, among other things, which are not attributable to our drilling operations. The components of “Other, net” fluctuate based on the level of activity, as well as fluctuations in foreign currencies. During the three months ended September 30, 2008, we recognized net foreign currency exchange losses of $29.0 million, including $25.1 million in net losses on foreign currency forward exchange contracts ($28.7 million in net unrealized losses resulting from mark-to-market accounting on open positions at September 30, 2008, partially offset by $3.6 million net realized gains on settlement of forward contracts). During the three months ended September 30, 2007, we recognized net foreign currency exchange gains of $2.1 million.

Income Tax Expense.

     Our estimated annual effective tax rate as of September 30, 2008 was 29.5%, compared to 27.9% as of September 30, 2007. The higher effective tax rate in the current quarter is primarily due to differences in the mix of our domestic and international pre-tax earnings and losses, respectively, as well as the mix of international tax jurisdictions in which we operate.

     We adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” on January 1, 2007. During the three months ended September 30, 2008 and September 30, 2007 we recognized tax expense of $1.6 million and $0.8 million, respectively, for uncertain tax positions related to the respective fiscal periods. There were no new uncertain tax positions or significant changes in existing uncertain tax positions during the quarter ended September 30, 2008.

Nine Months Ended September 30, 2008 and 2007

     Comparative data relating to our revenue and operating expenses by equipment type are listed below. We have reclassified certain amounts applicable to the prior period to conform to the classifications we currently follow. These reclassifications do not affect earnings.

		Nine Months Ended
		September 30,								Favorable/
		2008				2007				(Unfavorable)
		(In thousands)
CONTRACT DRILLING REVENUE
High-Specification Floaters		$	979,313			$	769,087			$	210,226
Intermediate Semisubmersibles			1,239,711				725,753				513,958
Jack-ups			369,895				359,245				10,650
Total Contract Drilling Revenue		$	2,588,919			$	1,854,085			$	734,834
Revenues Related to Reimbursable Expenses		$	51,931			$	46,936			$	4,995
CONTRACT DRILLING EXPENSE
High-Specification Floaters		$	275,171			$	224,577			$	(50,594	)
Intermediate Semisubmersibles			437,521				345,480				(92,041	)
Jack-ups			153,260				130,033				(23,227	)
Other			6,764				14,534				7,770
Total Contract Drilling Expense		$	872,716			$	714,624			$	(158,092	)
Reimbursable Expenses		$	50,660			$	45,435			$	(5,225	)
OPERATING INCOME
High-Specification Floaters		$	704,142			$	544,510			$	159,632
Intermediate Semisubmersibles			802,190				380,273				421,917
Jack-ups			216,635				229,212				(12,577	)
Other			(6,764	)			(14,534	)			7,770
Reimbursable expenses, net			1,271				1,501				(230	)
Depreciation			(211,725	)			(171,605	)			(40,120	)
General and administrative expense			(45,434	)			(37,245	)			(8,189	)
Casualty loss			(6,281	)			—				(6,281	)
Gain on disposition of assets			505				5,418				(4,913	)
Total Operating Income		$	1,454,539			$	937,530			$	517,009
Other income (expense):
Interest income			10,369				26,127				(15,758	)
Interest expense			(6,226	)			(16,959	)			10,733
Gain on sale of marketable securities			674				1,755				(1,081	)
Other, net			(14,947	)			2,517				(17,464	)
Income before income tax expense			1,444,409				950,970				493,439
Income tax expense			(426,851	)			(269,370	)			(157,481	)
NET INCOME		$	1,017,558			$	681,600			$	335,958