Expectations for rig companies are incredibly low right now, so even the slightest good news is going to lead to some large stock bumps. This was certainly the case when Diamond Offshore Drilling (OTC:DO) reported earnings. Even though revenue declined from the prior quarter, the company posted a slight earnings beat that sent shares up close to 10%. Let's dig into Diamond's most recent numbers to see what had Wall Street excited. 

Drilling rigs in a dockyard at night.

Image source: Getty Images.

By the numbers

Metric Q3 2017 Q2 2017 Q3 2016
Revenue $366 million $399 million $349 million
Operating income $58.5 million $20.8 million $54.1 million
Net income $10.7 million $15.9 million $13.9 million
EPS $0.08 $0.12 $0.10

Source: Diamond Offshore Drilling earnings release. EPS= earnings per share.

As has been the case with so many other quarters for Diamond, there were some charges and special items this past quarter that had an impact on the bottom line. In the third quarter, management issued senior notes that will come due in 2025 in order to pay off its outstanding notes due 2019. As part of that exchange, the company took a $35.5 million pre-tax loss on the impairment of those notes, which explains why the company posted a lower net income result compared to its operating earnings result. 

I know that it isn't great that the company is losing revenue and contracts are rolling off, but the declines in profitability came from its deepwater and midwater fleet. These are Diamond's older, less capable assets, which have gone out of favor throughout the industry. More likely than not, these older assets will be retired as they roll off contract, which has been the case with so many of its peers in recent quarters. 

The more important aspect of these results is that Diamond's ultra-deepwater fleet remains contracted and generating the bulk of operating earnings. At the end of the quarter, the company's utilization rate for its ultra-deepwater fleet was 61% and operational efficiency -- the total days a contracted rig worked of the possible days in the quarter -- for the fleet was 94.3%.  

DO operating income by business segment for Q3 2016, Q2 2017, and Q3 2017. Shows losses for Deepwater and Midwater but a year over year gain for Ultra-Deepwater.

Source: Diamond Offshore earnings release. Chart by author.

While earnings remain low, the company's cash generation is still going strong. So far this year, the company has generated enough cash to cover all capital spending, pay back $104 million in short-term debts, and still pad the balance sheet with $120 million in cash. 

What management had to say

Even though Diamond has made some progress this year in contracting its most advanced fleet, CEO Marc Edwards still thinks we have not yet reached the bottom of the market for certain rigs. 

We here are at Diamond are still not ready to call a bottom as the number of contract rollovers in the next 12 months exceeds new fixture opportunities currently in the pipeline.

Utilization, certainly for sixth-generation assets, will track down another peg, but we do believe we have some visibility as to what the trough may look like. The number of tenders has increased, albeit from a very low platform, and customer inquiries have picked up, although also starting from a low base. Yet, contract durations for the most part remain short and pricing is very challenged.

DO Chart

DO data by YCharts.

What a Fool believes

Diamond has done a bang-up job keeping its finances in order and obtaining enough contract work for its high specification rigs to maintain a certain level of profitability. There aren't many rig companies that can say they have done that recently. If one wanted to nitpick management's decisions, you could point to that debt exchange. The company elected to take on a higher interest rate for a longer tenure now, but one has to wonder if it was absolutely necessary to do that today as it builds cash on the books and had close to two years until those notes were due. 

That will likely become a non-issue in the coming years. As long as it can continue to have success with putting its rigs to work, Diamond should be able to maintain its profitable ways for a while. 

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.