Rowan generated income from continuing operations of $345.3 million in the first nine months of 2007 compared to $254.6 million in the same period of 2006. This 36% increase was largely due to effects of rig fleet additions, increased average drilling day rates and higher manufacturing sales between periods.
A comparison of the revenues and income from drilling, manufacturing and consolidated operations for the first nine months of 2007 and 2006, respectively, is reflected below (dollars in millions):
| | | | | | | | | Manufacturing | | | | |
| | | | | | | | | Drilling Products | | Mining, Forestry and | | | | |
| | | | | Drilling | | and Systems | | Steel Products | | Consolidated |
| | | | | 2007 | | 2006 | | 2007 | | 2006 | | 2007 | | 2006 | | 2007 | | 2006 |
| | | | | | | | | | | | | | | | | | | |
| Revenues | | | $ 1,010.2 | | $ 786.8 | | $ 316.4 | | $ 160.9 | | $ 144.9 | | $ 152.1 | | $ 1,471.5 | | $ 1,099.8 |
| Percent of total | | | 69% | | 72% | | 22% | | 15% | | 10% | | 14% | | 100% | | 100% |
| |
| | | | | | | | | | | | | | | | | | | |
| Operating costs | | | $ 436.8 | | $ 357.9 | | $ 279.7 | | $ 133.8 | | $ 115.7 | | $ 127.1 | | $ 832.2 | | $ 618.8 |
| Percent of revenues | | 43% | | 45% | | 88% | | 83% | | 80% | | 84% | | 57% | | 56% |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| Depreciation expense | | $ 74.7 | | $ 56.2 | | $ 7.8 | | $ 5.8 | | $ 3.8 | | $ 3.4 | | $ 86.3 | | $ 65.4 |
| Percent of revenues | | 7% | | 7% | | 2% | | 4% | | 3% | | 2% | | 6% | | 6% |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | |
| SG&A expenses | | | $ 47.5 | | $ 42.6 | | $ 10.3 | | $ 5.0 | | $ 10.0 | | $ 10.4 | | $ 67.8 | | $ 58.0 |
| Percent of revenues | | 5% | | 5% | | 3% | | 3% | | 7% | | 7% | | 5% | | 5% |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| Income from operations | | $ 491.2 | | $ 358.2 | | $ 18.5 | | $ 16.3 | | $ 15.3 | | $ 12.4 | | $ 525.0 | | $ 386.9 |
| Percent of revenues | | 49% | | 46% | | 6% | | 10% | | 11% | | 8% | | 36% | | 35% |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| Income from continuing operations | | | | | | | | | | | | | $ 345.3 | | $ 254.6 |
| | | | | | | | | | | | | | | | | | | |
As shown in the preceding table, our consolidated income from operations increased by $138.1 million or 36%, when comparing the first nine months of 2007 and 2006, on a $371.7 million or 34% increase in revenues between periods.
Drilling operations– Our Drilling operations generated a $223.4 million or 28% increase in revenues between periods. Our average offshore day rate was $153,400 during the first nine months of 2007, compared to $140,400 in the same period of 2006. Our offshore fleet was 93% utilized during the first nine months of 2007, compared to 87% in the same period of 2006, with much of the downtime in both periods associated with the mobilization of rigs. The addition of the Hank Boswell in September 2006 and reactivation of the Rowan-Louisiana in December 2006 helped us to realize 800 or 18% more rig operating days between periods. Our fleet of land rigs, which increased to 27 units with the addition of six new rigs over the past year, was 95% utilized during the first nine months of 2007, compared to 99% in the same period of 2006, and achieved a 3% increase in average day rates between periods.
Drilling expenses during the first nine months of 2007 increased by $78.9 million or 22% over the same period of 2006, with over 60% of the increase attributable to the growth in our rig fleets between periods. Most of the remaining increase in drilling expenses between periods reflects higher labor, overhead, rig maintenance and towing costs associated with our redeployment of several offshore rigs to foreign markets. Selling, general and administrative expenses incurred by our Drilling segment increased by $4.9 million or 11% between periods due primarily to incremental incentive-based compensation associated with the division’s improved operating results. Drilling depreciation expense increased by $18.5 million or 33% between periods due primarily to the rig additions discussed previously.
Our Drilling operations included $40.0 million of gains on property and equipment disposals during the first nine months of 2007, compared to $28.1 million during the same period of 2006, with the increase primarily due to the June 2007 sale of our Alaska drilling camps. Thus, our Drilling operations yielded a $133.0 million or 37% increase in operating income between periods.
Manufacturing operations– Our collective manufacturing operations generated a $148.3 million or 47% increase in revenues. Drilling Products and Systems revenues increased by $155.5 million or 97% between periods. Revenues included $115.3 million recognized on long-term rig and rig kit construction projects during the first nine months of 2007, up from $70.4 million in the same period of 2006. Revenues also included shipments of 46 mud pumps during the first nine months of 2007, compared to 49 units in the same period of 2006, 227 motors, $15.2 million of AC drive and control systems packages and another $77.1 million of land rigs and drilling equipment packages.
Mining, Forestry and Steel Products revenues decreased by $7.2 million or 5% between periods, as shipments of new front-end mining loaders and log stackers totaled 19 units during the first nine months of 2007, compared to 25 units in the same period of 2006. Parts sales decreased by $0.5 million or 1% between periods to $44.5 million during the first nine months of 2007.
Selling, general and administrative expenses incurred by the manufacturing segments changed as follows between periods, primarily due to changes in allocations of shared costs based upon relative revenues: Drilling Products and Systems increased by $5.3 million or 106% and Mining, Forestry and Steel Products decreased by $0.4 million or 4%. Depreciation and amortization expense increased as follows, primarily due to ongoing capacity improvements: $2.0 million or 34% by Drilling Products and Systems and $0.4 million or 11% by Mining, Forestry and Steel Products.
The profitability of manufacturing products and services is greatly influenced by the mix of product sales. Our mining equipment, for example, has traditionally yielded lower margins than the related after-market parts sales. A rig construction project takes longer to complete and involves significantly greater labor effort than a rig kit, and thus typically yields a lower margin.
Our operating results during the first nine months of 2007 included a $15.8 million loss recorded on our external rig construction project that was completed in June. This additional loss resulted from an increase in the total cost of the project, most of which was due to the project requiring many more labor hours than were originally anticipated. The efforts by Rowan’s Drilling Products and Systems segment to deliver the Hank Boswell three months ahead of schedule, rebuild the Rowan-Louisiana and assist with modifications to the Company’s Middle East rigs had the effect of delaying progress on this project. As a result, the average margin on direct costs yielded by Drilling Products and Systems decreased to 16% of revenues during the first nine months of 2007 from 22% in the prior-year period and, despite the near doubling of revenues, operating income increased by only $2.2 million or 13% between periods. The average margin on direct costs yielded by Mining, Forestry and Steel Products improved to 28% of revenues during the first nine months of 2007, up from 24% in the prior-year period, as the prior-year period included a $4.0 million charge for environmental remediation at our Longview steel mill. Operating income increased by $2.9 million or 24% between periods.
Our Drilling Products and Systems operating results exclude the effects of approximately $186 million of products and services provided to our Drilling segment during the first nine months of 2007, most of which was attributable to construction progress on our fourth Tarzan Class jack-up, the J. P. Bussell, and the Company’s first two 240C class jack-ups, compared to approximately $173 million in the same period of 2006.
Three Months Ended September 30, 2007 Compared to Three Months Ended September 30, 2006
Rowan generated income from continuing operations of $130.8 million in the third quarter of 2007 compared to $85.8 million in the same period of 2006. This 53% increase was largely due to effects of rig fleet additions and increased average drilling day rates between periods.
A comparison of the revenues and income from drilling, manufacturing and consolidated operations for the third quarters of 2007 and 2006, respectively, is reflected below (dollars in millions):
| | | | | | | | | Manufacturing | | | | |
| | | | | | | | | Drilling Products | | Mining, Forestry and | | | | |
| | | | | Drilling | | and Systems | | Steel Products | | Consolidated |
| | | | | 2007 | | 2006 | | 2007 | | 2006 | | 2007 | | 2006 | | 2007 | | 2006 |
| | | | | | | | | | | | | | | | | | | |
| Revenues | | | $ 368.8 | | $ 289.6 | | $ 83.7 | | $ 69.2 | | $ 49.7 | | $ 58.3 | | $ 502.2 | | $ 417.1 |
| Percent of total | | | 73% | | 69% | | 17% | | 17% | | 10% | | 14% | | 100% | | 100% |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | |
| Operating costs | | | $ 145.4 | | $ 131.3 | | $ 66.7 | | $ 63.0 | | $ 40.8 | | $ 51.4 | | $ 252.9 | | $ 245.7 |
| Percent of revenues | | 39% | | 45% | | 80% | | 91% | | 82% | | 88% | | 50% | | 59% |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| Depreciation expense | | $ 25.4 | | $ 20.2 | | $ 3.1 | | $ 1.9 | | $ 1.3 | | $ 1.2 | | $ 29.8 | | $ 23.3 |
| Percent of revenues | | 7% | | 7% | | 4% | | 3% | | 3% | | 2% | | 6% | | 6% |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | |
| SG&A expenses | | | $ 15.8 | | $ 13.3 | | $ 3.1 | | $ 2.0 | | $ 3.6 | | $ 3.7 | | $ 22.5 | | $ 19.0 |
| Percent of revenues | | 4% | | 5% | | 4% | | 3% | | 7% | | 6% | | 4% | | 5% |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| Income from operations | | $ 183.5 | | $ 127.0 | | $ 10.6 | | $ 2.4 | | $ 4.0 | | $ 2.0 | | $ 198.1 | | $ 131.4 |
| Percent of revenues | | 50% | | 44% | | 13% | | 3% | | 8% | | 3% | | 39% | | 32% |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| Income from continuing operations | | | | | | | | | | | | | $ 130.8 | | $ 85.8 |
| | | | | | | | | | | | | | | | | | | |
As shown in the preceding table, our consolidated income from operations increased by $66.7 million or 51%, when comparing the third quarters of 2007 and 2006, on an $85.1 million or 20% increase in revenues between periods.
Drilling operations– Our drilling operations generated a $79.2 million or 27% increase in revenues between periods. Our average offshore day rate was $158,200 during the third quarter of 2007, compared to $146,800 in the third quarter of 2006. Our offshore fleet was 99% utilized during the third quarter of 2007, compared to 91% in the third quarter of 2006. The addition of the Hank Boswell in September 2006 and reactivation of the Rowan-Louisiana in December 2006 helped us to realize 308 or 19% more rig operating days between periods. For our fleet of land rigs, which increased to 27 units with the addition of six new rigs over the past year, utilization was 96% during the third quarter of 2007, compared to 98% in the third quarter of 2006, and average day rates were virtually unchanged between periods at $23,300.
Drilling expenses during the third quarter of 2007 increased by $14.1 million or 11% over the third quarter of 2006 due to the growth in our rig fleets between periods. Selling, general and administrative expenses incurred by our Drilling segment increased by $2.5 million or 19% between periods due primarily to incremental incentive-based compensation associated with the segment’s improved operating results. Drilling depreciation expense increased by $5.1 million or 25% between periods due primarily to the rig additions discussed above.
Our Drilling operations included $1.2 million of gains on property and equipment disposals during the third quarter of 2007, compared to $2.2 million during the third quarter of 2006. Thus, our Drilling operations yielded a $56.5 million or 44% improvement in operating income between periods.
Manufacturing operations– Our collective manufacturing operations generated a $5.9 million or 5% increase in revenues. Drilling Products and Systems revenues increased by $14.5 million or 21% between periods and included $34.9 million recognized on long-term rig kit construction projects during the third quarter of 2007, up from $32.8 million in the third quarter of 2006. Revenues also included shipments of 11 mud pumps during the third quarter of 2007, compared to 19 units in the third quarter of 2006, 36 motors, $2.7 million of AC drive and control systems packages and another $20.0 million of land rigs and drilling equipment packages.
Mining, Forestry and Steel Products revenues decreased by $8.6 million or 15% between periods, as shipments of front-end mining loaders and log stackers totaled seven units during the third quarter of 2007, compared to ten units in the third quarter of 2006. Parts sales increased by $0.1 million or 1% between periods to $16.4 million during the third quarter of 2007.
Selling, general and administrative expenses changed as follows between periods, primarily due to changes in allocations of shared costs based upon relative revenues: Drilling Products and Systems increased by $1.1 million or 55% and Mining, Forestry and Steel Products decreased by $0.1 million or 3%. Depreciation and amortization expense increased as follows, primarily due to ongoing capacity improvements: $1.2 million or 63% by Drilling Products and Systems and $0.1 million or 8% by the Mining, Forestry and Steel Products.
The profitability of each manufacturing segment is greatly influenced by the mix of product sales. Our mining equipment, for example, has traditionally yielded lower margins than the related after-market parts sales. A rig construction project takes longer to complete and involves a significantly greater labor effort than a rig kit, and thus typically yields a lower margin. The average margin on direct costs yielded by Drilling Products and Systems increased to 26% of revenues during the third quarter of 2007 from 13% in the prior-year period and operating income increased by $8.2 million between periods. The average margin on direct costs yielded by Mining, Forestry and Steel Products was 27% of revenues during the third quarter of 2007, up from 19% in the prior-year period, and operating income increased by $2.0 million or 50% between periods. The prior-year period included a $4.0 million charge for environmental remediation at our Longview steel mill.
Our Drilling Products and Systems operating results exclude the effects of approximately $60 million of products and services provided to our Drilling segment during the third quarter of 2007, most of which was attributable to construction progress on the J. P. Bussell and the Company’s first two 240C class jack-ups, compared to about $70 million in the same period of 2006.
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, weather patterns, lease expirations and 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, and oil and gas prices are ultimately a function of the supply of and demand for those commodities. With consistently high prices in recent years, energy companies have realized substantial cash flows which we believe should continue to result in additional drilling projects.
Currently, the worldwide drilling market appears to be strong, as the expected demand for jack-ups exceeds the current supply of rigs in the Middle East, West Africa, India and Southeast Asia. Thus, we believe that the migration of high specification drilling equipment from mature jack-up markets like the Gulf of Mexico and the North Sea will continue.
The 2005 hurricanes caused tremendous damage to drilling and production equipment and facilities throughout the Gulf Coast, and we suffered a significant loss of prospective revenues. During 2006, there was a noticeable decline in demand for drilling equipment that coincided with the onset of hurricane season in June and grew more pronounced as growing natural gas inventories caused prices to weaken during the third and early fourth quarters. This ultimately forced jack-up contractors, including Rowan, to accept reduced rates in certain cases in order to keep available rigs fully utilized. This pattern of reduced drilling opportunities during hurricane season was repeated in 2007, and Gulf of Mexico rig demand has not returned to peak 2006 levels.
This global demand for drilling equipment in recent years has led to greater requirements for parts, supplies and people, which have in turn increased the cost of each category. In addition, drilling equipment running near capacity for extended periods ultimately requires more extensive maintenance and repairs. We expect these inflationary pressures to continue through the end of 2007 and early 2008 which, unless we are able to recover the increased costs through higher day rates, will reduce our future profitability. In addition, the cost of insurance in the Gulf of Mexico has risen dramatically since 2005. Though we were recently able to obtain rate reductions for our offshore operations and fleet, the cost of our coverage is still much higher than the pre-storm level even after we assumed more of the risk of certain losses. Our relocation of rigs from the Gulf of Mexico has helped to offset the increase in insurance rates.
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. Additionally, on November 1, 2007, we announced plans to construct two additional 240C jack-up rigs and signed contracts with Keppel AmFELS, Inc. to have four Super 116E class rigs constructed. We currently anticipate funding construction of all these rigs through operating cash flows, but will consider attractive financing alternatives. If market conditions deteriorate, our cash flows may be insufficient, and we could be forced to accept unfavorable financing terms in order to complete construction.
Though considerably less volatile than our drilling operations, our manufacturing operations are impacted by world commodities prices; in particular, prices for copper, iron ore, coal and gold. In addition, the prospects for our Drilling Products and Systems are closely tied to the condition of the overall drilling industry and its demand for equipment, parts and services.
Many commodity prices continue to be near historically high levels due to strong worldwide demand. Our external manufacturing backlog at September 30, 2007 was approximately $404 million, compared to $578 million one year before, with the decline primarily associated with the completion of our $130 million external rig construction project during the second quarter of 2007. The backlog included $342.6 million related to Drilling Products and Systems, featuring $151.5 million associated with long-term rig or rig kit construction projects that are expected to run through mid 2008 and $175.3 million associated with mud pumps, top drives, drawworks and other rig components.
We are optimistic that many commodity prices will remain firm, sustaining the demand for the types of equipment that we manufacture, 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
A comparison of key balance sheet figures and ratios as of September 30, 2007 and December 31, 2006 is as follows (dollars in millions):
| | | September 30, 2007 | | | December 31, 2006 | |
| | | | | | | |
| Cash and cash equivalents | | $ | 341.3 | | | $ | 258.0 | |
| Current assets | | $ | 1,328.0 | | | $ | 1,102.8 | |
| Current liabilities | | $ | 534.0 | | | $ | 516.7 | |
| Current ratio | | | 2.49 | | | | 2.13 | |
| Long-term debt – less current maturities | | $ | 434.2 | | | $ | 485.4 | |
| Stockholders' equity | | $ | 2,204.0 | | | $ | 1,874.0 | |
| Long-term debt/total capitalization | | | .16 | | | | .21 | |
Reflected in the comparison above are the effects in the first nine months of 2007 of:
| · | net cash provided by operations of $321.8 million |
| · | decrease in restricted cash of $106.1 million |
| · | proceeds from disposals of property, plant and equipment of $44.9 million |
| · | proceeds from stock option and convertible debenture plans of $13.5 million |
| · | capital expenditures of $318.7 million |
| · | debt repayments of $51.2 million |
| · | cash dividend payments of $33.2 million |
Operating cash flows during the first nine months of 2007 included non-cash or non-operating adjustments to our net income totaling $94.1 million offset by a net increase in working capital of $133.6 million. Non-cash or non-operating adjustments included depreciation of $86.3 million, deferred income taxes of $30.0 million, net retirement plan expenses in excess of funding of $10.8 million and stock-based compensation expense of $6.7 million, partially offset by net gains on asset disposals of $39.8 million. Receivables decreased by $4.9 million as reimbursement of hurricane-related survey and salvage costs and collections against asset sales more than offset the impact of increased revenues. Inventories were increased by $136.6 million in order to position our manufacturing operations for further growth.
Capital expenditures during the first nine months of 2007 included $48.6 million related to the construction of our fourth Tarzan Class jack-up rig, the J. P. Bussell, and $19.6 million related to the construction of four 2000 horsepower land rigs. Another shipyard is constructing the hull of the J. P. Bussell and we expect the rig to be completed during the third quarter of 2008. We currently expect to continue funding construction of the J. P. Bussell from available cash. Our last new land rig should be delivered in November 2007.
Capital expenditures during the first nine months of 2007 also included $94.5 million for progress towards the construction of the first of two 240C jack-up rigs, which was funded from available cash. Another $22.7 million was expended on the second 240C rig. The 240C will be equipped for high pressure/high temperature drilling in water depths of up to 400 feet. We believe the 240C design will set a new standard as a replacement for the 116C, which has been the “workhorse” of the global jack-up drilling industry for the past 25 years. The 240C will have more deck space, higher variable load, more drilling capacity (two million pound hook-load capability), more cantilever reach (up to 100 feet) and greater personnel capacity (108 man) than the 116C. Each rig will cost approximately $200 million and will be constructed at Vicksburg, Mississippi with delivery expected during the third quarters of 2008 and 2009.
On November 1, 2007, we announced plans to construct two additional 240C jack-up rigs, with delivery expected in 2010 and 2011. We currently anticipate funding construction of all 240C rigs through operating cash flows, but will consider attractive financing alternatives. Should our cash flows prove to be insufficient, we could be forced to delay or halt construction.
On November 1, 2007, we signed contracts with Keppel AmFELS, Inc. to have four Super 116E class rigs constructed at their Brownsville, Texas shipyard, with delivery expected in 2010 and 2011. We estimate that each rig will cost approximately $175 million, with more than a third of that amount attributed to the kit and drilling equipment provided by our manufacturing businesses. We currently anticipate funding construction of all 116E rigs through operating cash flows, but will consider attractive financing alternatives. Should our cash flows be insufficient, we could be forced to accept unfavorable financing terms in order to complete construction.
We currently estimate that remaining 2007 capital expenditures will be between $120 million and $140 million, including approximately $15 million towards the construction of the J. P. Bussell, $30-40 million towards the construction of our first two 240C class jack-ups and $43 million towards construction of the four Super 116E class jack-ups.
In October 2005, we sold our only semi-submersible rig for approximately $60 million in cash. Payment for the rig occurred over a 15-month period ending in January 2007, at which point the title to the rig was transferred to the buyer. We retained ownership of much of the drilling equipment on the rig, which was sold in 2006, and continued to provide (through February 2007) a number of operating personnel under a separate services agreement. The transaction was accounted for as a sales-type lease with the expected gain on the sale and imputed interest income of approximately $46 million deferred until the net book value of the rig had been recovered. During the nine months ended September 30, 2007, we received all remaining payments totaling $23.4 million and recognized such amount as additional gain on the sale.
Our debt agreements contain provisions that require minimum levels of working capital and stockholders’ equity and limit the amount of long-term debt and, in the event of noncompliance, restrict investment activities, asset purchases and sales, lease obligations, borrowings and mergers or acquisitions. We were in compliance with each of these provisions at September 30, 2007. Our debt agreements also specify the minimum insurance coverage for our financed rigs. Upon our April 1, 2006 policy renewal, we determined that windstorm coverage meeting the requirements of our existing debt agreements was cost-prohibitive. We obtained from MARAD a waiver of the original insurance requirements in return for providing additional security. Effective March 30, 2007, in connection with our 2007 policy renewal, the additional security provisions were modified. Our minimum restricted cash balance was reduced from $156.1 million to $50 million. This amount is maintained in a separate account in which MARAD has a security interest and is shown separately as Restricted cash on our Consolidated Balance Sheet. Our unrestricted cash requirement was reduced from $100 million to $31 million. We remain subject to restrictions on the use of certain insurance proceeds should we experience further losses. Each of these additional security provisions will be released by MARAD if we are able to obtain windstorm coverage that satisfies the original terms of our debt agreements.
On February 24, 2006, we paid a special cash dividend of $.25 per common share to stockholders of record on February 8, 2006. On May 9, 2006, we announced a regular quarterly dividend of $.10 per common share, which we have paid approximately every three months since. At September 30, 2007, we had approximately $310 million of retained earnings available for distribution to stockholders under the most restrictive provisions of our debt agreements. On October 30, 2007, we announced a dividend of $.10 per common share payable on November 30, 2007 to stockholders of record on November 14, 2007.
We have contributed more than $155 million to our defined benefit pension plans over the past five years, including almost $90 million during 2005. Minimum contribution amounts are determined based upon actuarial calculations of pension assets and liabilities that involve, among other things, assumptions about long-term asset returns and interest rates. Similar calculations were used to estimate pension costs and obligations as reflected in our consolidated financial statements, which showed an unfunded pension liability of $119.1 million at December 31, 2006. We expect to make additional pension contributions over the next several years even if plan assets perform as expected, and our funding requirement for 2007 was approximately $11 million. The Pension Protection Act of 2006 generally requires that plans be fully funded within seven years, and will therefore increase and accelerate our annual funding requirements beginning in 2008. We currently estimate that our 2007 pension expense will decrease by approximately $2.6 million or about 10% from the 2006 amount.
Based on current and anticipated near-term operating levels, we believe that operating cash flows together with existing working capital will be adequate to sustain planned capital expenditures and debt service and other requirements at least through 2008. We currently have no other available credit facilities, but believe financing could be obtained if deemed necessary.
During the third quarter of 2005, we lost four offshore rigs, including the Rowan-Halifax, and incurred significant damage on a fifth as a result of Hurricanes Katrina and Rita. Since that time, we have been working to locate the lost or damaged rigs, salvage related equipment, remove debris, wreckage and pollutants from the water, mark or clear navigational hazards and clear rights of way. At September 30, 2007, we had incurred $129.1 million of costs related to such efforts, of which $80.7 million had been reimbursed through insurance, leaving $48.4 million included in Receivables. We expect to incur additional costs to fulfill our obligations to remove wreckage and debris in amounts that will depend on the extent and nature of work ultimately required and the duration thereof. Previously, we reported the filing of a lawsuit styled Rowan Companies, Inc. vs. Certain Underwriters at Lloyd’s and Insurance Companies Subscribing to Cover Note ARS 4183 in the 215th Judicial District Court of Harris County, Texas. The lawsuit was withdrawn following the agreement by such underwriters to reimburse us for the reasonable cost of removing wreckage and debris remaining on the drilling locations. Certain of our insurance underwriters at higher limits of liability have notified us that they are reserving their right to deny coverage for any costs incurred in wreckage and debris removal activities that they believe are outside the scope of their policy. We will reach these limits during the fourth quarter of 2007. Although we believe that we have adequate insurance coverage and will be reimbursed for costs incurred and to be incurred, it is possible that a portion of such costs will not be reimbursed, requiring a charge to future operations for any shortfall.
We 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, a value that we believe 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 claimed that the rig should have been insured for its fair market value and sought recovery from us for compensation above the insured value. Thus, we assumed no insurance proceeds related to the Rowan-Halifax and recorded a charge during 2005 for the full carrying value of our equipment. On November 3, 2005, we filed a declaratory judgment action styled Rowan Companies, Inc. vs. Textron Financial Corporation and Wilmington Trust Company as Owner Trustee of the Rowan-Halifax 116-C Jack-Up Rig in the 215th Judicial District Court of Harris County, Texas. The owner filed a similar declaratory judgment action, claiming a value of approximately $83 million for the rig. The owner’s motion for summary judgment was granted on January 25, 2007 which, unless overturned on appeal, would make us liable for the approximately $40 million difference between the owner’s claim and the insurance coverage, plus interest and costs. We continue to believe our interpretation of the charter agreement is correct and are vigorously pursuing an appeal to overturn the summary judgment ruling in the Texas Court of Appeals. We do not, therefore, believe that it is probable that we have incurred a loss, nor one that is estimable, and have made no accrual for such at September 30, 2007.
During 2004, we learned that the Environmental and Natural Resources Division, Environmental Crimes Section of the U.S. Department of Justice (DOJ) had begun conducting a criminal investigation of environmental matters involving several of our offshore drilling rigs, including a rig known as the Rowan-Midland, which at various times operated at locations in the Gulf of Mexico.
On October 9, 2007, we entered into a plea agreement (“Plea”) with the DOJ, under which we pled guilty to three criminal felony charges relating to operations on the Rowan-Midland between 2002 and 2004: (i) causing the discharge of a pollutant, abrasive sandblast media, into U.S. navigable waters, thereby violating the Clean Water Act, (ii) failing to immediately report the discharge of waste hydraulic oil from the Rowan-Midland into U.S. navigable waters, thereby violating the Clean Water Act, and (iii) discharging garbage from the Rowan- Midland in violation of the Act to Prevent Pollution from Ships. As part of the Plea, we will pay a criminal fine of $7,000,000 and complete community service payments totaling $2,000,000 to various organizations. In anticipation of such payments, we recognized $9,000,000 as a charge to our fourth quarter 2006 operations. Under the Plea, we would have been subject to unsupervised probation for a period of two years. The Plea was submitted for approval to the United States District Court for the Eastern District of Texas. On November 8, 2007, we entered into an amended plea agreement with the DOJ extending the unsupervised probationary period from two to three years. We believe that the amended plea agreement will be acceptable to the Court. There can be no assurance, however, that the Court will approve the amended plea agreement. During the period of unsupervised probation, we must ensure that we commit no further criminal violations of federal, state, or local laws or regulations and must also continue to implement its comprehensive Environmental Management System Plan. Subsequent to the conduct at issue, we sold the Rowan-Midland to a third party.
The Environmental Protection Agency has approved a compliance agreement with us which, among other things, contains a certification that the conditions giving rise to the violations to which we entered guilty pleas have been corrected. If we fully comply with the terms of the compliance agreement, we believe that we will not be suspended or debarred from entering into or participating in contracts with the U.S. Government or any of its agencies.
In June 2007, we received a subpoena for documents from the U.S. District Court in the Eastern District of Louisiana relating to a grand jury hearing. The agency requesting the information is the U.S. Department of the Interior, Office of Inspector General Investigations. The documents requested include all records relating to use of our entertainment facilities and entertainment expenses for a former employee of the Minerals Management Service, U.S. Department of Interior and other records relating to items of value provided to any official or employee of the U.S. Government. We are fully cooperating with the subpoena request.
During 2005, we learned that the DOJ was conducting an investigation of potential antitrust violations among helicopter transportation providers in the Gulf of Mexico. Our former aviation subsidiary, which was sold effective December 31, 2004, received a subpoena in connection with the investigation. We have not been contacted by the DOJ, but the purchaser claimed that we are responsible for any exposure it may have. We have disputed that claim.
We are involved in various legal proceedings incidental to our businesses and are vigorously defending our position in all such matters. We believe that there are no other known contingencies, claims or lawsuits that could have a material adverse effect on our financial position, results of operations or cash flows.
Critical Accounting Policies and Management Estimates
Our significant accounting policies are outlined in Note 1 of the Notes to Consolidated Financial Statements included in our Form 10-K for the year ended December 31, 2006. These policies, and management judgments, assumptions and estimates made in their application, underlie reported amounts of assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. We believe that our most critical accounting policies and management estimates involve revenue recognition (primarily upfront service fees for equipment moves and modifications and longer-term manufacturing projects), property and depreciation (particularly capitalizable costs, useful lives and salvage values) and pension and other postretirement benefit liabilities and costs (specifically assumptions used in actuarial calculations), as changes in such policies and/or estimates would produce significantly different amounts from those reported herein.
Revenue recognition. Our drilling contracts generally provide for payment on a day rate basis, and revenues are recognized as the work progresses with the passage of time. We frequently receive lump-sum payments at the outset of a drilling assignment as upfront service fees for equipment moves or modifications, and such payments (and related costs) are recognized as drilling revenues (and expenses) over the contract period. At September 30, 2007, we had deferred $93.3 million of revenues and $60.9 million of costs related to such upfront service fees, with such amounts primarily related to mobilization and modification activities in connection with Middle East drilling contracts.
We generally recognize manufacturing sales and related costs when title passes as products are shipped. Revenues from longer-term manufacturing projects such as rigs and rig kits are recognized on the percentage-of-completion basis using costs incurred relative to total estimated costs. We do not recognize any estimated profit until such projects are at least 10% complete, though a full provision is made immediately for any anticipated losses. Total estimated costs are critical to this process and are therefore reviewed on a regular basis. During the nine months ended September 30, 2007, we recognized $115.3 million of manufacturing revenues and $106.0 million of costs and anticipated losses related to such projects on the percentage-of-completion basis. Such costs include an additional $15.8 million loss recognized on our external rig construction project which was completed in June 2007, resulting in a total loss on the project of approximately $17.9 million. This additional loss resulted from an increase in the total cost of the project, most of which was due to the project requiring many more labor hours than were originally anticipated. The efforts by our Drilling Products and Systems segment to deliver the Hank Boswell three months ahead of schedule, rebuild the Rowan-Louisiana and assist with modifications to our Middle East rigs had the effect of increasing the cost of this project.
Property and depreciation. We provide depreciation under the straight-line method from the date an asset is placed into service based upon estimated service lives ranging up to 40 years and salvage values ranging up to 20%. We continue to operate 14 offshore jack-up rigs that were placed into service at various dates during the 1971-1986 period. Many of those rigs had met or far exceeded their assigned useful lives of 12-15 years when our next rig, the Super Gorilla class Gorilla V, was delivered in 1998. The Super Gorilla class and the subsequent Tarzan Class have been assigned 25-year useful lives and are specifically designed to achieve greater drilling performance while encountering tougher well conditions. Each class of rig employs technological advances in load-bearing capability, power distribution and solids control designed to provide more efficient drilling to greater depths, which should help to ensure its continuing economic life to the Company.
Expenditures for new property or enhancements to existing property are capitalized and expenditures for maintenance and repairs are charged to operations as incurred. Capitalized cost includes labor expended during installation and, on newly constructed assets, a portion of interest cost incurred during the construction period. Long-lived assets are reviewed for impairment whenever circumstances indicate their carrying amounts may not be recoverable, such as following a sustained deficit in operating cash flows caused by a prominent decline in overall rig activity and average day rates.
Pension and other postretirement benefit liabilities and costs. As previously mentioned, our pension and other postretirement benefit liabilities and costs are based upon actuarial computations that reflect our assumptions about future events, including long-term asset returns, interest rates, annual compensation increases, mortality rates and other factors. Key assumptions for 2007 include discount rates ranging from 5.82% to 5.92%, an expected long-term rate of return on pension plan assets of 8% and annual healthcare cost increases ranging from 10% in 2007 to 5% in 2011 and beyond. The assumed discount rate is based upon the average yield for Moody’s Aa-rated corporate bonds and the rate of return assumption reflects a probability distribution of expected long-term returns that is weighted based upon plan asset allocations. A 1-percentage-point decrease in the assumed discount rate would increase our recorded pension and other postretirement benefit liabilities by approximately $83 million, while a 1-percentage-point change in the expected long-term rate of return on plan assets would change annual net benefits cost by approximately $3 million. A 1-percentage-point increase in the assumed healthcare cost trend rate would increase 2007 other benefits costs by $0.6 million.
New Accounting Pronouncements
As a result of the implementation of FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109”, effective January 1, 2007, the Company recognized a $1.6 million decrease in Retained earnings and a $5.5 million increase in Other liabilities as of that date. On January 1, 2007, Rowan had $3.6 million of unrecognized tax benefits, all of which would reduce the Company’s income tax provision if recognized. Rowan does not expect to recognize significant increases or decreases in unrecognized tax benefits during the next 12 months.
In September 2006, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value Measurements. This statement defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS No. 157 will become effective for our fiscal year beginning January 1, 2008, and we are currently assessing the potential impact of this statement on our financial statements.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, Including an amendment of FASB Statement No. 115. SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. SFAS No. 159 will become effective for our fiscal year beginning January 1, 2008, and we are currently assessing the potential impact of this statement on our financial statements.
FORWARD-LOOKING STATEMENTS
This report contains “forward-looking statements” as defined by the Securities and Exchange Commission (SEC). Such statements are those concerning contemplated transactions and strategic plans, expectations and objectives for future operations. These include, without limitation:
| · | statements, other than statements of historical fact, that address activities, events or developments that we expect, believe or anticipate will or may occur in the future; |
| · | statements relating to future financial performance, future capital sources and other matters; and |
| · | any other statements preceded by, followed by or that include the words “anticipates”, “believes”, “expects”, “plans”, “intends”, “estimates”, “projects”, “could”, “should”, “may”, or similar expressions. |
Although we believe that our plans, intentions and expectations reflected in or suggested by the forward-looking statements we make in this Form 10-Q are reasonable, we can give no assurance that such plans, intentions and expectations will be achieved. These statements are based on assumptions made by us based on our experience and perception of historical trends, current conditions, expected future developments and other factors that we believe are appropriate in the circumstances. Such statements are subject to a number of risks and uncertainties, many of which are beyond our control. You are cautioned that any such statements are not guarantees of future performance and that actual results or developments may differ materially from those projected in the forward-looking statements. Among the factors that could cause actual results to differ materially are the following:
| · | oil and natural gas prices |
| · | the level of exploration and development expenditures by energy companies |
| · | the general economy, including inflation |
| · | weather conditions in our principal operating areas |
| · | environmental and other laws and regulations |
| · | adverse consequences that may be found in or result from the DOJ investigations, including potential financial consequences and governmental actions, proceedings, charges or penalties |
All forward-looking statements contained in this report only speak as of the date of this document. We undertake no obligation to update or revise publicly any revisions to any such forward-looking statements that may be made to reflect events or circumstances after the date of this report, or to reflect the occurrence of unanticipated events.
Details of these and other relevant factors have been disclosed in our previous filings with the U.S. Securities and Exchange Commission.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Rowan believes that its exposure to risk of earnings loss due to changes in market interest rates is not significant. The Company’s outstanding debt at September 30, 2007 was comprised as follows: $275.8 million of fixed-rate notes bearing a weighted average annual interest rate of 4.43% and $223.4 million of floating-rate notes bearing a weighted average annual interest rate of 5.61%. In addition, virtually all of the Company’s transactions are carried out in U. S. dollars. Thus, Rowan’s foreign currency exposure is not material. Fluctuating commodity prices materially affect Rowan’s future earnings only to the extent that they influence demand for the Company’s products and services. Rowan does not hold or issue derivative financial instruments.
Item 4. Controls and Procedures
The Company’s management has evaluated, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, the effectiveness of the Company’s disclosure controls and procedures, as of the end of the period covered by this report, pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the Company’s Chief Executive Officer, along with the Company’s Chief Financial Officer, concluded that the Company’s disclosure controls and procedures were effective as of September 30, 2007.
Our management is responsible for establishing and maintaining internal control over financial reporting (ICFR). Our internal control system was designed to provide reasonable assurance to the Company’s management and Board of Directors regarding the preparation and fair presentation of published financial statements. All internal control systems, no matter how well designed, have inherent limitations, and therefore can only provide reasonable assurance with respect to financial statement preparation and presentation.
On February 26, 2007, our management reported that the Company did maintain effective ICFR as of December 31, 2006 within the context of the framework established by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). No change has occurred since that date that management believes has materially affected, or is reasonably likely to materially affect, the Company’s IFCR.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
During the third quarter of 2005, Rowan lost four offshore rigs, including the Rowan-Halifax, and incurred significant damage on a fifth as a result of Hurricanes Katrina and Rita. 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, a value that Rowan believes satisfied the requirements of the charter agreement, and by a margin sufficient to cover the $6.3 million carrying value of Rowan equipment installed on the rig. However, the owner of the rig claimed that the rig should have been insured for its fair market value and sought recovery from Rowan for compensation above the insured value. Thus, Rowan assumed no insurance proceeds related to the Rowan-Halifax and recorded a charge during 2005 for the full carrying value of its equipment. On November 3, 2005, the Company filed a declaratory judgment action styled Rowan Companies, Inc. vs. Textron Financial Corporation and Wilmington Trust Company as Owner Trustee of the Rowan-Halifax 116-C Jack-Up Rig in the 215th Judicial District Court of Harris County, Texas. The owner filed a similar declaratory judgment action, claiming a value of approximately $83 million for the rig. The owner’s motion for summary judgment was granted on January 25, 2007 which, unless overturned on appeal, would make Rowan liable for the approximately $40 million difference between the owner’s claim and the insurance coverage, plus interest and costs. The Company continues to believe its interpretation of the charter agreement is correct and is vigorously pursuing an appeal to overturn the summary judgment ruling in the Texas Court of Appeals. The Company does not, therefore, believe that it is probable that it has incurred a loss, nor one that is estimable, and has made no accrual for such at September 30, 2007.
During 2004, Rowan learned that the Environmental and Natural Resources Division, Environmental Crimes Section of the U.S. Department of Justice (DOJ) had begun conducting a criminal investigation of environmental matters involving several of the Company’s offshore drilling rigs, including a rig known as the Rowan-Midland, which at various times operated at locations in the Gulf of Mexico.
On October 9, 2007, the Company entered into a plea agreement (“Plea”) with the DOJ, under which the Company pled guilty to three criminal felony charges relating to operations on the Rowan-Midland between 2002 and 2004: (i) causing the discharge of a pollutant, abrasive sandblast media, into U.S. navigable waters, thereby violating the Clean Water Act, (ii) failing to immediately report the discharge of waste hydraulic oil from the Rowan-Midland into U.S. navigable waters, thereby violating the Clean Water Act, and (iii) discharging garbage from the Rowan-Midland in violation of the Act to Prevent Pollution from Ships. As part of the Plea, the Company will pay a criminal fine of $7,000,000 and complete community service payments totaling $2,000,000 to various organizations. In anticipation of such payments, the Company recognized $9,000,000 as a charge to its fourth quarter 2006 operations. Under the Plea, the Company would have been subject to unsupervised probation for a period of two years. The Plea was submitted for approval to the United States District Court for the Eastern District of Texas. On November 8, 2007, the Company entered into an amended plea agreement with the DOJ extending the unsupervised probationary period from two to three years. The Company believes that the amended plea agreement will be acceptable to the Court. There can be no assurance, however, that the Court will approve the amended plea agreement. During the period of unsupervised probation, the Company must ensure that it commits no further criminal violations of federal, state, or local laws or regulations and must also continue to implement its comprehensive Environmental Management System Plan. Subsequent to the conduct at issue, the Company sold the Rowan-Midland to a third party.
The Environmental Protection Agency has approved a compliance agreement with Rowan which, among other things, contains a certification that the conditions giving rise to the violations to which the Company entered guilty pleas have been corrected. The Company believes that if it fully complies with the terms of the compliance agreement, it will not be suspended or debarred from entering into or participating in contracts with the U.S. Government or any of its agencies.
In June 2007, the Company received a subpoena for documents from the U.S. District Court in the Eastern District of Louisiana relating to a grand jury hearing. The documents requested include all records relating to use of the Company entertainment facilities and entertainment expenses for a former employee of the Minerals Management Service, U.S. Department of Interior and other records relating to items of value provided to any official or employee of the U.S. Government. The Company is fully cooperating with the subpoena request.
During 2005, the Company learned that the DOJ was 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, received a subpoena in connection with the investigation. The Company has not been contacted by the DOJ, but the purchaser claimed that Rowan is responsible for any exposure it may have. The Company has disputed that claim.
Rowan is involved in various legal proceedings incidental to its businesses and is vigorously defending its position in all such matters. The Company believes that there are no other known contingencies, claims or lawsuits that could have a material adverse effect on its financial position, results of operations or cash flows.
Item 1A. Risk Factors
You should carefully consider the risk factors set forth in our Part I, Item IA. of our Annual Report on Form 10-K for the year ended December 31, 2006 before deciding to invest in Rowan Common Stock.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
The Company repurchased 25,065 shares of its outstanding common stock during the first nine months of 2007. The Company did not repurchase any shares of its outstanding common stock during the first nine months of 2006. Under the terms of a Share Repurchase Program begun in June 1998, the Company was authorized, at September 30, 2007, to buy back up to approximately 1.5 million shares of its common stock.
At September 30, 2007, Rowan had approximately $310 million of retained earnings available for distribution to stockholders under the most restrictive provisions of our debt agreements. On October 30, 2007, the Company announced a dividend of $.10 per common share payable on November 30, 2007 to stockholders of record on November 14, 2007.
Item 6. Exhibits
The following is a list of Exhibits filed with this Form 10-Q:
