SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-K

 

 

Rowan Companies, Inc.

 

2800 Post Oak Boulevard

Suite 5450

Houston, Texas 77056-6127

 

Registrant’s telephone number, including area code: (713) 621-7800

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act: NONE

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes. þ     No o

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.  Yes o     No þ

 

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

 

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

 

 

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

 

The aggregate market value of the voting stock held by non-affiliates of the registrant was approximately $3.2 billion as of June 30, 2005 based upon the closing price of the registrant’s Common Stock on the New York Stock Exchange Composite Tape of $29.71 per share.

 

The number of shares of Common Stock, $.125 par value, outstanding at February 28, 2006 was 109,975,782.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

 

 

TABLE OF CONTENTS

 

 

Rowan Companies, Inc. (hereinafter referred to as “Rowan” or “the Company”) is a major provider of international and domestic contract drilling services. Rowan also owns and operates a manufacturing division that produces equipment for the drilling, mining and timber industries. Rowan was organized in 1947 as a Delaware corporation and a successor to a contract drilling business conducted since 1923 under the name Rowan Drilling Company, Inc.

 

Information regarding each of Rowan’s industry segments, including revenues, income (loss) from operations, assets and foreign-source revenues for 2005, 2004 and 2003 is shown in Footnote 10 of the Notes to Consolidated Financial Statements on pages 57 and 58 of this Form 10-K. Information regarding Rowan’s discontinued operations is shown in Footnote 12 of the Notes to Consolidated Financial Statements on pages 58 and 59 of this Form 10-K.

 

During 2005 and 2004, no one customer accounted for 10% or more of Rowan’s consolidated revenues. In 2003, 14% of Rowan’s consolidated revenues were derived from El Paso Corporation and 10% were derived from Anadarko Petroleum Corporation, primarily from drilling services.

 

Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act are made available free of charge on our website at http://www.rowancompanies.com as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission.

 

Rowan provides contract drilling services utilizing a fleet of 20 self-elevating mobile offshore drilling platforms (“jack-up rigs”) and 17 land drilling rigs. Rowan’s drilling operations are conducted primarily in the Gulf of Mexico, the Middle East, the North Sea, offshore eastern Canada and in Texas, Louisiana and Oklahoma. In 2005, drilling operations generated revenues of $775.4 million and income from operations of $332.9 million.

 

Since 1970, Rowan’s drilling operations have featured jack-up rigs performing both exploratory and development drilling and, in certain areas, well workover operations. Rowan operates larger, deep-water type jack-up rigs capable of drilling to depths of 20,000 to 35,000 feet in maximum water depths ranging from 250 to 550 feet, depending on the size of the rig and its location.

 

Rowan’s jack-up rigs are designed with a floating hull with three independently elevating legs, drilling equipment, supplies, crew quarters, loading and unloading facilities, a helicopter landing deck and other related equipment. Drilling equipment includes engines, drawworks or hoist, derrick, pumps to circulate the drilling fluid, drill pipe and drilling bits. At the drilling site, the legs are lowered until they penetrate the ocean floor and the hull is jacked-up on the legs to the desired elevation above the water. The hull then serves as a drilling platform until the well is completed, at which time the hull is lowered into the water, the legs are elevated and the rig is towed to the next drilling site. Rowan’s rigs are equipped with propulsion thrusters to assist in towing.

 

Rowan’s cantilever jack-ups can extend a portion of the sub-structure containing the drawworks, derrick and related equipment over fixed production platforms so that development or workover operations on the platforms can be carried out with a minimum of interruption to production. In 1989, Rowan acquired and developed a “skid base” technology, whereby the rig floor drilling equipment on a conventional jack-up rig can be “skidded” out over the top of a fixed platform. Thus, conventional jack-up rigs can be used on certain drilling assignments that previously required a cantilever jack-up or platform rig.

At March 15, 2006, Rowan’s offshore drilling fleet included the following:

 

 

The Company operates one of the cantilever jack-up rigs under an operating lease that expires in 2008.

 

The fleet declined by five units during 2005. Two units were sold during the year: the Rowan-Texas was sold outright for cash and the Rowan-Midland was sold under a lease-purchase agreement that expires in early 2007. Four units, the Rowan-New Orleans, Rowan-Halifax, Rowan-Odessa and Rowan-Fort Worth, were lost during Hurricanes Katrina and Rita. A fifth rig, the Rowan-Louisiana, was significantly damaged during Katrina and is undergoing efforts to return it to service during the third quarter of 2006. In August 2005, Rowan’s second Tarzan Class jack-up rig, the Bob Keller, was added to its offshore fleet.

 

Rowan’s Gorilla class rigs were designed in the early 1980s as a heavier-duty class of jack-up rig, capable of operating in water depths up to 328 feet in extreme hostile environments (winds up to 100 miles per hour and seas up to 90 feet) such as in the North Sea and offshore eastern Canada. Gorillas II and III can drill up to 30,000 feet and Gorilla IV is equipped to reach 35,000 feet.

 

In late 1998, Rowan completed construction of its first Super Gorilla class rig, Gorilla V. Gorilla VI followed in June 2000 and Gorilla VII was delivered in December 2001. The Super Gorillas are enhanced versions of Rowan’s Gorilla class rigs, featuring a simultaneous drilling and production capability. They can operate year-round in 400 feet of water south of the 61st parallel in the North Sea, within the worst-case combination of 100-year storm criteria for waves, wave periods, winds and currents. Rowan financed an aggregate $509.5 million of the cost of Gorillas V, VI and VII through separate bank loans guaranteed by the U.S. Department of Transportation’s Maritime Administration under its Title XI Program.

 

In August 2003, Rowan completed construction of the Bob Palmer (formerly Gorilla VIII), an enhanced version of the Super Gorilla class jack-up designated a Super Gorilla XL. The Bob Palmer has 713 feet of leg, 139 feet more than the Super Gorillas, and has 30% larger spud cans, enabling operation in the Gulf of Mexico in water depths up to 550 feet. The Bob Palmer can also operate in water depths up to 400 feet in the hostile environments offshore eastern Canada and in the North Sea. Rowan financed $187.3 million of the cost of the Bob Palmer through bank loans guaranteed under the Title XI Program.

 

In July 2001, Rowan’s Board of Directors approved the design and construction of a new class of jack-up rig, specifically targeted for drilling beyond 25,000 feet in water depths up to 300 feet on the Gulf of Mexico’s outer continental shelf. The Tarzan Class rig offers drilling capabilities similar to our Super Gorilla class jack-ups, but with reduced environmental criteria (wind, wave and current) and at around one-half the construction cost. The first Tarzan Class rig, the Scooter Yeargain, was delivered in April 2004 and the second, the Bob Keller, was delivered in August 2005. Rowan financed $180.9 million of the cost of the first two Tarzan Class rigs through separate government-guaranteed Title XI bank loans.

 

Construction of a third Tarzan Class jack-up, the Hank Boswell, began in January 2005 and should be completed in the third quarter of 2006. Construction of a fourth Tarzan Class rig is underway at a third-party shipyard and should be completed during the third quarter of 2007. Rowan has applied for Title XI financing for the third and fourth Tarzan Class rigs on terms and conditions similar to those in effect for the Bob Keller.

 

In November 2005, Rowan’s Board of Directors approved the design and construction of a new class of jack-up rig specifically targeted for high pressure/high temperature drilling in water depths up to 400 feet. The Company believes that the new 240C class will set a new standard as the replacement for the industry’s current fleet of 116C class rigs, which have been the “workhorse” of the global drilling industry for more than 25 years. The 240C will have more deck space, higher variable load capacity, greater hook-load capability, more cantilever reach and greater personnel capacity compared to the 116C. Construction of the first 240C should be completed around mid-year 2008, with the second rig scheduled to arrive in early 2009.

The current fleet expansion program began in 1995 following Rowan’s acquisition of the manufacturing and rig-building operations formerly conducted by Marathon LeTourneau Company, which had designed all of Rowan’s existing jack-up rigs, the last of which had been delivered in 1986. In the intervening years, Rowan’s drilling capital expenditures were primarily for enhancements to existing drilling rigs.

 

Rowan also takes advantage of lulls in drilling activity to perform needed maintenance and make certain enhancements to its drilling fleet. During 1998 and 1999, the Company completed significant upgrades to several offshore drilling rigs which were carried out to increase their operating capabilities. See ITEM 2. PROPERTIES beginning on page 15 of this Form 10-K for additional information with respect to the capabilities and operating status of the Company’s rigs.

 

For a further discussion of Rowan’s availability of funds in 2006 to sustain operations, debt service and planned capital expenditures, including those related to construction of the Tarzan Class and 240C rigs, see “Liquidity and Capital Resources” under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” on pages 22 through 34 of this Form 10-K.

 

Rowan has drilling equipment, personnel and camps available on a contract basis for exploration and development of onshore areas. Rowan currently owns 17 deep-well land rigs located in Texas (9), Louisiana (7) and Oklahoma (1). The fleet features four newly constructed rigs and eleven rigs that have been substantially rebuilt in recent years. Another 12 new rigs are under construction with deliveries expected at various dates during 2006.

 

The drilling equipment comprising an onshore rig consists basically of engines, drawworks or hoist, derrick, pumps to circulate the drilling fluid, drill pipe and drilling bits. The type of rig required by a customer depends upon the anticipated well depth, terrain and conditions in the drilling area.

 

Rowan’s drilling contracts generally provide for compensation on a day rate basis, whereby the Company earns a fixed amount per day, and are usually obtained either through competitive bidding or individual negotiations. A number of factors affect a drilling contractor’s ability, both onshore and offshore, to obtain contracts at a profitable rate within an area. Such factors include the location and availability of equipment, its suitability for the project, the comparative cost of the equipment, the competence of personnel and the reputation of the contractor. Profitability may also be dependent upon receiving adequate compensation for the cost of moving equipment to drilling locations.

 

When weak market conditions characterized by declining drilling day rates prevail, Rowan generally accepts lower rate contracts in an attempt to maintain its competitive position and to offset the substantial costs of maintaining and reactivating stacked rigs. When drilling markets are strong and increasing rates prevail, Rowan generally pursues short rather than long-term contracts for its rigs to maximize its ability to obtain rate increases and pass through any cost increases to customers.

 

Rowan’s drilling contracts are either “well-to-well”, “multiple well” or for a fixed term generally ranging from one to twelve months. Well-to-well contracts are cancelable by either party upon completion of drilling at any one site, and fixed-term contracts usually provide for termination by either party if drilling operations are suspended for extended periods by events of force majeure. While most fixed-term contracts are for relatively short periods, some fixed-term and well-to-well contracts continue for a longer period than the original term or for a specific series of wells. Many offshore contracts contain renewal or extension provisions exercisable at the option of the customer at prices agreeable to the Company and require additional payments for mobilization and demobilization costs. Rowan’s contracts for work in foreign countries generally provide for payment in United States dollars except for minimal amounts required to meet local expenses, such as payroll.

 

Rowan believes that the contract status of its onshore and offshore rigs is more informative than backlog calculations, and that backlog information is neither calculable nor meaningful given the cancellation options contained in, and the short duration of, fixed-term contracts and the indeterminable duration of well-to-well and

multiple well contracts. See ITEM 2. PROPERTIES beginning on page 15 of this Form 10-K for the contract status of the Company’s rigs as of March 15, 2006.

 

The contract drilling industry is highly competitive and involves many factors, including price, equipment capability, operating and safety performance and reputation. Rowan believes that it competes favorably with respect to all of these factors.

 

Rowan competes with more than 20 offshore drilling contractors together having available more than 500 mobile rigs worldwide and approximately 20 domestic drilling contractors with about 200 available deep-well land rigs in the aggregate. Based upon the number of rigs as tabulated by ODS-Petrodata, Rowan is the eighth largest offshore drilling contractor in the world and the seventh largest jack-up rig operator. Some of the Company’s competitors have greater financial and other resources and may be more able to make technological improvements to existing equipment or replace equipment that becomes obsolete.

 

Technological advances can create competitive advantages and eventually cause less capable equipment to be less suitable for certain drilling operations. Following the development of the Company’s Gorilla class rigs in the early 1980s, Rowan has continued to employ a drilling rig modification and enhancement program designed to provide a fleet of jack-up rigs reflecting the latest technological advancements. In 1995, Rowan began a drilling rig expansion program that has produced enhanced versions of the Gorilla class rig and, in recent years, the Tarzan Class and 240C rig designs.

 

At March 15, 2006, Rowan had 13 jack-ups located in the Gulf of Mexico, four jack-ups in the Middle East, two jack-ups in the North Sea and one jack-up offshore eastern Canada. Based upon the number of rigs as tabulated by ODS-Petrodata, Rowan is the fifth largest offshore drilling contractor in the Gulf of Mexico and the third largest jack-up rig operator in the area. Relocation of equipment from one geographic location to another is dependent upon changing market dynamics, with moves occurring only when the likelihood of higher returns makes such action economical over the longer term. These moves have traditionally featured our Super Gorilla class rigs: Gorilla VII was relocated from the Gulf of Mexico to the North Sea in 2002; Gorilla V was relocated from eastern Canada to the North Sea in 2004 and Gorilla VI was relocated from the Gulf of Mexico to eastern Canada in 2005.

 

Rowan markets its drilling services by directly contacting present and potential customers, including large international energy companies, many smaller energy companies and foreign government-owned or controlled energy companies. Since 1992, with the many restructurings, downsizings and mergers by major energy companies, followed by periods of significant reductions in their domestic budgets, the Company has increased its marketing emphasis on independent operators.

 

See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” on pages 22 through 34 of this Form 10-K for a discussion of current industry conditions and their impact on operations.

 

Rowan’s drilling operations are subject to many hazards, including blowouts and well fires, which could cause personal injury, suspend drilling operations, seriously damage or destroy the equipment involved and cause substantial damage to producing formations and the surrounding areas. Offshore drilling operations are also subject to marine hazards, either while on site or under tow, such as vessel capsizing, collision or grounding. Raising and lowering the legs of jack-up rigs into the ocean bottom requires skillful handling to avoid capsizing or other serious damage. Drilling into high-pressure formations is a complex process and problems can frequently occur.

 

Rowan believes that it is adequately insured for physical damage to its rigs, and for marine liabilities, worker’s compensation, maritime employers liability, automobile liability and for various other types of exposures customarily encountered in the Company’s operations. Certain of Rowan’s liability insurance policies specifically exclude coverage for fines, penalties and punitive or exemplary damages. Rowan anticipates that its present insurance coverage will be maintained, but no assurance can be given that insurance coverage will continue to be available at rates considered reasonable, that self-insured amounts or deductibles will not increase or that certain

types of coverage will be available at any cost. The extensive damage caused by hurricanes in recent years has reduced the availability of insurance for certain risks while also increasing the cost of the coverage that is available.

 

Foreign operations are often subject to political, economic and other uncertainties not encountered in domestic operations, such as arbitrary taxation policies, onerous customs restrictions, unstable currencies and the risk of asset expropriation due to foreign sovereignty over operating areas. As noted previously, Rowan attempts to minimize the risk of currency rate fluctuations by generally contracting for payment in U.S. dollars.

 

Many aspects of Rowan’s operations are subject to government regulation, as in the areas of equipping and operating vessels, drilling practices and methods and taxation. In addition, various countries (including the United States) have regulations relating to environmental protection and pollution control. Recent events have also increased the sensitivity of the oil and gas industry to environmental matters. Rowan could become liable for damages resulting from pollution of offshore waters and, under United States regulations, must establish financial responsibility. Generally, Rowan is substantially indemnified under its drilling contracts for pollution damages, except in certain cases of pollution emanating above the surface of land or water from spills of pollutants, or in the case of pollutants emanating from the Company’s drilling rigs, but no assurance can be given regarding the enforceability of such indemnification provisions.

 

Rowan believes that it complies in all material respects with legislation and regulations affecting the drilling of oil and gas wells and the discharge of wastes. To date, the Company has made significant modifications to its Gulf of Mexico rigs to reduce waste and rain water discharge and believes that it could operate those rigs at “zero discharge” without material additional expenditures. Otherwise, regulatory compliance has not materially affected the capital expenditures, earnings or competitive position of the Company to date, although such measures do increase drilling costs and may reduce drilling activity. Further regulations may reasonably be anticipated, but any effects thereof on Rowan’s drilling operations cannot be accurately predicted. In the third quarter of 2004, Rowan learned that a unit of the U.S. Department of Justice (DOJ) is conducting a criminal investigation of environmental matters involving several of our offshore drilling rigs. Rowan is cooperating with the investigation, including responding to the DOJ’s subpoenas for certain documentation regarding our operations. The Company does not have sufficient information at this time to comment on the outcome of the investigation.

 

Rowan is subject to the requirements of the Federal Occupational Safety and Health Act (“OSHA”) and comparable state statutes. OSHA’s hazard communication standard, the Environmental Protection Agency’s “community right-to-know” regulations and comparable state statutes require Rowan to organize and report certain information about the hazardous materials used in its operations to employees, state and local government authorities and local citizens.

 

Since the exploration activities of Rowan’s present and potential customers are directly impacted by state, federal and foreign regulations associated with the production and transportation of oil and gas, the demand for Rowan’s drilling services is also affected.

 

In 1994, LeTourneau, Inc. (“LeTourneau”), a wholly-owned subsidiary of the Company, acquired the net assets of Marathon LeTourneau Company, headquartered in Longview, Texas. LeTourneau’s steel group operates a mini-steel mill that recycles scrap and produces steel plate for internal needs and external customers. The equipment group produces heavy equipment such as front-end mining loaders and log stackers. The marine group built the first jack-up drilling rig in 1955 and has designed or built more than 200 rigs since, including all 20 in the Rowan fleet. The drilling products group designs and manufactures LEWCO mud pumps in a wide range of sizes for a variety of applications, and has recently introduced other rig components such as drawworks, rotary tables and top drives.

 

During January 2002, the Company completed the purchase of certain assets of Oilfield-Electric-Marine, Inc. and Industrial Logic Systems, Inc. (OEM), issuing from treasury 439,560 shares of Rowan common stock valued at approximately $8 million. OEM designs and manufactures variable speed AC motors, variable frequency drive systems and other electrical components for the oil and gas, marine, mining and dredging industries within the drive systems group.

In 2005, the manufacturing division generated revenues of $293.4 million and income from operations of $7.7 million. External manufacturing backlog for all product lines was approximately $388 million at December 31, 2005, most of which is expected to be realized in 2006, compared with $79 million at December 31, 2004, almost all of which was realized during 2005.

 

The mining equipment product line features front-end loaders with bucket capacities of 18, 22, 28, 33 and 53 cubic yards. LeTourneau’s loaders are generally used in coal, gold, copper, diamond and iron ore mines and utilize LeTourneau’s diesel-electric drive system with digital controls. This system allows large, mobile equipment to stop, start and reverse without gear shifting and high maintenance braking. LeTourneau loaders can load rear-dump trucks in the 85-ton to 400-ton range. LeTourneau’s mining equipment and parts are distributed through a worldwide network of independent distributors and its own distribution network serving the western United States and Australia.

 

The timber equipment product line features diesel-electric powered log stackers with either two or four wheel drive configurations and load capacities ranging from 35 to 55 tons. LeTourneau is one of two manufacturers that sell electrically powered jib cranes rated from 25,000 to 52,000 lbs. at a reach of 100 to 150 feet and with a 360-degree rotation. LeTourneau’s timber equipment is marketed primarily in North America through independent dealers and its own dealer in the northwestern United States.

 

LeTourneau also sells parts and components to repair and maintain mining and timber equipment. Equipment parts are marketed through two independent dealers and its own dealer in the United States with 16 parts-stocking locations, one dealer in Canada with 12 parts-stocking locations, and 25 independent international dealers and its own Australian dealer with 40 parts-stocking locations.

 

The steel group’s Longview, Texas mini-steel mill produces carbon, alloy and tool steel plate products. LeTourneau concentrates on “niche” markets that require higher end steel grades, including mold steels, free machining, aircraft quality steels and hydrogen-induced, crack-resistant steels. External steel sales, which are garnered through a direct sales force, consist primarily of steel plate, but also include value-added fabrication of steel products. Steel products are generally sold to steel service centers, fabricators and manufacturers. The market for LeTourneau plate products is North America. The markets for fabricated product sales are regional and encompass Texas, Oklahoma, Louisiana, Mississippi and Arkansas. LeTourneau ships alloy and specialty grades of plate products nationally and exports quantities to Mexico and Canada. Carbon and alloy plate products are also used internally in the production of equipment and parts.

 

The marine group’s Vicksburg, Mississippi shipyard, which currently employs about 700 people, was reactivated during 1995-1996 following Rowan’s announcement of the planned construction of Gorilla V and is dedicated to providing equipment, spare parts and engineering support to the offshore drilling industry. Some rig component manufacturing and rig repair services, as well as design engineering, continue to be performed at the Longview, Texas facility.

 

As noted previously, the marine group completed Gorilla V in late 1998 and Gorilla VI in June 2000, delivered Gorilla VII in December 2001, the Bob Palmer in August 2003, the Scooter Yeargain in April 2004 and the Bob Keller in August 2005, and is currently constructing for the Company a third Tarzan Class jack-up rig, the Hank Boswell, and the first 240C jack-up. A fourth Tarzan Class rig is being constructed at a third party facility under a sub-contract arrangement. In addition, a Super 116 Class jack-up drilling rig purchased by Perforadora Central, S.A. de C.V. is under construction at LeTourneau’s Vicksburg facility.

 

LeTourneau engages in a limited amount of research and product development, primarily to increase the capacity of and provide innovative improvements to its product lines. The Company evaluates on an ongoing basis the manufacturing product and service lines with the intention of making enhancements.

 

The principal raw material utilized in LeTourneau’s manufacturing operations is steel plate, much of which is supplied by LeTourneau’s mini-steel mill. Other required materials are generally available in sufficient quantities to meet its manufacturing needs through purchases in the open market. LeTourneau does not believe that it is dependent on any single supplier.

 

LeTourneau markets and sells its equipment and support parts primarily through an established international dealer association. LeTourneau dealers are predominantly independent business organizations and all have established dealer agreements with LeTourneau. The dealers are responsible for selling equipment on behalf of LeTourneau to end users and providing the necessary follow-up service and parts supply directly to those end users.

 

LeTourneau’s mining equipment competes worldwide with several competitors. LeTourneau’s loader product line has only two direct competitors; however, the larger loader models compete with other types of loading equipment, primarily electric shovels and hydraulic excavators. Internal market studies indicate that, in the large-loader market (above 1,000 horsepower), LeTourneau has achieved about a 40% share of worldwide sales over the past seven years. LeTourneau recently reentered the small-loader market (1,000 horsepower and below), and currently has less than a 1% market share due to the availability of smaller and cheaper alternatives.

 

There are four major competitors for log stackers. Based upon market studies, LeTourneau’s estimated share of the domestic log-stacker market is around 20% and its estimated share of the Canadian market is around 15%.

 

The competition LeTourneau encounters in the parts business is fragmented with only three other companies considered to be direct competitors. Vendors supplying parts directly to end users and others who obtain and copy parts for cheaper and lower quality substitutes provide more intense competition than LeTourneau’s direct competitors.

 

To be competitive in the mining and timber equipment markets, LeTourneau offers warranties at the time of purchase and parts guarantees. The warranties extend for stipulated periods of ownership or hours of usage, whichever occurs first. Parts consumption guaranties and maintenance and repair contracts are made on the same basis. LeTourneau’s parts-return policy provides that returned parts must be in new, usable condition, in current production and readily resalable.

 

The steel group encounters competition from a total of six major competitors, with four in plate products and two in fabricated products. LeTourneau’s share of the overall steel market is negligible. The internal requirements of the equipment, marine and drilling products groups provide a base load for the steel mill, and LeTourneau uses a small, direct sales force to sell specialized alloy, carbon and tool steel products to steel service centers, fabricators, manufacturers and brokers.

 

Since 1955, when the first LeTourneau unit was delivered, the marine group has been recognized as a leading designer and builder of jack-up drilling rigs. We believe that there are currently approximately 50 competitive jack-ups under construction or contracted for construction worldwide, 10 of which are LeTourneau designs. At present, LeTourneau has a limited number of competitors in the rig construction and support industry. However, there are numerous shipyard facilities with the capability for jack-up rig construction.

 

The drilling products group’s two principal competitors in the mud pump business have a combined market share approaching 90%.

 

Historically, LeTourneau’s customer base has been diverse, such that none of its product lines have been dependent upon any one customer or small group of customers.

 

LeTourneau’s manufacturing operations and facilities are subject to regulation by a variety of local, state and federal agencies which regulate safety and the discharge of materials into the environment, including the Environmental Protection Agency (EPA), the Texas Commission on Environmental Quality (TCEQ) and the Mississippi Department of Environmental Quality. LeTourneau’s manufacturing facilities are also subject to the requirements of OSHA and comparable state statutes.

 

Hazardous materials are generated at LeTourneau’s Longview, Texas plant in association with the steel making process. Industrial wastewater generated at the mini-steel mill facility for cooling purposes is re-circulated and quality tests are conducted regularly. The facility has permits for wastewater discharges, solid waste disposal and air

emissions. Waste products considered hazardous by the EPA are disposed of by shipment to an EPA or state approved waste disposal facility.

 

LeTourneau jack-up designs are subject to regulatory approval by various agencies, depending upon the geographic areas where the rig will be qualified for drilling. The rules vary by location and are subject to frequent change, and primarily relate to safety and environmental issues, in addition to those which classify the jack-up as a vessel.

 

LeTourneau may be liable for damages resulting from pollution of air, land and inland waters associated with its manufacturing operations. LeTourneau believes that compliance with environmental protection laws and regulations will have no material effect on its capital expenditures, earnings or competitive position during 2006. Further regulations may reasonably be anticipated, but any effects thereof on the Company’s manufacturing operations cannot be accurately predicted.

 

As a manufacturing company, LeTourneau may be responsible for certain risks associated with the use of its products. These risks include product liability claims for personal injury and/or death, property damage, loss of product use, business interruption and necessary legal expenses to defend LeTourneau against such claims. LeTourneau carries insurance that it believes adequately covers such risks. LeTourneau did not assume certain liabilities of Marathon LeTourneau Company, such as product liability and tort claims, associated with all products manufactured, produced, marketed or distributed prior to the date of the acquisition.

 

LeTourneau anticipates incurring expenses associated with the warranty of its products. In the equipment business, dealers of LeTourneau’s products perform the warranty work. In the rig construction business, LeTourneau generally performs warranty work directly.

 

Through 2004, Rowan provided, through a wholly-owned subsidiary, Era Aviation, Inc. (“Era”), contract and charter helicopter and fixed-wing aviation services principally in Alaska, the coastal areas of Louisiana and Texas, and the western United States, using a combined fleet of more than 100 helicopters and fixed-wing aircraft. Effective December 31, 2004, Rowan sold the stock of Era for cash.

 

During the 2000-2005 period, Rowan operated six anchor-handling, towing and supply boats obtained under operating lease agreements. The boats were fully-crewed by the lessor, but managed by Rowan to provide towing and supply services for its drilling operations or third parties. During 2005, Rowan assigned the remaining lease term and sold its purchase options on four anchor-handling boats and allowed the leases covering the two remaining boats to expire.

 

See Note 12 of the Notes to Consolidated Financial Statements on pages 58 and 59 of this Form 10-K for more information regarding the Company’s discontinued operations.

 

Rowan had 4,637 employees at February 28, 2006 and 4,577, 4,392 and 5,395 employees at December 31, 2005, 2004 and 2003 respectively. Included in these numbers are citizens of the United States and other countries. None of the Company’s employees are covered by collective bargaining agreements with labor unions. Rowan considers relations with its employees to be satisfactory.

 

You should consider carefully the following risk factors, in addition to the other information contained and incorporated by reference in this Form 10-K, before deciding to invest in our common stock.

 

Our operations are volatile and heavily dependent upon commodity prices and other factors beyond our control.

 

The success of our drilling operations depends heavily upon the condition of the oil and gas industry and the level of offshore drilling activity. Demand for our drilling services is vulnerable to periodic declines in drilling

activity that are typically associated with depressed oil and natural gas prices. Oil and natural gas prices have historically been very volatile, and our drilling operations have in the past suffered through long periods of weak market conditions.

 

Demand for our drilling services also depends on additional factors that are beyond our control, including:

 

 

Our drilling operations will be adversely affected by future declines in oil and natural gas prices, but we cannot predict the extent of that effect. Nor can we assure you that a reduction in offshore drilling activity will not occur for other reasons. Our manufacturing operations, though less volatile, are also dependent on commodity prices which affect demand for rigs and rig components and mining and timber equipment.

 

We have incurred losses recently and over prolonged periods in the past, a circumstance that could occur again in the future.

 

In 2004, we incurred a net loss of $1.3 million. In 2003, we incurred a $3.3 million net loss from continuing operations. In 2002, we experienced a 19% decline in revenues and incurred a loss from operations of $26.1 million. During the 1985-1995 period, we consistently incurred net losses that totaled more than $360 million. The inherent volatility of the businesses in which we operate makes it likely that we will incur additional losses in the future.

 

Our markets are highly competitive, which may make it difficult for us to maintain satisfactory price levels.

 

Our drilling and manufacturing markets are highly competitive, and no single participant is dominant. In our drilling markets, drilling contracts are often awarded on a competitive bid basis, with intense price competition frequently being the primary factor determining which qualified contractor is awarded the job, although rig availability and location, the contractor’s safety and operational record and the quality and technical capability of service and equipment are also factors. Additionally, recent mergers among oil and natural gas exploration and production companies have reduced the number of available customers, which may further increase competition in our drilling markets. Our manufacturing markets are also characterized by vigorous competition among several competitors. Some of our competitors possess greater financial resources than we do. We may have to reduce our prices in order to remain competitive in our markets, which could have an adverse effect on our operating results.

 

The drilling history has historically been cyclical, and periods of low demand could have an adverse effect on our operating results.

 

The contract drilling industry has historically been cyclical, with periods of high demand, short rig supply and high day rates, followed by periods of lower demand, excess rig supply and low day rates. Although demand for drilling services is currently strong, there can be no assurances that demand will not decline in future periods. Strong demand may lead to an increase in new rig construction and reactivation of cold-stacked rigs, which could lead to increased price competition. We believe there are currently approximately 50 competitive jack-ups under construction or contracted for construction worldwide. There can be no assurances that the market will be able to fully absorb the addition of these new rigs to the worldwide fleet, and the addition of these rigs could lead to decreased rig utilization, increased price competition and lower day rates. Prolonged periods of low rig utilization and day rates

require us to enter into lower rate contracts or idle rigs, which could have an adverse effect on our operating results and cash flows. Prolonged periods of low rig utilization and day rates could also result in the recognition of impairment charges on certain of our drilling rigs if future cash flow estimates, based upon information available to management at the time, indicate that their carrying value may not be recoverable.

 

Most of our drilling contracts are fixed day rate contracts, and increases in our operating costs could have an adverse effect on the profitability of those contracts.

 

Most of our contracts with customers for our drilling units provide for the payment of a fixed day rate per rig operating day. However, many of our operating costs are unpredictable and vary based on events beyond our control. Our gross margins on these fixed day rate contracts will vary based on fluctuations in our operating costs during the terms of these contracts. If our costs increase or we encounter unforeseen costs, we may not be able to recover such costs from our customers, which could adversely affect our financial position, results of operations and cash flows.

 

Our fleet expansion program may encounter liquidity problems.

 

If operating conditions deteriorate, our results of operations would suffer and working capital may not be adequate to finance our ongoing fleet expansion program. Because outside financing may not be available, we could be forced to suspend rig construction activities.

 

We have in progress an offshore fleet expansion program under which we plan to spend approximately $515 million over the 2006-2009 period towards the completion of our third and fourth Tarzan Class jack-up rigs and the construction of two new 240C rigs. Another $257 million is committed in 2006 toward the construction of 12 new land rigs and for ongoing upgrades to existing equipment and facilities. We currently have no available lines of credit, thus all of our expected capital expenditures over the next two to three years may need to be internally financed through working capital or operating cash flows. If we experience cost overruns or delays in our capital projects or if we should need additional financing and are unable to obtain it at commercially favorable rates, we could experience liquidity problems.

 

Rig upgrade, enhancement and new construction projects are subject to risks which could cause delays or cost overruns and adversely affect our financial condition and results of operations.

 

As noted above, we currently have a substantial fleet expansion program in progress. These projects and other projects of this type are subject to risks of delay or cost overruns inherent in any large construction project from numerous factors, including the following:

 

 

Significant cost overruns or delays could adversely affect our financial condition of operations. Additionally, failure to complete a project on time may result in the delay of revenue from that rig, which also could adversely affect our financial condition, results of operations and cash flows.

 

Our Super Gorilla and Tarzan Class offshore jack-up drilling rigs are pledged as security under our government-guaranteed debt arrangements.

 

If operating conditions deteriorate and if market conditions were to remain depressed for a long period of time, our results of operations would suffer and working capital and other financial resources may not be available or

adequate to service our outstanding debt. Our four Super Gorilla class jack-ups and our two Tarzan Class jack-ups are pledged as security under our government-guaranteed debt arrangements. If we were unable to service our debt, it is possible that these assets could be removed from our fleet, in which case our ability to generate revenues would be significantly reduced.

 

Our results of operations will be adversely affected if we are unable to secure drilling contracts for our rigs on economically favorable terms.

 

The drilling markets in which we compete frequently experience significant fluctuations in the demand for drilling services, as measured by the level of exploration and development expenditures, and the supply of capable drilling equipment. In response to fluctuating market conditions, we can, as we have done in the past, relocate drilling rigs from one geographic area to another, but only when such moves are economically justified over the longer term. If demand for our rigs declines, our rig utilization and day rates are generally adversely affected.

 

The expansion of our drilling fleet increases our daily operating costs. We may be unable to secure economical drilling contracts for our new rigs, in which case their delivery will negatively impact our operating results.

 

If our customers terminate or seek to renegotiate our drilling contracts, our results of operations may be adversely affected.

 

Some of our drilling contracts are cancelable by the customer upon specific notice by the customer, or upon the occurrence of events beyond our control, such as the loss or destruction of the rig or the suspension of drilling operations for a specified period of time as a result of a breakdown of major equipment. Although our contracts may require the customer to make an early termination payment upon cancellation of the contract, such payment may not be sufficient to fully compensate us for the loss of the contract. Early termination of a contract may result in a rig being idle for an extended period of time. Our revenues, results of operations and cash flows may be adversely affected by customers’ early termination of contracts, especially if we are unable to re-contract the affected rig within a short period of time. Additionally, during adverse market conditions, a customer may be able to obtain a comparable rig at a lower daily rate, and as a result, may seek to renegotiate the terms of their existing drilling contract with us. The renegotiation of a number of our drilling contracts could adversely affect our revenues, results of operations and cash flows.

 

 

Failure to obtain or retain highly skilled personnel could adversely affect our operations.

 

We require highly skilled personnel to operate and provide technical services and support for our businesses. Competition for skilled and other labor required for our drilling operations has increased in recent years as the number of rigs activated or added to worldwide fleets has increased. If this expansion continues and the demand for drilling services remains strong or increases, shortages of qualified personnel could develop, creating upward pressure on wages and making it more difficult to staff and service our rigs, which could adversely affect our operating results.

 

Many of our drilling rigs are subject to damage or destruction by severe weather.

 

Much of the Gulf of Mexico, the North Sea and offshore eastern Canada experience hurricanes or other extreme weather conditions on a relatively frequent basis. Many of our offshore drilling rigs are located in these areas and are thus subject to damage or destruction by these storms. Damage caused by high winds and turbulent seas could cause us to suspend operations on such drilling rigs for significant periods of time until the damage can be repaired. Additionally, even if our drilling rigs are not directly damaged by such storms, we may still experience disruptions in our operations due to damage to our customer’s platforms and other related facilities in these areas. During Hurricanes Katrina and Rita in 2005, we lost four rigs and another was significantly damaged. Future storms could result in the loss or damage of additional rigs, which could adversely affect our financial condition, results of operations and cash flows.

We are subject to operating risks such as blowouts and well fires that could result in environmental damage, property loss, personal injury and death, some of which may not be covered by insurance or recoverable indemnification.

 

Our drilling operations are subject to many hazards that could increase the likelihood of accidents. Accidents can result in:

 

 

Our offshore drilling operations are also subject to marine hazards, either at offshore sites or while drilling equipment is under tow, such as vessel capsizings, collisions or groundings. In addition, raising and lowering jack-up rigs and drilling into high-pressure formations are complex, hazardous activities and we frequently encounter problems.

 

Our manufacturing operations also present serious risks. Our manufacturing processes could pollute the air, land, and inland waters, and the products we manufacture could be implicated in lawsuits alleging environmental harm, property loss, personal injury and death.

 

We have had accidents in the past demonstrating some of the hazards described above, including high pressure drilling accidents resulting in lost or damaged drilling formations and towing accidents resulting in lost drilling equipment. Any similar events could yield future operating losses and have significant adverse impact on our business.

 

We currently maintain broad insurance coverage, subject to certain significant deductibles and levels of self-insurance, but it does not cover all types of losses, and in some situations it may not provide full coverage of losses or liabilities resulting from our operations. Further, due to the losses sustained by us and the offshore drilling industry as a consequence of hurricanes that occurred in the Gulf of Mexico in 2004 and 2005, we may not be able to obtain future insurance coverage comparable with that of prior years, thus putting us at a greater risk of loss due to severe weather conditions and other hazards, which could have a material adverse effect on our financial position, results of operations and cash flows. In addition, we are likely to experience increased costs for available insurance coverage which may impose higher deductibles and limit maximum aggregated recoveries for certain perils, such as hurricane related windstorm damage or loss. We may be required to modify our risk management program in response to changes in the insurance market, including increased risk retention.

 

Consistent with standard industry practice, we typically obtain contractual indemnification from our customers whereby such customers generally agree to protect and indemnify us for liabilities resulting from various hazards associated with the drilling industry. However, there can be no assurance that our customers will be financially able to meet these indemnification obligations, and the failure of a customer to meet such obligations, the failure of one or more of our insurance providers to meet claim obligations, or losses or liabilities resulting from unindemnified, uninsured or underinsured events could have a material adverse effect on our financial position, results of operations and cash flows.

 

Government regulations and environmental risks, which reduce our business opportunities and increase our operating costs, might worsen in the future.

 

Government regulations dictate design and operating criteria for drilling vessels, determine taxation levels to which we (and our customers) are subject, control and often limit access to potential markets and impose extensive requirements concerning employee safety, environmental protection and pollution control. Environmental regulations, in particular, prohibit access to some markets and make others less economical, increase equipment and personnel costs and often impose liability without regard to negligence or fault. In addition, governmental regulations may discourage our customers’ activities, reducing demand for our products and services. We may

be liable for damages resulting from pollution of offshore waters and, under United States regulations, must establish financial responsibility in order to drill offshore.

 

In response to the significant damage to offshore rigs in recent years caused by Gulf of Mexico hurricanes, various industry and regulatory organizations are considering additional operating constraints during the tropical storm season. Such constraints, if required, could limit the capability of many of the Company’s rigs to operate at certain locations in the Gulf of Mexico during a significant portion of each year. Depending upon the Company’s ability to obtain work elsewhere, the impact of these additional regulations could be to reduce the Company’s ability to generate drilling revenues.

 

Anti-takeover provisions in our Certificate of Incorporation, bylaws and stockholder rights plan could make it difficult for holders of our common stock to receive a premium for their shares upon a change of control.

 

Holders of the common stock of acquisition targets may receive a premium for their shares upon a change of control. Delaware law and the following provisions, among others, of our Certificate of Incorporation, bylaws and rights plan could have the effect of delaying or preventing a change of control and could prevent holders of our common stock from receiving such a premium:

 

 

The Company has no unresolved Securities and Exchange Commission staff comments.

 

Rowan leases as its corporate headquarters 61,800 square feet of space in an office tower located at 2800 Post Oak Boulevard in Houston, Texas.

 

Following are summaries of the principal drilling equipment owned or operated by Rowan and in service at March 15, 2006. See “Liquidity and Capital Resources” under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” on pages 22 through 34 of this Form 10-K.

 

OFFSHORE RIGS

 

 

 

 

ONSHORE RIGS (a)

 

 

 

 

Rowan’s drilling division leases and, in some cases, owns various operating and administrative facilities generally consisting of office, maintenance and storage space in the states of Alaska, Texas and Louisiana and in the countries of Canada and England. During 2001, we completed construction of an operating and administrative facility with approximately 19,000 square feet near Aberdeen, Scotland.

 

LeTourneau’s principal manufacturing facility and headquarters are located in Longview, Texas on approximately 2,400 acres with approximately 1.2 million square feet of covered working area. The facility contains:

 

 

The marine group’s rig construction facility is located in Vicksburg, Mississippi on 1,850 acres of land and has approximately 560,000 square feet of covered work area. The group’s rig service and repair operation is carried out primarily at the Company’s Sabine Pass, Texas facility.

 

LeTourneau’s mud pumps are machined, fabricated, assembled and tested at a facility in Houston, Texas, having approximately 140,000 square feet of covered work area and 16,000 square feet of office space. LeTourneau mud pumps are also machined at its Longview, Texas facility.

 

In 2003, the Company relocated its electrical components, service and supply business conducted by OEM to a newly-constructed facility in Houston, Texas, having approximately 187,000 square feet of covered work area and 17,000 square feet of office space.

 

LeTourneau’s distributor of forest products in the northwestern United States is located on a six-acre site in Troutdale, Oregon with approximately 22,000 square feet of building space.

 

LeTourneau’s distributor of mining equipment products in the western United States is located in a leased facility in Tucson, Arizona having approximately 20,000 square feet. Its distributor of mining equipment products in Australia is located in a leased facility in Murarrie, Queensland having approximately 29,500 square feet.

 

The Company leased the Rowan-Halifax under a charter agreement that commenced in 1984 and was scheduled to expire in March 2008. The rig was insured for $43.4 million prior to it being lost in September 2005 during Hurricane Rita. We believe the insured value satisfied the requirements of the charter agreement, and by a margin sufficient to cover the $6.3 million carrying value of our equipment installed on the rig. However, the owner of the rig has claimed that the rig should have been insured for its fair market value and may seek recovery from Rowan for compensation above the insured value. Thus, we have assumed no insurance proceeds related to the Rowan-Halifax and recorded a charge during the third quarter of 2005 for the full carrying value of our equipment. On November 3, 2005, the Company filed a declaratory judgement action in Texas State Court to resolve the disagreement among the parties. Recent appraisals obtained by the owner indicate that the fair market value of the rig ranged from $75-$91 million.

 

During 2005, the Company learned that a unit of the U.S. Department of Justice (DOJ) is conducting an investigation of potential antitrust violations among helicopter transportation providers in the Gulf of Mexico. Rowan’s former aviation subsidiary, which was sold effective December 31, 2004, has received a subpoena in connection with the investigation. The Company has not been contacted by the DOJ, but the purchaser has made a claim that Rowan is responsible for any exposure it may have. The Company has disputed that claim.

 

During 2004, the Company learned that a unit of the DOJ is conducting a criminal investigation of environmental matters involving several of Rowan’s offshore drilling rigs. Rowan is cooperating with the investigation, including responding to the DOJ’s subpoenas for certain documentation regarding our operations. The Company does not have sufficient information at this time to comment on the possible outcome of the investigation.

Rowan is involved in various legal proceedings incidental to its businesses and is vigorously defending its position in all such matters. Rowan believes that there are no known contingencies, claims or lawsuits that will have a material adverse effect on its financial position, results of operations or cash flows.

 

There were no matters submitted to a vote of Rowan common stockholders during the fourth quarter of the fiscal year ended December 31, 2005.

 

The names, positions, years of credited service and ages of the officers of the Company as of March 15, 2006 are listed below. Officers are appointed by the Board of Directors and serve at the discretion of the Board of Directors. There are no family relationships among these officers, nor any arrangements or understandings between any officer and any other person pursuant to which the officer was selected.

 

 

 

 

Each of the officers listed above continuously served in the position shown above for more than the past five years except as noted in the following paragraphs.

 

Since May 2004, Mr. McNease’s principal occupation has been in the position set forth. From May 2003 to May 2004, Mr. McNease served as President and Chief Executive Officer of the Company. From August 2002 to May 2003, Mr. McNease served as President and Chief Operating Officer of the Company. From April 1999 to August 2002, Mr. McNease served as Executive Vice President of the Company and President of its drilling subsidiaries. Mr. McNease was first elected to the Board of Directors in April 1998.

 

Since August 2002, Mr. Croyle’s principal occupation has been in the position set forth. For more than five years prior to that time, Mr. Croyle served as Executive Vice President of the Company. Mr. Croyle was first elected to the Board of Directors in April 1998.

 

Since April 2003, Mr. Buvens’ principal occupation has been in the position set forth. For more than five years prior to that time, Mr. Buvens served as Vice President — Legal.

 

Since May 2005, Mr. Wells’ principal occupation has been in the position set forth. For more than five years prior to that time, Mr. Wells served as Controller.

 

The following information summarizes Rowan’s results of operations and financial position for each of the last five years.

 

 

 

 

RESULTS OF OPERATIONS

 

The following table highlights Rowan’s operating results for the years indicated (in millions):

 

 

As indicated in the preceding table, Rowan’s results of operations are heavily dependent upon the performance of our drilling division, which comprises about 94% of our fixed assets and, over the past three years, has generated 73% of our aggregate revenues and 96% of our aggregate operating income. Our manufacturing division has strategically led the expansion and upgrade of our drilling fleet and, in recent years, has improved its contribution to our operating results. The performance of each of our continuing operations over the 2003-2005 period is discussed more fully below.

 

On December 31, 2004, we completed the sale of our aviation operations. In February 2005, we sold our options to purchase four larger anchor-handling boats and, in May 2005, leases covering our remaining boats expired and we exited the marine vessel business. The amounts shown in the table above for Income (loss) from discontinued operations reflect the aggregate after-tax results of our aviation and boat operations for each of the past three years, and include a $13.1 million after-tax gain recognized on the sale of our boat purchase options in 2005 and a $16.0 million after-tax loss recognized on the sale of our aviation operations in 2004.

 

Drilling Operations

 

Rowan’s drilling operating results are a function of rig activity and day rates in our principal operating areas, which have historically been offshore in the Gulf of Mexico, the North Sea and eastern Canada and onshore in Texas and Louisiana. We are selective in pursuing work in other overseas markets where our harsh environment jack-up rigs are well-suited, and seek opportunities to maximize long-term returns.

 

Rig activity and day rates are primarily determined by energy company exploration and development expenditures, which are heavily influenced by oil and natural gas prices, and the availability of competitive equipment. Day rates generally follow the trend in rig activity and, due to intense competition in the contract drilling industry, both have historically declined much faster than they have risen.

 

Rowan’s rig fleet consists of 20 offshore jack-up rigs and 17 actively-marketed land rigs. Our offshore fleet features three Gorilla class jack-ups built during the early 1980s, four Super Gorilla class jack-ups constructed during the 1998-2003 period, and two Tarzan Class jack-ups delivered in 2004 and 2005. Our land fleet includes four rigs constructed during 2001-2002 and eleven rigs that have been substantially rebuilt in recent years.

 

For the past several years, our offshore drilling operations have been focused in the Gulf of Mexico, where 13 of our offshore rigs are currently deployed. This market is extremely fragmented among many oil and gas

companies, most of whom are independent operators whose drilling activities are often highly dependent upon near-term operating cash flows. A typical drilling assignment may call for 30-60 days of exploration or development work, performed under a single-well contract with negotiable renewal options. Long-term contracts have been rare, and generally are available only from the major integrated oil companies and a few of the larger independent operators. Thus, drilling activity and day rates in this market have tended to fluctuate rather quickly, and generally follow trends in natural gas prices. Rowan has historically avoided long-term commitments unless they provided opportunities for rate adjustments in the future.

 

As discussed more fully below, high natural gas prices and the continued migration of rigs to foreign markets in recent years, coupled with the significant loss of equipment in 2005 due to hurricanes, have created a jack-up supply deficit in the Gulf of Mexico. As a result, rig day rates have increased dramatically over the past several months to record levels and term drilling contracts are becoming more prevalent. Thus, Rowan is currently more receptive to longer-term commitments than in the past.

 

The North Sea is a mature offshore drilling market that has long been dominated by major oil and gas companies operating within a relatively tight regulatory environment. Drilling assignments can range from several months to several years, and project lead times are often lengthy. Thus, drilling activity and day rates in the North Sea move slowly in response to market conditions, and generally follow trends in oil prices. Following a two-year absence, we returned to the North Sea with the newbuild Gorilla VII in early 2002, and added Gorilla V to that market in late 2004. We recently extended the Gorilla VII commitment into the third quarter of 2007.

 

We have operated offshore eastern Canada to varying degrees since the early 1980s, and our presence there peaked at three fully utilized rigs in mid-2000. More recently, demand for harsh environment jack-ups offshore eastern Canada has been sporadic. We returned to that market with the Gorilla VI during the second quarter of 2005 and recently committed the rig for work there through November 2006.

 

In August 2005, we obtained a three-year contract from Saudi Aramco for four jack-up rigs offshore Saudi Arabia, our first drilling assignment in the Middle East in 25 years. The Rowan-Middletown, Charles Rowan, Arch Rowan and Rowan-California departed the Gulf of Mexico in January 2006 and are expected to be working in the Persian Gulf in April.

 

Rowan does not cold-stack its drilling rigs during slack periods as we believe the long-term costs of retraining personnel and restarting equipment negates any short-term savings. Thus, our drilling expenses do not typically fluctuate with rig activity, though they have increased as our rig fleets have been expanded. Rig fleet additions in recent years have included the second Tarzan Class jack-up Bob Keller delivered in August 2005, the first Tarzan Class jack-up Scooter Yeargain delivered in April 2004, the Super Gorilla XL class jack-up Bob Palmer delivered in August 2003 and four existing land rigs that were substantially rebuilt during 2005 (two rigs) and 2003 (two rigs).

 

2005 Compared to 2004

 

The following table highlights the performance of our drilling division during 2005 compared to 2004 (dollars in millions):

 

 

Drilling revenues increased by $303.3 million in 2005, due primarily to the effects of increased average day rates, as follows (in millions):

 

 

Our overall offshore fleet utilization was 96% in 2005, up from 92% in 2004. Our average offshore day rate was $78,100 in 2005, an increase of approximately 60% over 2004. We compute rig utilization as revenue-

producing days divided by total available rig-days. Average day rates are determined as recorded revenues, excluding rebilled expenses, divided by revenue-producing days.

 

Natural gas prices were at historically high levels in early 2005, and increased further during the year primarily due to declining domestic production and growing demand. Prices went even higher following Hurricanes Katrina and Rita, as significant gas production from the Gulf of Mexico was shut-in due to damaged platforms and pipelines. These storms also removed eight units from the competitive jack-up fleet, including four of our rigs. Another six rigs migrated to foreign markets during the year. As a result, we were able to consistently increase our Gulf of Mexico day rates during 2005. The following table summarizes average natural gas prices and our Gulf of Mexico fleet utilization and average day rates during the year:

 

 

 

 

As shown in the preceding table, our average Gulf of Mexico day rate increased by 57% in 2005. Our Gulf of Mexico fleet declined to 17 units during the year as four rigs were lost during the hurricanes, two rigs were sold and one rig was relocated to eastern Canada. Our second Tarzan Class jack-up, the Bob Keller, was delivered in August and commenced operations in September. Another rig was severely damaged during Hurricane Katrina and should return to service in 2006. As a result, our total revenue-producing days in the Gulf of Mexico decreased by 221 or 3% during 2005. Four of our rigs departed the area in early 2006 for work in Saudi Arabia.

 

Oil prices reached new heights during 2005, peaking at just below $70 per barrel, and ended the year at around $65. Thus, rig demand remained strong in most foreign markets, which contributed to the further migration of jack-ups from the Gulf of Mexico.

 

Market conditions in our principal foreign areas, the North Sea and offshore eastern Canada, improved during the year, enabling Rowan to secure more profitable drilling assignments. Gorilla V was 94% utilized in the North Sea in 2005, and generated more than $160,000 per day in drilling revenues during the year. The Gorilla VII simultaneous drilling/production assignment in the United Kingdom sector ended during the second quarter of 2005 and the rig was relocated to Denmark during the third quarter. Gorilla VII was 94% utilized in the area and averaged more than $175,000 per day in revenues thereafter. Gorilla VI was relocated from the Gulf of Mexico to offshore eastern Canada during the second quarter of 2005, where the rig was 82% utilized and generated almost $160,000 per day in revenues during the remainder of the year.

 

Rowan’s 17 actively marketed deep-well land rigs were 98% utilized in Texas, Louisiana and Oklahoma in 2005, and achieved an average day rate of $18,400 during the year, compared to 97% and $12,200 in 2004. The fleet includes one rig, idle since 2002, that was substantially rebuilt during the year and returned to service in late December 2005. Twelve new 2000 horsepower land rigs are at varying stages of construction and should be delivered by the end of 2006. Ten of these new rigs have been contracted for terms ranging from two to three years.

Drilling operating costs increased by $67.9 million or 21% in 2005 compared to 2004, due primarily to effects of the following (in millions):

 

 

Selling, general and administrative costs increased by 18.3 million or 68% in 2005, due primarily to higher professional services fees associated with Sarbanes-Oxley Act compliance and incremental incentive compensation costs. Depreciation and amortization increased by $0.8 million or 1% in 2005, due primarily to the addition of the rigs shown above.

 

Drilling operating income in 2005 included $52.8 million of gains on asset disposals during the year, $39.1 million of which was recognized on the sale of our 32-year old jack-up Rowan-Texas during the third quarter. Another $13.9 million of operating income reflects the net of insurance proceeds received over the carrying values of our four jack-up rigs that were lost during Hurricanes Katrina and Rita and related uninsured salvage costs.

 

2004 Compared to 2003

 

The following table highlights the performance of our drilling division during 2004 compared to 2003 (dollars in millions):

 

 

Drilling revenues increased by $79.9 million in 2004, due to the effects of increases in both drilling activity and average day rates, as follows (in millions):

 

 

Our overall offshore fleet utilization was 92% in 2004, up from 89% in 2003. Our average offshore day rate was $48,900 in 2004, an increase of approximately 12% over 2003. We consider only revenue-producing days in computing rig utilization and average day rates.

 

Natural gas prices remained fairly stable at well above $5.00 per mcf throughout 2004, due largely to constrained supply coupled with growing demand. At the same time, the size of the competitive Gulf of Mexico jack-up fleet again declined during the year as rigs continued to be attracted to foreign markets. Following the unexpected cancellation of projects for three Gorilla class jack-ups in the first quarter, overall demand for our Gulf of Mexico rigs improved throughout the remainder of 2004, which enabled Rowan to consistently increase average day rates in the area. The following table summarizes average natural gas prices and our Gulf of Mexico fleet utilization and average day rates during 2004:

 

 

 

As shown in the preceding table, our average Gulf of Mexico day rate increased by 19% in 2004. Our Gulf of Mexico fleet increased to 23 units in May 2004 with the commencement of operations by the Scooter Yeargain. As a result, our total revenue-producing days in the Gulf of Mexico increased by 462 or 6% during 2004.

 

Oil prices rose significantly during 2004, to a peak of more than $50 per barrel, which helped sustain strong rig demand in many foreign markets and influenced the continued migration of many jack-ups from the Gulf of Mexico. However, market conditions in our principal foreign areas, the North Sea and offshore eastern Canada, did not improve measurably during the year.

 

Rowan’s drilling operating results for the first nine months of 2004 were considerably affected by our North Sea drilling contract for Gorilla VII. The contract, under which operations began in June 2003, specified an 18-month minimum term and provided for a day rate tied to an average oil price. In March 2004, following declining oil production from the first three wells, we agreed to reduce the day rate under the contract in an attempt to extend the field’s economic life. In late December, we extended the contract at the existing day rate through 2005 and collected $9.6 million toward our outstanding receivables, which paid in full all amounts that originated prior to the fourth quarter. However, as our collection of additional amounts was dependent upon cash flows from the project, we ceased recognizing further drilling revenues under the contract until collected. Accordingly, we did not recognize fourth quarter revenues totaling $10.4 million, which left the year-end balance of recorded receivables related to this contract at zero. Rowan had realized almost $65 million in revenues under the contract since its inception, including more than $35 million during 2004.

 

Gorilla V was 87% utilized offshore eastern Canada in 2004 before relocating to the North Sea during the third quarter. After outfitting, the rig began a nine-month drilling assignment in the Glenelg Field in January 2005.

 

Rowan’s 15 actively-marketed deep-well land rigs were 97% utilized in Texas and Louisiana in 2004, and achieved an average day rate of $12,200 during the year, compared to 88% and $10,700 in 2003. Another rig, idle since 2001, was substantially rebuilt and returned to service in March 2005. Our carrying values and ongoing costs related to the two remaining idle rigs are not significant.

 

Drilling operating costs increased by $24.5 million or 8% in 2004 compared to 2003, due primarily to effects of the following (in millions):

 

 

Selling, general and administrative costs increased by $2.3 million or 9% in 2004, due primarily to higher professional services, incentive compensation and retirement plan costs. Depreciation and amortization increased by $8.2 million or 14% in 2004, due primarily to the addition of the rigs shown above.

 

Outlook

 

Worldwide rig demand is inherently volatile and has historically varied from one market to the next, as has the supply of competitive equipment. Exploration and development expenditures are affected by many local factors, such as political and regulatory policies, seasonal weather patterns, lease expirations, and new oil and gas discoveries. In the end, however, the level and expected direction of oil and natural gas prices are what most impact drilling activity. With consistently high prices in recent years, energy companies have realized substantial cash flows which we believe should, over time, lead to additional drilling projects.

 

Currently, the outlook for most worldwide drilling markets appears to be strong or improving. Expected demand for jack-ups exceeds the supply of rigs in the Middle East, West Africa, India and most other foreign locations. Thus, energy companies in markets like the Gulf of Mexico and North Sea may be forced to aggressively compete for drilling equipment. Assuming these events occur, our drilling operations should continue to benefit. The volatility inherent in this business, however, makes any prediction of future market conditions speculative. Thus, we can offer no assurance that existing market conditions will continue beyond the near term, or that expected improvements will materialize.

Our three-year contract covering four rigs in the Middle East will bring more global diversification to our drilling operations and, over time, should improve the average return on our investments. During 2005, we began drilling operations offshore Denmark and performed the first jack-up drilling assignment ever undertaken in the Grand Banks area offshore Newfoundland. Our Denmark contract was recently extended for one year with a 40% increase in the day rate. We recently obtained a one-year contact in Trinidad that should begin during the third quarter of 2006 and provide an 80% increase from the current Gulf of Mexico rate. We will continue to pursue overseas assignments that we believe will maximize the contribution of our offshore rigs and enhance our operating results.

 

Hurricanes Katrina and Rita caused tremendous damage to drilling and production equipment and facilities throughout the Gulf Coast during the third quarter of 2005, and we suffered a significant loss of current and prospective revenues. These storms also had the effect of further reducing the supply of available drilling equipment in the Gulf of Mexico, which has thus far greatly improved market conditions for our remaining rigs. We were recently awarded a two-year $160-170 million contract to drill one or more ultra deep shelf wells. The cost of doing business there, however, is also rising, especially in the insurance area. Though we have obtained coverage for our offshore operations and fleet beyond the end of 2006, our annual insurance cost will be about four times the pre-storm level and we have assumed more of the risk of certain losses.

 

Following the 2005 hurricanes, and based upon improving business conditions, we accelerated our building program to provide earlier deliveries of the Hank Boswell (third quarter 2006) and our fourth Tarzan Class rig (expected third quarter 2007) and expanded it to include the construction of two of a new class of jack-up, the 240C. We expect delivery of the first 240C in mid 2008 and the second in early 2009. The Rowan-Louisiana, which was significantly damaged during Hurricane Rita, is currently undergoing repairs and is expected to rejoin the Company’s fleet during the third quarter of 2006.

 

Additionally, we saw land drilling day rates improve and drilling assignments lengthen in 2005 to the point where long-term contracts became available from many energy companies looking for newly constructed rigs. During the third quarter, we obtained drilling contracts for six new 2000 horsepower rigs covering 14 rig years. Another six new rigs are on order and four of these have three-year drilling contracts. All of the new land rigs will contain the latest products from our manufacturing division, including the drawworks, mud pumps, top drive, rotary table and power controls.

 

Our drilling operations are currently benefiting from predominantly favorable market conditions worldwide and are profitable. There is no assurance, however, that such conditions will be sustained beyond the near term or that our drilling operations will remain profitable. Our drilling operations will be adversely affected if market conditions deteriorate.

 

Manufacturing Operations

 

We have manufacturing facilities in Longview and Houston, Texas and Vicksburg, Mississippi that collectively produce mining, timber and transportation equipment, alloy steel and steel plate, and drilling rigs and various rig components. Our manufacturing division built the first jack-up drilling rig in 1955 and has designed or built more than 200 rigs since, including all 20 in our fleet. During 2005, the division delivered the second Tarzan Class jack-up, the Bob Keller, achieved significant construction progress on the third, the Hank Boswell, began construction of the fourth and developed a new jack-up rig design, the 240C.

2005 Compared to 2004

 

Rowan’s manufacturing division achieved an $85.8 million or 41% increase in revenues in 2005, primarily comprised as follows (dollars in millions):

 

 

The equipment group shipped 34 new mining loaders and log stackers in 2005, up from 23 units in 2004. Parts sales improved by $4.7 million or 12% during 2005. Marine group revenues in 2005 included $36.1 million recognized on long-term rig and rig kit construction projects that began during the year. The drilling products group shipped 39 mud pumps to outside customers during 2005, up from 23 in 2004. The steel group experienced an 18% decrease in external steel shipments in 2005 that was more than offset by a 28% increase in average steel prices during the year. Internal steel shipments increased by 300% in 2005. Drive systems group revenues declined during 2005 due primarily to efforts required to complete a $10 million dredge barge for the US Army Corps of Engineers.

 

Our mining equipment, especially the smaller loaders, has traditionally yielded lower margins than the related after-market parts sales. In addition, a rig construction project usually takes longer to complete and involves a significantly greater labor effort than a rig kit, and thus typically yields a lower margin. As a result of the greater activity in these areas in 2005, our direct cost of sales increased by $71.9 million or 46% during the year, and our average margin declined to 22% of revenues in 2005 from 25% in 2004. A $2.3 million loss incurred on the dredge barge project contributed to the decline in margins in 2005.

 

Other manufacturing operating expenses increased by $4.7 million or 22% in 2005 compared to 2004, due primarily to incremental engineering efforts and higher shipping and warehousing costs. Selling, general and administrative costs increased by $6.1 million or 44% in 2005, due primarily to higher selling-related expenses, professional service fees associated with Sarbanes-Oxley Act compliance and incentive compensation costs. Depreciation and amortization increased by $1.9 million or 19% in 2005, due primarily to ongoing capacity improvements at our manufacturing facilities. As a result, operating income increased by only $0.9 million or 13% during the year, and remained unchanged at 3% of revenues in 2005.

 

Our 2005 manufacturing operating results exclude the effects of approximately $118 million of products and services provided at cost to our drilling division during the year, most of which was attributable to completion of the Bob Keller and construction progress on the Hank Boswell.

 

2004 Compared to 2003

 

Rowan’s manufacturing division achieved a $70.5 million or 51% increase in revenues in 2004, primarily comprised as follows (dollars in millions):

 

 

The equipment group shipped 23 new mining loaders and log stackers in 2004, up from 14 units in 2003. Parts sales improved by $4.2 million or 12% during 2004. Growing worldwide demand enabled the steel group to achieve a $13.6 million or 81% increase in revenues in 2004 on a 45% increase in external steel shipments. Average steel selling prices increased by more than 50% during the year, which helped to offset the impact of higher steel costs on

the other manufacturing groups. Marine group revenues in 2004 included $8.2 million of incremental specialty fabrication work. Drive systems group revenues included $7.5 million recognized on the $10 million dredge barge for the US Army Corps of Engineers. The drilling products group shipped 23 mud pumps to outside customers during 2004, up from 15 in 2003.

 

Our mining equipment, especially the smaller loaders, has traditionally yielded lower margins than the related after-market parts sales. Thus, our direct cost of sales increased by $60.0 million or 63% during the year, and our average margin declined to 25% of revenues in 2004 from 30% in 2003.

 

Other manufacturing operating expenses increased by $3.2 million or 18% in 2004 compared to 2003, due primarily to incremental engineering efforts and higher shipping and warehousing costs. Selling, general and administrative costs increased by $2.3 million or 20% in 2004, due primarily to higher selling-related expenses, professional service fees and incentive compensation costs. Depreciation and amortization increased by $0.3 million or 3% in 2004. As a result, operating income increased by $4.6 million during the year, and improved to 3% of revenues in 2004.

 

Our 2004 manufacturing operating results exclude the effects of approximately $83 million of products and services provided at cost to our drilling division during the year, most of which was attributable to completion of the Scooter Yeargain and construction progress on the Bob Keller.

 

Outlook

 

Though considerably less volatile than our drilling operations, our manufacturing operations, especially the equipment group, are impacted by world commodities prices; in particular, prices for copper, iron ore, coal and gold. In addition, the prospects for our marine and drilling products groups are closely tied to the condition of the overall drilling industry and its demand for equipment, parts and services.

 

Many commodity prices are at or near historically high levels due to growth in worldwide demand. Our external manufacturing backlog at December 31, 2005, of approximately $388 million, was almost five times the prior-year level and at an all-time high. The backlog included $225 million related to the long-term marine construction projects that are expected to run through April 2008 and $90 million associated with 19 loaders and stackers and 63 mud pumps that should be shipped during 2006. Thus far, we have been able to pass along the effects of cost increases to our customers in the form of higher sales prices.

 

During 2005, in order to meet the growing demand for the Company’s manufacturing products, we began expanding the steel production capacity and upgrading facilities and machinery to enable faster delivery of rig components and other manufacturing products.

 

We are optimistic that prices will remain firm, sustaining the demand for the types of equipment that we provide, and that our increased volumes will yield improved profitability. We cannot, however, accurately predict the duration of current business conditions or their impact on our operations. Our manufacturing operations will be adversely affected if conditions deteriorate.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Key balance sheet amounts and ratios for 2005 and 2004 were as follows (dollars in millions):

 

Reflected in the comparison above are the effects in 2005 of the following sources and uses of cash and cash equivalents:

 

 

Operating cash flows in 2005 included non-cash or non-operating adjustments to our net income totaling $89.8 million and additional working capital of $19.5 million. Non-cash or non-operating adjustments included deferred income taxes of $121.7 million, depreciation of $81.3 million and hurricane-related insurance proceeds of $51.4 million, offset by pension contributions and other benefit payments of $92.5 million and net gains on asset disposals of $101.7 million during the year. The primary source of working capital was customer advances under sales contracts and toward future drilling services, which increased by $94 million in 2005 and more than offset our additional investments made in trade receivables and inventories during the year.

 

Capital expenditures in 2005 included $119.8 million towards construction of our second and third Tarzan Class jack-up rigs, the Bob Keller and the Hank Boswell. The Tarzan Class was designed specifically for deep drilling in water depths up to 300 feet on the outer continental shelf in the Gulf of Mexico, offering drilling capabilities similar to our Super Gorilla class jack-ups, but with reduced environmental criteria (wind, wave and current) and at around one-half the construction cost.

 

Construction of the Bob Keller was completed on August 31, 2005 and substantially financed through a long-term bank loan guaranteed by the U.S. Department of Transportation’s Maritime Administration (“MARAD”). Under the MARAD Title XI Program, we obtain reimbursements for qualifying expenditures up to a pre-approved limit based upon actual construction progress. Outstanding borrowings initially bear a floating rate of interest and notes require semi-annual payments of principal and accrued interest. The notes are secured by a preferred mortgage on the rig. All of our recent newbuild rigs have been financed in this manner and the following table summarizes the status of each of our Title XI borrowings at December 31, 2005 (dollars in millions).