e10vq
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2006
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____ to ____
Commission file number
1-8514
Smith International, Inc.
(Exact name of Registrant as specified in its charter)
| |
|
|
Delaware
(State or other jurisdiction of
incorporation or organization)
|
|
95-3822631
(I.R.S. Employer
Identification No.) |
| |
|
|
411 North Sam Houston Parkway, Suite 600
Houston, Texas
(Address of principal executive offices)
|
|
77060
(Zip Code) |
(281) 443-3370
(Registrant’s telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the Registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer,
or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in
Rule 12b-2 of the Exchange Act.
Large Accelerated Filer þ Accelerated Filer o Non-Accelerated Filer o.
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act). Yes o No þ
The number of shares outstanding of the Registrant’s common stock as of November 2, 2006 was
214,061,005.
PART I — FINANCIAL INFORMATION
Item 1. Financial Statements
SMITH INTERNATIONAL, INC.
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Three Months Ended |
|
|
Nine Months Ended |
|
| |
|
September 30, |
|
|
September 30, |
|
| |
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
Revenues |
|
$ |
1,914,184 |
|
|
$ |
1,410,162 |
|
|
$ |
5,334,568 |
|
|
$ |
4,048,563 |
|
Costs and expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Costs of revenues |
|
|
1,295,971 |
|
|
|
985,558 |
|
|
|
3,644,739 |
|
|
|
2,839,409 |
|
Selling expenses |
|
|
253,569 |
|
|
|
199,972 |
|
|
|
703,018 |
|
|
|
575,166 |
|
General and administrative expenses |
|
|
76,919 |
|
|
|
53,217 |
|
|
|
216,508 |
|
|
|
159,019 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total costs and expenses |
|
|
1,626,459 |
|
|
|
1,238,747 |
|
|
|
4,564,265 |
|
|
|
3,573,594 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income |
|
|
287,725 |
|
|
|
171,415 |
|
|
|
770,303 |
|
|
|
474,969 |
|
Interest expense |
|
|
17,287 |
|
|
|
11,001 |
|
|
|
44,808 |
|
|
|
32,333 |
|
Interest income |
|
|
(830 |
) |
|
|
(339 |
) |
|
|
(2,123 |
) |
|
|
(1,143 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes and
minority interests |
|
|
271,268 |
|
|
|
160,753 |
|
|
|
727,618 |
|
|
|
443,779 |
|
Income tax provision |
|
|
88,600 |
|
|
|
51,970 |
|
|
|
232,172 |
|
|
|
143,944 |
|
Minority interests |
|
|
49,743 |
|
|
|
29,279 |
|
|
|
136,472 |
|
|
|
86,119 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
132,925 |
|
|
$ |
79,504 |
|
|
$ |
358,974 |
|
|
$ |
213,716 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings per share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic |
|
$ |
0.66 |
|
|
$ |
0.40 |
|
|
$ |
1.79 |
|
|
$ |
1.06 |
|
Diluted |
|
$ |
0.66 |
|
|
$ |
0.39 |
|
|
$ |
1.78 |
|
|
$ |
1.05 |
|
Weighted average shares outstanding: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic |
|
|
200,009 |
|
|
|
201,013 |
|
|
|
200,484 |
|
|
|
202,063 |
|
Diluted |
|
|
201,811 |
|
|
|
203,031 |
|
|
|
202,158 |
|
|
|
204,120 |
|
The accompanying notes are an integral part of these consolidated condensed financial statements.
1
SMITH INTERNATIONAL, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
(In thousands, except par value data)
(Unaudited)
| |
|
|
|
|
|
|
|
|
| |
|
September 30, |
|
|
December 31, |
|
| |
|
2006 |
|
|
2005 |
|
Assets |
|
|
|
|
|
|
|
|
Current Assets: |
|
|
|
|
|
|
|
|
Cash and cash equivalents |
|
$ |
82,340 |
|
|
$ |
62,543 |
|
Receivables, net |
|
|
1,510,396 |
|
|
|
1,200,289 |
|
Inventories, net |
|
|
1,332,611 |
|
|
|
1,059,992 |
|
Deferred tax assets, net |
|
|
48,821 |
|
|
|
48,467 |
|
Prepaid expenses and other |
|
|
102,220 |
|
|
|
65,940 |
|
|
|
|
|
|
|
|
Total current assets |
|
|
3,076,388 |
|
|
|
2,437,231 |
|
|
|
|
|
|
|
|
Property, Plant and Equipment, net |
|
|
812,584 |
|
|
|
665,389 |
|
Goodwill, net |
|
|
871,030 |
|
|
|
737,048 |
|
Other Intangible Assets, net |
|
|
141,900 |
|
|
|
78,779 |
|
Other Assets |
|
|
166,696 |
|
|
|
141,467 |
|
|
|
|
|
|
|
|
Total Assets |
|
$ |
5,068,598 |
|
|
$ |
4,059,914 |
|
|
|
|
|
|
|
|
Liabilities and Stockholders’ Equity |
|
|
|
|
|
|
|
|
Current Liabilities: |
|
|
|
|
|
|
|
|
Short-term borrowings and current portion of long-term debt |
|
$ |
282,604 |
|
|
$ |
133,650 |
|
Accounts payable |
|
|
593,253 |
|
|
|
479,206 |
|
Accrued payroll costs |
|
|
126,270 |
|
|
|
108,419 |
|
Income taxes payable |
|
|
119,799 |
|
|
|
91,303 |
|
Other |
|
|
145,219 |
|
|
|
120,575 |
|
|
|
|
|
|
|
|
Total current liabilities |
|
|
1,267,145 |
|
|
|
933,153 |
|
|
|
|
|
|
|
|
Long-Term Debt |
|
|
847,034 |
|
|
|
610,857 |
|
Deferred Tax Liabilities |
|
|
128,761 |
|
|
|
107,838 |
|
Other Long-Term Liabilities |
|
|
102,820 |
|
|
|
86,853 |
|
Minority Interests |
|
|
874,750 |
|
|
|
742,708 |
|
Commitments and Contingencies (Note 13) |
|
|
|
|
|
|
|
|
Stockholders’ Equity: |
|
|
|
|
|
|
|
|
Preferred stock, $1 par value; 5,000 shares authorized; no
shares issued or outstanding in 2006 or 2005 |
|
|
— |
|
|
|
— |
|
Common stock, $1 par value; 250,000 shares authorized;
214,054 shares issued in 2006 (213,270 shares issued in 2005) |
|
|
214,054 |
|
|
|
213,270 |
|
Additional paid-in capital |
|
|
417,544 |
|
|
|
383,695 |
|
Retained earnings |
|
|
1,526,425 |
|
|
|
1,215,483 |
|
Accumulated other comprehensive income |
|
|
22,028 |
|
|
|
6,901 |
|
Less — Treasury securities, at cost; 14,671 common shares in
2006 (12,301 common shares in 2005) |
|
|
(331,963 |
) |
|
|
(240,844 |
) |
|
|
|
|
|
|
|
Total stockholders’ equity |
|
|
1,848,088 |
|
|
|
1,578,505 |
|
|
|
|
|
|
|
|
Total Liabilities and Stockholders’ Equity |
|
$ |
5,068,598 |
|
|
$ |
4,059,914 |
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these consolidated condensed financial statements.
2
SMITH INTERNATIONAL, INC.
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
| |
|
|
|
|
|
|
|
|
| |
|
Nine Months Ended |
|
| |
|
September 30, |
|
| |
|
2006 |
|
|
2005 |
|
Cash flows from operating activities: |
|
|
|
|
|
|
|
|
Net income |
|
$ |
358,974 |
|
|
$ |
213,716 |
|
Adjustments to reconcile net income to net cash provided
by operating activities, excluding the net effects of
acquisitions: |
|
|
|
|
|
|
|
|
Depreciation and amortization |
|
|
106,937 |
|
|
|
86,555 |
|
Minority interests |
|
|
136,472 |
|
|
|
86,119 |
|
Deferred income tax benefit |
|
|
(4,380 |
) |
|
|
(3,427 |
) |
Provision for losses on receivables |
|
|
5,443 |
|
|
|
2,864 |
|
Increase in LIFO inventory reserves |
|
|
16,864 |
|
|
|
22,557 |
|
Gain on disposal of property, plant and equipment |
|
|
(16,060 |
) |
|
|
(11,805 |
) |
Foreign currency translation losses (gains) |
|
|
2,992 |
|
|
|
(80 |
) |
Share-based compensation expense |
|
|
20,173 |
|
|
|
2,995 |
|
Equity earnings, net of dividends received |
|
|
(7,310 |
) |
|
|
(5,116 |
) |
Gain on sale of operations |
|
|
(5,930 |
) |
|
|
(5,898 |
) |
Changes in operating assets and liabilities: |
|
|
|
|
|
|
|
|
Receivables |
|
|
(284,765 |
) |
|
|
(160,586 |
) |
Inventories |
|
|
(285,098 |
) |
|
|
(158,364 |
) |
Accounts payable |
|
|
101,046 |
|
|
|
103,999 |
|
Other current assets and liabilities |
|
|
25,988 |
|
|
|
13,464 |
|
Other non-current assets and liabilities |
|
|
(22,318 |
) |
|
|
(13,648 |
) |
|
|
|
|
|
|
|
Net cash provided by operating activities |
|
|
149,028 |
|
|
|
173,345 |
|
|
|
|
|
|
|
|
Cash flows from investing activities: |
|
|
|
|
|
|
|
|
Acquisitions, net of cash acquired |
|
|
(224,305 |
) |
|
|
(31,702 |
) |
Purchases of property, plant and equipment |
|
|
(198,824 |
) |
|
|
(115,645 |
) |
Proceeds from disposal of property, plant and equipment |
|
|
25,649 |
|
|
|
20,377 |
|
Proceeds from sale of operations |
|
|
9,296 |
|
|
|
20,496 |
|
|
|
|
|
|
|
|
Net cash used in investing activities |
|
|
(388,184 |
) |
|
|
(106,474 |
) |
|
|
|
|
|
|
|
Cash flows from financing activities: |
|
|
|
|
|
|
|
|
Proceeds from issuance of long-term debt |
|
|
646,471 |
|
|
|
132,049 |
|
Principal payments of long-term debt |
|
|
(250,443 |
) |
|
|
(54,287 |
) |
Net change in short-term borrowings |
|
|
(8,243 |
) |
|
|
1,757 |
|
Purchases of treasury stock |
|
|
(91,119 |
) |
|
|
(108,228 |
) |
Proceeds from employee stock option exercises |
|
|
9,984 |
|
|
|
26,561 |
|
Payment of common stock dividends |
|
|
(44,114 |
) |
|
|
(24,316 |
) |
Distributions to minority interest partner |
|
|
— |
|
|
|
(28,000 |
) |
Debt issuance costs |
|
|
(4,744 |
) |
|
|
— |
|
|
|
|
|
|
|
|
Net cash provided by (used in) financing activities |
|
|
257,792 |
|
|
|
(54,464 |
) |
|
|
|
|
|
|
|
Effect of exchange rate changes on cash |
|
|
1,161 |
|
|
|
(661 |
) |
|
|
|
|
|
|
|
Increase in cash and cash equivalents |
|
|
19,797 |
|
|
|
11,746 |
|
Cash and cash equivalents at beginning of period |
|
|
62,543 |
|
|
|
53,596 |
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of period |
|
$ |
82,340 |
|
|
$ |
65,342 |
|
|
|
|
|
|
|
|
Supplemental disclosures of cash flow information: |
|
|
|
|
|
|
|
|
Cash paid for interest |
|
$ |
45,888 |
|
|
$ |
39,080 |
|
Cash paid for income taxes |
|
|
206,199 |
|
|
|
127,495 |
|
The accompanying notes are an integral part of these consolidated condensed financial statements.
3
SMITH INTERNATIONAL, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
1. Basis of Presentation of Interim Financial Statements
The accompanying unaudited consolidated condensed financial statements of Smith International, Inc.
and subsidiaries (the “Company”) were prepared in accordance with U.S. generally accepted
accounting principles and applicable rules and regulations of the Securities and Exchange
Commission (the “Commission”) pertaining to interim financial information. These interim financial
statements do not include all information or footnote disclosures required by generally accepted
accounting principles for complete financial statements and, therefore, should be read in
conjunction with the audited financial statements and accompanying notes included in the Company’s
2005 Annual Report on Form 10-K and other current filings with the Commission. All adjustments
which are, in the opinion of management, of a normal and recurring nature and are necessary for a
fair presentation of the interim financial statements have been included.
Preparation of financial statements in conformity with U.S. generally accepted accounting
principles requires management to make estimates and assumptions that affect the reported amounts
of assets and liabilities, the disclosed amounts of contingent assets and liabilities and the
reported amounts of revenues and expenses. If the underlying estimates and assumptions, upon which
the financial statements are based, change in future periods, actual amounts may differ from those
included in the accompanying consolidated condensed financial statements.
Management believes the consolidated condensed financial statements present fairly the financial
position, results of operations and cash flows of the Company as of the dates indicated. The
results of operations for the interim periods presented may not be indicative of results for the
fiscal year.
2. Recent Accounting Pronouncements
From time to time, new accounting pronouncements are issued by the Financial Accounting Standards
Board (“FASB”) which are adopted by the Company as of the specified effective date. On January 1,
2006, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 123r,
“Share-Based Payment,” (“SFAS No. 123r”) using the modified prospective method. In accordance with
this method, results for prior periods have not been restated. See Note 11 for further disclosure
regarding SFAS No. 123r.
In July 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes -
an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 clarifies the accounting for
uncertainty in income taxes recognized in an entity’s financial statements in accordance with SFAS
No. 109, “Accounting for Income Taxes”, and prescribes a consistent recognition threshold and
measurement attribute for financial statement recognition and disclosure of tax positions taken, or
expected to be taken, on a tax return. This interpretation is effective for fiscal years beginning
after December 15, 2006. We are currently evaluating the provisions of FIN 48 and have not yet
determined the impact, if any, on our consolidated condensed financial statements.
In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension
and Other Postretirement Plans — an amendment of FASB Statements No. 87, 88, 106, and 132(R)”
(“SFAS 158”). Effective December 31, 2006, SFAS 158 requires recognition of the funded status of
an entity’s defined benefit pension and other postretirement benefit plans as an asset or liability
in the Company’s consolidated balance sheet. Subsequent changes to the funded status are to be
recognized through stockholders’ equity as a component of comprehensive income. Additionally, for
fiscal years ending after December 31, 2008, SFAS 158 requires measurement of plan assets and
obligations as of the end of the employer’s fiscal year. We are currently evaluating the
provisions of SFAS 158 and have not yet determined the impact on our consolidated condensed
financial statements.
Management believes the impact of other recently issued standards, which are not yet effective,
will not have a material impact on the Company’s consolidated condensed financial statements upon
adoption.
4
3. Acquisitions and Dispositions
During the nine months ended September 30, 2006, the Company completed six acquisitions in exchange
for aggregate cash consideration of $224.3 million. The current year transactions primarily consist
of the following:
On August 3, 2006, M-I SWACO acquired Specialised Petroleum Services Group Limited (“SPS”) in
exchange for cash consideration of approximately $165 million. SPS, based in Aberdeen, Scotland,
is a global provider of patented well-bore clean-up products and engineering services used to
remove debris from the wellbore to facilitate improved well production.
On February 23, 2006, M-I SWACO acquired Epcon Offshore AS (“Epcon”) in exchange for cash
consideration of approximately $45 million. Epcon, based in Porsgrunn, Norway, is a global
provider of proprietary water treatment technology designed to optimize the removal of hydrocarbons
from water generated during the oil and gas production process.
The excess of the purchase price over the estimated fair value of the net assets acquired related
to these transactions totaled $133.6 million, which has been recorded as goodwill in the
accompanying consolidated condensed balance sheet. The purchase price allocation related to the
2006 acquisitions is based on preliminary information and is subject to change when additional data
concerning final asset and liability valuations is obtained; however, material changes in the
preliminary allocations are not anticipated by management.
Additionally, during the nine months ended September 30, 2006, the Company completed the
disposition of its ownership interest in two oilfield business operations for aggregate cash
proceeds of $9.3 million. These transactions resulted in an aggregate pre-tax gain of
approximately $5.9 million and, $2.9 million net of taxes and minority interest, which has been
reflected as a reduction in general and administrative expenses in the accompanying consolidated
condensed statements of operations.
Pro forma results of operations have not been presented because the effect of these transactions
was not material to the Company’s consolidated condensed financial statements.
4. Earnings Per Share
Basic earnings per share (“EPS”) is computed using the weighted average number of common shares
outstanding during the period. Diluted EPS gives effect to the potential dilution of earnings that
could have occurred if additional shares were issued for stock option and restricted stock awards
under the treasury stock method. For the three and nine-month periods ended September 30, 2006,
11,266 and 12,047 outstanding stock option awards, respectively, were excluded from the
computations of diluted EPS because they were anti-dilutive. No stock option awards were excluded
in the 2005 computations and the impact of restricted stock awards is reflected in all periods
shown. The following schedule reconciles the income and shares used in the basic and diluted EPS
computations (in thousands, except per share data):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Three Months Ended |
|
|
Nine Months Ended |
|
| |
|
September 30, |
|
|
September 30, |
|
| |
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
Basic EPS: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
132,925 |
|
|
$ |
79,504 |
|
|
$ |
358,974 |
|
|
$ |
213,716 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average number of common shares outstanding |
|
|
200,009 |
|
|
|
201,013 |
|
|
|
200,484 |
|
|
|
202,063 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic EPS |
|
$ |
0.66 |
|
|
$ |
0.40 |
|
|
$ |
1.79 |
|
|
$ |
1.06 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted EPS: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
132,925 |
|
|
$ |
79,504 |
|
|
$ |
358,974 |
|
|
$ |
213,716 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average number of common shares outstanding |
|
|
200,009 |
|
|
|
201,013 |
|
|
|
200,484 |
|
|
|
202,063 |
|
Dilutive effect of stock options and restricted stock units |
|
|
1,802 |
|
|
|
2,018 |
|
|
|
1,674 |
|
|
|
2,057 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
201,811 |
|
|
|
203,031 |
|
|
|
202,158 |
|
|
|
204,120 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted EPS |
|
$ |
0.66 |
|
|
$ |
0.39 |
|
|
$ |
1.78 |
|
|
$ |
1.05 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5
5. Inventories
Inventories are stated at the lower of cost or market. Cost is determined using the average cost
method for the majority of the Company’s inventories; however, a significant portion of the
Company’s U.S.-based inventories are valued utilizing the last-in, first-out (“LIFO”) method.
Inventory costs, consisting of materials, labor and factory overhead, are as follows (in
thousands):
| |
|
|
|
|
|
|
|
|
| |
|
September 30, |
|
|
December 31, |
|
| |
|
2006 |
|
|
2005 |
|
Raw materials |
|
$ |
115,205 |
|
|
$ |
86,961 |
|
Work-in-process |
|
|
132,068 |
|
|
|
111,399 |
|
Products purchased for resale |
|
|
398,902 |
|
|
|
303,307 |
|
Finished goods |
|
|
777,900 |
|
|
|
632,925 |
|
|
|
|
|
|
|
|
|
|
|
1,424,075 |
|
|
|
1,134,592 |
|
Reserves to state certain U.S.
inventories (FIFO cost of $519,924
and $386,643 in 2006 and 2005,
respectively) on a LIFO basis |
|
|
(91,464 |
) |
|
|
(74,600 |
) |
|
|
|
|
|
|
|
|
|
$ |
1,332,611 |
|
|
$ |
1,059,992 |
|
|
|
|
|
|
|
|
During the first nine months of 2006, the Company recorded additional LIFO reserves of $16.9
million. The increase primarily related to the revaluation of on-hand inventories to current
standards, largely reflecting higher manufacturing costs in the Oilfield segment.
6. Property, Plant and Equipment
Property, plant and equipment consist of the following (in thousands):
| |
|
|
|
|
|
|
|
|
| |
|
September 30, |
|
|
December 31, |
|
| |
|
2006 |
|
|
2005 |
|
Land |
|
$ |
45,837 |
|
|
$ |
37,753 |
|
Buildings |
|
|
178,090 |
|
|
|
153,467 |
|
Machinery and equipment |
|
|
668,144 |
|
|
|
587,808 |
|
Rental tools |
|
|
572,094 |
|
|
|
472,913 |
|
|
|
|
|
|
|
|
|
|
|
1,464,165 |
|
|
|
1,251,941 |
|
Less-Accumulated depreciation |
|
|
(651,581 |
) |
|
|
(586,552 |
) |
|
|
|
|
|
|
|
|
|
$ |
812,584 |
|
|
$ |
665,389 |
|
|
|
|
|
|
|
|
7. Goodwill and Other Intangible Assets
Goodwill
The following table presents goodwill on a segment basis as of the dates indicated, as well as
changes in the account during the period shown. Beginning and ending goodwill balances are
presented net of accumulated amortization of $53.6 million.
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Oilfield |
|
|
Distribution |
|
|
|
|
| |
|
Segment |
|
|
Segment |
|
|
Consolidated |
|
| |
|
(in thousands) |
|
Balance as of December 31, 2005 |
|
$ |
699,142 |
|
|
$ |
37,906 |
|
|
$ |
737,048 |
|
Goodwill acquired |
|
|
131,237 |
|
|
|
2,314 |
|
|
|
133,551 |
|
Purchase price and other adjustments |
|
|
— |
|
|
|
431 |
|
|
|
431 |
|
|
|
|
|
|
|
|
|
|
|
Balance as of September 30, 2006 |
|
$ |
830,379 |
|
|
$ |
40,651 |
|
|
$ |
871,030 |
|
|
|
|
|
|
|
|
|
|
|
6
Other Intangible Assets
The Company amortizes other identifiable intangible assets on a straight-line basis over the
periods expected to be benefited, ranging from two to 27 years. The components of these other
intangible assets included in the accompanying consolidated condensed balance sheets, are as
follows (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
September 30, 2006 |
|
|
December 31, 2005 |
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted |
|
| |
|
Gross |
|
|
|
|
|
|
|
|
|
|
Gross |
|
|
|
|
|
|
|
|
|
|
Average |
|
| |
|
Carrying |
|
|
Accumulated |
|
|
|
|
|
|
Carrying |
|
|
Accumulated |
|
|
|
|
|
|
Amortization |
|
| |
|
Amount |
|
|
Amortization |
|
|
Net |
|
|
Amount |
|
|
Amortization |
|
|
Net |
|
|
Period (years) |
|
Patents |
|
$ |
99,369 |
|
|
$ |
20,613 |
|
|
$ |
78,756 |
|
|
$ |
43,191 |
|
|
$ |
16,938 |
|
|
$ |
26,253 |
|
|
|
14.1 |
|
License
agreements |
|
|
31,231 |
|
|
|
9,732 |
|
|
|
21,499 |
|
|
|
29,308 |
|
|
|
7,181 |
|
|
|
22,127 |
|
|
|
10.4 |
|
Non-compete
agreements and
trademarks |
|
|
34,801 |
|
|
|
15,836 |
|
|
|
18,965 |
|
|
|
29,150 |
|
|
|
12,414 |
|
|
|
16,736 |
|
|
|
8.8 |
|
Customer lists
and contracts |
|
|
29,183 |
|
|
|
6,503 |
|
|
|
22,680 |
|
|
|
17,282 |
|
|
|
3,619 |
|
|
|
13,663 |
|
|
|
9.1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
194,584 |
|
|
$ |
52,684 |
|
|
$ |
141,900 |
|
|
$ |
118,931 |
|
|
$ |
40,152 |
|
|
$ |
78,779 |
|
|
|
12.0 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization expense of other intangible assets was $5.3 million and $2.5 million for the
three-month periods ended September 30, 2006 and 2005, respectively, and $12.5 million and $7.1
million for the nine-month periods ended September 30, 2006 and 2005, respectively. Additionally, estimated future amortization expense is
expected to range between $12.3 million and $20.0 million per year for the next five fiscal years.
8. Debt
The following summarizes the Company’s outstanding debt (in thousands):
| |
|
|
|
|
|
|
|
|
| |
|
September 30, |
|
|
December 31, |
|
| |
|
2006 |
|
|
2005 |
|
Current: |
|
|
|
|
|
|
|
|
Short-term borrowings |
|
$ |
111,363 |
|
|
$ |
122,174 |
|
Current portion of long-term debt |
|
|
171,241 |
|
|
|
11,476 |
|
|
|
|
|
|
|
|
|
|
$ |
282,604 |
|
|
$ |
133,650 |
|
|
|
|
|
|
|
|
Long-Term: |
|
|
|
|
|
|
|
|
Notes, net of unamortized discounts |
|
$ |
651,350 |
|
|
$ |
386,959 |
|
Revolving credit facilities |
|
|
330,500 |
|
|
|
232,700 |
|
Term loans and other |
|
|
36,425 |
|
|
|
2,674 |
|
|
|
|
|
|
|
|
|
|
|
1,018,275 |
|
|
|
622,333 |
|
Less current portion of long-term debt |
|
|
(171,241 |
) |
|
|
(11,476 |
) |
|
|
|
|
|
|
|
|
|
$ |
847,034 |
|
|
$ |
610,857 |
|
|
|
|
|
|
|
|
Short-term borrowings consist of amounts outstanding under lines of credit and short-term notes.
The current portion of long-term debt at September 30, 2006 primarily reflects the Company’s $150.0
million principal amount of Senior Notes that are scheduled to mature on September 15, 2007.
In June 2006, the Company completed a public offering of $275.0 million of ten-year Senior Notes
issued under an existing Indenture. Net proceeds of $272.8 million were received in connection
with the offering and were primarily used to repay indebtedness under the Smith U.S. revolving
credit facility. The Senior Notes are unsecured obligations of the Company, carry an effective
interest rate of 6.11 percent and require semi-annual interest payments.
Principal payments, net of unamortized discounts, of long-term debt for the twelve-month periods
ending subsequent to September 30, 2007 are as follows (in thousands):
| |
|
|
|
|
2008 |
|
$ |
15,201 |
|
2009 |
|
|
6,975 |
|
2010 |
|
|
330,526 |
|
2011 |
|
|
219,601 |
|
Thereafter |
|
|
274,731 |
|
|
|
|
|
|
|
$ |
847,034 |
|
|
|
|
|
7
9. Comprehensive Income
Comprehensive income includes net income and changes in the components of accumulated other
comprehensive income during the periods presented. The Company’s comprehensive income is as
follows (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Three Months Ended |
|
|
Nine Months Ended |
|
| |
|
September 30, |
|
|
September 30, |
|
| |
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
Net income |
|
$ |
132,925 |
|
|
$ |
79,504 |
|
|
$ |
358,974 |
|
|
$ |
213,716 |
|
Currency translation adjustments |
|
|
1,522 |
|
|
|
798 |
|
|
|
13,132 |
|
|
|
(12,468 |
) |
Changes in unrealized fair value of
derivatives, net |
|
|
354 |
|
|
|
148 |
|
|
|
1,995 |
|
|
|
(2,051 |
) |
Pension liability adjustments |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(476 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income |
|
$ |
134,801 |
|
|
$ |
80,450 |
|
|
$ |
374,101 |
|
|
$ |
198,721 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated other comprehensive income in the accompanying consolidated condensed balance sheet
consists of the following (in thousands):
| |
|
|
|
|
|
|
|
|
| |
|
September 30, |
|
|
December 31, |
|
| |
|
2006 |
|
|
2005 |
|
Currency translation adjustments |
|
$ |
26,280 |
|
|
$ |
13,148 |
|
Unrealized fair value of derivatives |
|
|
(181 |
) |
|
|
(2,176 |
) |
Pension liability adjustments |
|
|
(4,071 |
) |
|
|
(4,071 |
) |
|
|
|
|
|
|
|
Accumulated other comprehensive income |
|
$ |
22,028 |
|
|
$ |
6,901 |
|
|
|
|
|
|
|
|
10. Employee Benefit Plans
The Company maintains various noncontributory defined benefit pension plans covering certain U.S.
and non-U.S. employees. In addition, the Company and certain subsidiaries have postretirement
benefit plans which provide health care benefits to a limited number of current, and in some cases,
future retirees. Net periodic benefit expense related to the pension and postretirement benefit
plans, on a combined basis, approximated $1.0 million for each of the three-month
periods ended September 30, 2006 and 2005, respectively, and $2.9 million for each of the
nine-month periods ended September 30, 2006 and 2005, respectively. Company contributions to the
pension and postretirement benefit plans during 2006 are expected to total approximately $3.2
million.
11. Long-Term Incentive Compensation
The Company’s Board of Directors and its stockholders have authorized a long-term incentive plan
for the benefit of key employees.
Restricted stock units are considered compensatory awards and compensation expense related to these
units is being recognized over the established vesting period in the accompanying consolidated
condensed financial statements. However, prior to the mandatory adoption of SFAS No. 123r on
January 1, 2006, companies could continue to apply Accounting Principles Board Opinion No. 25,
“Accounting for Stock Issued to Employees” (“APB No. 25”) and related interpretations in accounting
for its stock option program. Accordingly, for periods ended prior to January 1, 2006, the Company
elected to make pro forma footnote disclosures rather than recognizing the related compensation
expense for stock option awards in the consolidated condensed financial statements.
Had the Company elected to apply the accounting standards of SFAS No. 123, “Accounting for
Stock-Based Compensation,” the Company’s net income and earnings per share for the three and
nine-month periods ended September 30, 2005 would have approximated the pro forma amounts indicated
below (in thousands, except per share data):
| |
|
|
|
|
|
|
|
|
| |
|
Three Months |
|
|
Nine Months |
|
Net income as reported |
|
$ |
79,504 |
|
|
$ |
213,716 |
|
Add: Stock-based compensation expense
included in reported income, net of
related tax effect |
|
|
1,037 |
|
|
|
1,941 |
|
Less: Stock-based compensation expense
determined under fair value methods, net
of related tax effect |
|
|
(3,382 |
) |
|
|
(8,863 |
) |
|
|
|
|
|
|
|
Net income, pro forma |
|
$ |
77,159 |
|
|
$ |
206,794 |
|
|
|
|
|
|
|
|
Earnings per share: |
|
|
|
|
|
|
|
|
As reported: |
|
|
|
|
|
|
|
|
Basic |
|
$ |
0.40 |
|
|
$ |
1.06 |
|
Diluted |
|
|
0.39 |
|
|
|
1.05 |
|
Pro forma: |
|
|
|
|
|
|
|
|
Basic |
|
$ |
0.38 |
|
|
$ |
1.02 |
|
Diluted |
|
|
0.38 |
|
|
|
1.01 |
|
8
Restricted Stock
The restricted stock program consists of a combination of performance-based restricted stock units
(“performance-based units”) and time-based restricted stock units (“time-based units”). The number
of performance-based units issued under the program, which can range from zero to 115 percent of
the target units granted, is solely dependent upon the return on equity achieved by the Company in
the fiscal year subsequent to the award. Estimated compensation expense for the performance-based
units, calculated as the difference between the market value and the exercise price, is recognized
over the three-year vesting period. Compensation expense related to time-based units is recognized
over a four-year vesting period.
Compensation expense related to restricted stock awards totaled $3.8 million and $1.7 million for
the three-month periods ended September 30, 2006 and 2005, respectively, and $12.6 million and $3.0
million for the nine-month periods ended September 30, 2006 and 2005, respectively. A summary of
the Company’s restricted stock program is presented below:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Time-based Awards |
|
|
Performance-based Awards |
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Aggregate |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
Intrinsic |
|
| |
|
No. of |
|
|
Fair |
|
|
No. of |
|
|
Fair |
|
|
Restricted |
|
|
Value(c) |
|
| |
|
Units |
|
|
Value(a) |
|
|
Units |
|
|
Value(a) |
|
|
Stock Units |
|
|
(in thousands) |
|
Outstanding at December 31, 2005. |
|
|
239,340 |
|
|
$ |
34.00 |
|
|
|
1,264,251 |
(b) |
|
$ |
36.28 |
|
|
|
1,503,591 |
|
|
$ |
55,371 |
|
Granted |
|
|
1,767 |
|
|
|
40.68 |
|
|
|
5,980 |
|
|
|
41.66 |
|
|
|
7,747 |
|
|
|
321 |
|
Forfeited |
|
|
(8,723 |
) |
|
|
33.66 |
|
|
|
(35,622 |
) |
|
|
37.63 |
|
|
|
(44,345 |
) |
|
|
— |
|
Vested |
|
|
(16,750 |
) |
|
|
17.83 |
|
|
|
(113,827 |
) |
|
|
29.68 |
|
|
|
(130,577 |
) |
|
|
5,404 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at September 30, 2006 |
|
|
215,634 |
|
|
$ |
35.33 |
|
|
|
1,120,782 |
|
|
$ |
36.94 |
|
|
|
1,336,416 |
|
|
$ |
51,564 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| (a) |
|
Reflects the weighted average grant-date fair value.
|
| |
| (b) |
|
Reflects achievement of performance criteria for awards granted in December 2005. |
| |
| (c) |
|
Reflects the value of outstanding awards at the end of the period determined using
the stock price at the end of the period and the exercise price, if any, of the related award. |
Stock Options
Stock options are generally granted at the fair market value on the date of grant, vest over a
four-year period and expire ten years after the date of grant. A summary of the Company’s stock
option program is presented below:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
Weighted |
|
|
|
|
| |
|
|
|
|
|
Weighted |
|
|
Average |
|
|
Aggregate |
|
| |
|
Shares |
|
|
Average |
|
|
Remaining |
|
|
Intrinsic |
|
| |
|
Under |
|
|
Exercise |
|
|
Contractual |
|
|
Value |
|
| |
|
Option |
|
|
Price |
|
|
Life |
|
|
(in thousands) |
|
Outstanding at December 31, 2005 |
|
|
4,751,824 |
|
|
$ |
18.37 |
|
|
|
7.0 |
|
|
$ |
89,067 |
|
Granted |
|
|
12,378 |
|
|
|
38.79 |
|
|
|
|
|
|
|
— |
|
Forfeited |
|
|
(72,141 |
) |
|
|
21.28 |
|
|
|
|
|
|
|
— |
|
Exercised |
|
|
(618,196 |
) |
|
|
15.89 |
|
|
|
|
|
|
|
16,175 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at September 30, 2006 |
|
|
4,073,865 |
|
|
$ |
18.75 |
|
|
|
6.5 |
|
|
$ |
81,672 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at September 30, 2006 |
|
|
2,088,838 |
|
|
$ |
16.89 |
|
|
|
6.0 |
|
|
$ |
45,775 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Compensation expense recorded for stock options in the three and nine-month periods ended September
30, 2006 was $3.0 million, and $7.6 million, respectively. The pro forma net income and earnings
per share data disclosed for the comparable 2005 period has been determined as if the Company had
accounted for its employee stock-based compensation program under the fair value method of SFAS No.
123. The Company used an open form (lattice) model to determine the fair value of options granted
during 2006 and 2005, and accordingly, calculate the stock-based compensation expense. The fair
value and assumptions used for the periods ended September 30, are as follows:
| |
|
|
|
|
|
|
|
|
| |
|
2006 |
|
|
2005 |
|
Fair value of stock options granted |
|
$ |
11.92 |
|
|
$ |
8.53 |
|
Expected life of option (years) |
|
|
5.0 |
|
|
|
5.0 |
|
Expected stock volatility |
|
|
31.0 |
% |
|
|
31.0 |
% |
Expected dividend yield |
|
|
0.8 |
% |
|
|
0.2 |
% |
Risk-free interest rate |
|
|
4.3 |
% |
|
|
4.0 |
% |
Share-based Compensation Expense
The total unrecognized share-based compensation expense, consisting of restricted stock and stock
options, for awards outstanding as of September 30, 2006 was $42.1 million and, net of taxes and
minority interests, approximately $26.3 million, which will be recognized over a weighted-average
period of 2.1 years.
9
12. Industry Segments
The Company manufactures and markets premium products and services to the oil and gas exploration
and production industry, the petrochemical industry and other industrial markets. The Company
aggregates its operations into two reportable segments: Oilfield Products and Services and
Distribution. The Oilfield Products and Services segment consists of three business units: M-I
SWACO, Smith Technologies and Smith Services. The Distribution segment includes the Wilson
business unit.
The following table presents financial information for each reportable segment and geographical
revenues on a consolidated basis (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Three Months Ended |
|
|
Nine Months Ended |
|
| |
|
September 30, |
|
|
September 30, |
|
| |
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
Revenues: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Oilfield Products and Services |
|
$ |
1,412,934 |
|
|
$ |
1,010,438 |
|
|
$ |
3,901,646 |
|
|
$ |
2,889,602 |
|
Distribution |
|
|
501,250 |
|
|
|
399,724 |
|
|
|
1,432,922 |
|
|
|
1,158,961 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
1,914,184 |
|
|
$ |
1,410,162 |
|
|
$ |
5,334,568 |
|
|
$ |
4,048,563 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues by Area: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United States |
|
$ |
905,002 |
|
|
$ |
625,167 |
|
|
$ |
2,463,403 |
|
|
$ |
1,827,303 |
|
Canada |
|
|
221,953 |
|
|
|
181,441 |
|
|
|
669,004 |
|
|
|
496,397 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North America |
|
|
1,126,955 |
|
|
|
806,608 |
|
|
|
3,132,407 |
|
|
|
2,323,700 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Latin America |
|
|
139,872 |
|
|
|
109,829 |
|
|
|
399,040 |
|
|
|
339,102 |
|
Europe/Africa |
|
|
418,845 |
|
|
|
310,357 |
|
|
|
1,147,683 |
|
|
|
865,704 |
|
Middle East |
|
|
156,818 |
|
|
|
123,084 |
|
|
|
447,452 |
|
|
|
350,790 |
|
Far East |
|
|
71,694 |
|
|
|
60,284 |
|
|
|
207,986 |
|
|
|
169,267 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-North America |
|
|
787,229 |
|
|
|
603,554 |
|
|
|
2,202,161 |
|
|
|
1,724,863 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
1,914,184 |
|
|
$ |
1,410,162 |
|
|
$ |
5,334,568 |
|
|
$ |
4,048,563 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating Income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Oilfield Products and Services |
|
$ |
270,710 |
|
|
$ |
162,755 |
|
|
$ |
722,453 |
|
|
$ |
446,487 |
|
Distribution |
|
|
25,359 |
|
|
|
13,966 |
|
|
|
73,591 |
|
|
|
41,527 |
|
General corporate |
|
|
(8,344 |
) |
|
|
(5,306 |
) |
|
|
(25,741 |
) |
|
|
(13,045 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
287,725 |
|
|
$ |
171,415 |
|
|
$ |
770,303 |
|
|
$ |
474,969 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
13. Commitments and Contingencies
Standby Letters of Credit
In the normal course of business with customers, vendors and others, the Company is contingently
liable for performance under standby letters of credit and bid, performance and surety bonds.
Certain of these outstanding instruments guarantee payment to insurance companies with respect to
certain liability coverages of the Company’s insurance captive. Excluding the impact of these
instruments, for which related liabilities are reflected in the accompanying consolidated condensed
balance sheet, the Company was contingently liable for approximately $49.8 million of standby
letters of credit and bid, performance and surety bonds at September 30, 2006. Management does not
expect any material amounts to be drawn on these instruments.
Litigation
Rose Dove Egle v. John M. Egle, et al.
In April 1997, the Company acquired all of the equity interests in Tri-Tech Fishing Services,
L.L.C. (“Tri-Tech”) in exchange for cash consideration of approximately $20.4 million (the
“Transaction”).
In August 1998, the Company was added as a defendant in a First Amended Petition filed in the 15th
Judicial District Court, Parish of Lafayette, Louisiana entitled Rose Dove Egle v. John M. Egle, et
al. In the amended petition, the plaintiffs alleged that, due to an improper conveyance of
ownership interest by the Tri-Tech majority partner prior to the Transaction, Smith purchased a
portion of its equity interest from individuals who were not legally entitled to their Tri-Tech
shares. The suit was tried in the first quarter of 2004, and a jury verdict of approximately $4.8
million was rendered in favor of the plaintiffs. The Company has appealed the verdict and does not
anticipate a ruling until the first quarter of 2007. Based upon the facts and circumstances and
the opinion of outside legal counsel, management believes that an unfavorable outcome on this
matter is not probable at this time. Accordingly, the Company has not recognized a loss provision
in the accompanying consolidated condensed financial statements.
10
Other
The Company is a defendant in various other legal proceedings arising in the ordinary course of
business. In the opinion of management, these matters will not have a material adverse effect on
the Company’s consolidated financial position or results of operations.
Environmental
The Company routinely establishes and reviews the adequacy of reserves for estimated future
environmental clean-up costs for properties currently or previously operated by the Company.
As of September 30, 2006, the Company’s environmental reserve totaled $9.4 million. This amount
reflects the future undiscounted estimated exposure related to identified properties, without
regard to indemnifications from former owners. While actual future environmental costs may differ
from estimated liabilities recorded at September 30, 2006, the Company does not believe that these
differences will have a material impact on the Company’s financial position or results of
operations.
During the first quarter of 2006, the Company settled a pending legal action which sought to
clarify certain contractual provisions of an environmental indemnification provided by M-I SWACO’s
former owners. The two parties executed a settlement agreement whereby the former owners agreed to
pay an outstanding receivable owed to the Company, assume all environmental liabilities associated
with two identified sites and reimburse the Company for certain future environmental remediation
costs. The impact of the settlement, which was recorded in the first quarter of 2006, was not
material to the Company’s financial condition or results of operations as of or for the nine months
ended September 30, 2006.
11
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
General
The following “Management’s Discussion and Analysis of Financial Condition and Results of
Operations” is provided to assist readers in understanding the Company’s financial performance
during the periods presented and significant trends which may impact the future performance of the
Company. This discussion should be read in conjunction with the consolidated condensed financial
statements of the Company and the related notes thereto included elsewhere in this Form 10-Q and
the Company’s 2005 Annual Report on Form 10-K.
Company Products and Operations
The Company manufactures and markets premium products and services to the oil and gas exploration
and production industry, the petrochemical industry and other industrial markets. The Company
provides a comprehensive line of technologically-advanced products and engineering services,
including drilling and completion fluid systems, solids-control and separation equipment,
waste-management services, oilfield production chemicals, three-cone and diamond drill bits,
turbine products, fishing services, drilling tools, underreamers, casing exit and multilateral
systems, packers and liner hangers. The Company also offers supply chain management solutions
through an extensive North American branch network providing pipe, valves and fittings as well as
mill, safety and other maintenance products.
The Company’s operations are largely driven by the level of exploration and production (“E&P”)
spending in major energy-producing regions around the world and the depth and complexity of these
projects. Although E&P spending is significantly influenced by the market price of oil and natural
gas, it may also be affected by supply and demand fundamentals, finding and development costs,
decline and depletion rates, political actions and uncertainties, environmental concerns, the
financial condition of independent E&P companies and the overall level of global economic growth
and activity. In addition, approximately seven percent of the Company’s consolidated revenues
relate to the downstream energy sector, including petrochemical plants and refineries, whose
spending is largely impacted by the general condition of the U.S. economy.
Capital investment by energy companies is largely divided into two markets, which vary greatly in
terms of primary business drivers and associated volatility levels. North American drilling
activity is primarily influenced by natural gas fundamentals, with over 80 percent of the current
rig count focused on natural gas finding and development activities. Conversely, drilling in areas
outside of North America is more dependent on crude oil fundamentals, which influence over
three-quarters of international drilling activity. Historically, business in markets outside of
North America has proved to be less volatile as the high cost E&P programs in these regions are
generally undertaken by major oil companies, consortiums and national oil companies as part of a
longer-term strategic development plan. Although over half of the Company’s consolidated revenues
were generated in North America during the third quarter of 2006, Smith’s profitability was largely
dependent upon business levels in markets outside of North America. The Distribution segment,
which accounts for approximately 26 percent of consolidated revenues and primarily supports a North
American customer base, serves to distort the geographic revenue mix of the Company’s Oilfield
segment operations. Excluding the impact of the Distribution operations, 55 percent of the
Company’s third quarter 2006 revenues were generated in markets outside of North America.
Business Outlook
U.S. drilling activity remains at some of the highest levels experienced in over two decades,
influenced by the continuing expansion in natural gas-directed drilling. The number of natural gas
drilling projects in the United States currently remains near historic highs despite elevated gas
storage levels that have created downward pressure on natural gas prices in the second half of
2006. Moreover, as of the current date, the number of active rigs in Canada, a market that primarily consists of natural
gas-directed projects, has fallen below the comparable prior year level due, in part, to lower well
economics. Although the long-term outlook for North American exploration and production activity
is favorable based upon expected growth in worldwide energy consumption, current market
fundamentals could cause short-term activity reductions related to marginal land-based drilling
projects. Any prolonged reduction in activity levels could adversely affect demand for the
Company’s products and services and the future financial results of the Company.
Although a number of factors impact drilling activity levels, our business is highly dependent on
the general economic environment in the United States and other major world economies — which
ultimately impact energy consumption and the resulting demand for our products and services. A
significant deterioration in the global economic environment could adversely affect worldwide
drilling activity and the future financial results of the Company.
12
Forward-Looking Statements
This document contains forward-looking statements within the meaning of the Section 21E of the
Securities Exchange Act of 1934, as amended, concerning, among other things, our outlook, financial
projections and business strategies, all of which are subject to risks, uncertainties and
assumptions. These forward-looking statements are identified by their use of terms such as
“anticipate,” “believe,” “could,” “estimate,” “expect,” “project” and similar terms. These
statements are based on certain assumptions and analyses that we believe are appropriate under the
circumstances. Such statements are subject to, among other things, general economic and business
conditions, the level of oil and natural gas exploration and development activities, global
economic growth and activity, political stability of oil-producing countries, finding and
development costs of operations, decline and depletion rates for oil and natural gas wells,
seasonal weather conditions, industry conditions, changes in laws or regulations and other risk
factors outlined in the Company’s Form 10-K for the fiscal year ended December 31, 2005, and Item
1A. of this Form 10-Q, many of which are beyond the control of the Company. Should one or more of
these risks or uncertainties materialize, or should the assumptions prove incorrect, actual results
may differ materially from those expected, estimated or projected. Our management believes these
forward-looking statements are reasonable. However, you should not place undue reliance on these
forward-looking statements, which are based only on our current expectations. Forward-looking
statements speak only as of the date they are made, and we undertake no obligation to publicly
update or revise any of them in light of new information, future events or otherwise.
13
Results of Operations
Segment Discussion
The Company markets its products and services throughout the world through four business units
which are aggregated into two reportable segments. The Oilfield Products and Services segment
consists of three business units: M-I SWACO, Smith Technologies and Smith Services. The
Distribution segment includes the Wilson business unit. The revenue discussion below has been
summarized by business unit in order to provide additional information in analyzing the Company’s
operations.
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Three Months Ended September 30, |
|
|
Nine Months Ended September 30, |
|
| |
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
| |
|
Amount |
|
|
% |
|
|
Amount |
|
|
% |
|
|
Amount |
|
|
% |
|
|
Amount |
|
|
% |
|
Financial
Data:
(dollars in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
M-I SWACO |
|
$ |
942,191 |
|
|
|
49 |
|
|
$ |
677,609 |
|
|
|
48 |
|
|
$ |
2,593,875 |
|
|
|
48 |
|
|
$ |
1,956,126 |
|
|
|
48 |
|
Smith Technologies |
|
|
205,448 |
|
|
|
11 |
|
|
|
154,451 |
|
|
|
11 |
|
|
|
571,861 |
|
|
|
11 |
|
|
|
434,356 |
|
|
|
11 |
|
Smith Services |
|
|
265,295 |
|
|
|
14 |
|
|
|
178,378 |
|
|
|
13 |
|
|
|
735,910 |
|
|
|
14 |
|
|
|
499,120 |
|
|
|
12 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Oilfield Products and Services |
|
|
1,412,934 |
|
|
|
74 |
|
|
|
1,010,438 |
|
|
|
72 |
|
|
|
3,901,646 |
|
|
|
73 |
|
|
|
2,889,602 |
|
|
|
71 |
|
Wilson |
|
|
501,250 |
|
|
|
26 |
|
|
|
399,724 |
|
|
|
28 |
|
|
|
1,432,922 |
|
|
|
27 |
|
|
|
1,158,961 |
|
|
|
29 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
1,914,184 |
|
|
|
100 |
|
|
$ |
1,410,162 |
|
|
|
100 |
|
|
$ |
5,334,568 |
|
|
|
100 |
|
|
$ |
4,048,563 |
|
|
|
100 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Geographic Revenues: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United States: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Oilfield Products and Services |
|
$ |
539,995 |
|
|
|
28 |
|
|
$ |
342,871 |
|
|
|
24 |
|
|
$ |
1,465,504 |
|
|
|
27 |
|
|
$ |
1,004,891 |
|
|
|
25 |
|
Distribution |
|
|
365,007 |
|
|
|
19 |
|
|
|
282,296 |
|
|
|
20 |
|
|
|
997,899 |
|
|
|
19 |
|
|
|
822,412 |
|
|
|
20 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total United States |
|
|
905,002 |
|
|
|
47 |
|
|
|
625,167 |
|
|
|
44 |
|
|
|
2,463,403 |
|
|
|
46 |
|
|
|
1,827,303 |
|
|
|
45 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Canada: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Oilfield Products and Services |
|
|
104,902 |
|
|
|
6 |
|
|
|
79,702 |
|
|
|
6 |
|
|
|
296,571 |
|
|
|
6 |
|
|
|
216,277 |
|
|
|
5 |
|
Distribution |
|
|
117,051 |
|
|
|
6 |
|
|
|
101,739 |
|
|
|
7 |
|
|
|
372,433 |
|
|
|
7 |
|
|
|
280,120 |
|
|
|
7 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Canada |
|
|
221,953 |
|
|
|
12 |
|
|
|
181,441 |
|
|
|
13 |
|
|
|
669,004 |
|
|
|
13 |
|
|
|
496,397 |
|
|
|
12 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-North America: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Oilfield Products and Services |
|
|
768,037 |
|
|
|
40 |
|
|
|
587,865 |
|
|
|
42 |
|
|
|
2,139,571 |
|
|
|
40 |
|
|
|
1,668,434 |
|
|
|
41 |
|
Distribution |
|
|
19,192 |
|
|
|
1 |
|
|
|
15,689 |
|
|
|
1 |
|
|
|
62,590 |
|
|
|
1 |
|
|
|
56,429 |
|
|
|
2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Non-North America |
|
|
787,229 |
|
|
|
41 |
|
|
|
603,554 |
|
|
|
43 |
|
|
|
2,202,161 |
|
|
|
41 |
|
|
|
1,724,863 |
|
|
|
43 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Revenue |
|
$ |
1,914,184 |
|
|
|
100 |
|
|
$ |
1,410,162 |
|
|
|
100 |
|
|
$ |
5,334,568 |
|
|
|
100 |
|
|
$ |
4,048,563 |
|
|
|
100 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating Income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Oilfield Products and Services |
|
$ |
270,710 |
|
|
|
19 |
|
|
$ |
162,755 |
|
|
|
16 |
|
|
$ |
722,453 |
|
|
|
19 |
|
|
$ |
446,487 |
|
|
|
15 |
|
Distribution |
|
|
25,359 |
|
|
|
5 |
|
|
|
13,966 |
|
|
|
3 |
|
|
|
73,591 |
|
|
|
5 |
|
|
|
41,527 |
|
|
|
4 |
|
General Corporate |
|
|
(8,344 |
) |
|
|
* |
|
|
|
(5,306 |
) |
|
|
* |
|
|
|
(25,741 |
) |
|
|
* |
|
|
|
(13,045 |
) |
|
|
* |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
287,725 |
|
|
|
15 |
|
|
$ |
171,415 |
|
|
|
12 |
|
|
$ |
770,303 |
|
|
|
14 |
|
|
$ |
474,969 |
|
|
|
12 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Market Data: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average Worldwide Rig Count: (1) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United States |
|
|
1,947 |
|
|
|
52 |
|
|
|
1,714 |
|
|
|
50 |
|
|
|
1,874 |
|
|
|
51 |
|
|
|
1,635 |
|
|
|
50 |
|
Canada |
|
|
437 |
|
|
|
11 |
|
|
|
423 |
|
|
|
12 |
|
|
|
424 |
|
|
|
12 |
|
|
|
376 |
|
|
|
12 |
|
Non-North America |
|
|
1,386 |
|
|
|
37 |
|
|
|
1,287 |
|
|
|
38 |
|
|
|
1,371 |
|
|
|
37 |
|
|
|
1,255 |
|
|
|
38 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
3,770 |
|
|
|
100 |
|
|
|
3,424 |
|
|
|
100 |
|
|
|
3,669 |
|
|
|
100 |
|
|
|
3,266 |
|
|
|
100 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Onshore |
|
|
3,263 |
|
|
|
87 |
|
|
|
2,903 |
|
|
|
85 |
|
|
|
3,149 |
|
|
|
86 |
|
|
|
2,754 |
|
|
|
84 |
|
Offshore |
|
|
507 |
|
|
|
13 |
|
|
|
521 |
|
|
|
15 |
|
|
|
520 |
|
|
|
14 |
|
|
|
512 |
|
|
|
16 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
3,770 |
|
|
|
100 |
|
|
|
3,424 |
|
|
|
100 |
|
|
|
3,669 |
|
|
|
100 |
|
|
|
3,266 |
|
|
|
100 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average Commodity Prices: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Crude Oil ($/Bbl) (2) |
|
$ |
70.60 |
|
|
|
|
|
|
$ |
63.31 |
|
|
|
|
|
|
$ |
68.29 |
|
|
|
|
|
|
$ |
55.61 |
|
|
|
|
|
Natural Gas ($/mcf) (3) |
|
$ |
6.18 |
|
|
|
|
|
|
$ |
9.73 |
|
|
|
|
|
|
$ |
6.88 |
|
|
|
|
|
|
$ |
7.75 |
|
|
|
|
|
|
|
|
| (1) |
|
Source: M-I SWACO. |
| |
| (2) |
|
Average daily West Texas Intermediate (“WTI”) spot closing prices, as quoted by NYMEX. |
| |
| (3) |
|
Average daily Henry Hub, Louisiana spot closing prices, as quoted by NYMEX. |
| |
| * |
|
not meaningful |
14
Oilfield Products and Services Segment
Revenues
M-I SWACO primarily provides drilling and completion fluid systems, engineering and technical
services to the oil and gas industry. Additionally, these operations provide oilfield production
chemicals and manufacture and market equipment and services used for solids-control, particle
separation, pressure control, rig instrumentation and waste-management. M-I SWACO’s operations are
significantly influenced by spending in markets outside of North America, which contributes
approximately two-thirds of the unit’s revenues, and by its exposure to the U.S. offshore market,
which constitutes approximately 10 percent of the revenue base. U.S. offshore drilling programs,
which account for approximately three percent of the worldwide rig count, are generally more
revenue-intensive than land-based projects due to the complex nature of the related drilling
environment. M-I SWACO’s revenues totaled $942.2 million for the third quarter of 2006, an
increase of 39 percent above the prior year period. Excluding the impact of operations acquired
during the prior twelve-month period, revenues grew 36 percent over the third quarter of 2005. The
majority of the base revenue increase was generated in markets outside of North America, primarily
reflecting increased drilling activity and new contract awards in Europe/Africa and the Middle East
markets. North American base revenues grew 50 percent above the prior year level, largely
attributable to increased exploration and production spending related to land-based drilling
programs, improved pricing and a favorable shift in the customer mix in the U.S. offshore market.
For the nine-month period, M-I SWACO reported revenues of approximately $2.59 billion, a 33 percent
increase over the amount reported in the first nine months of 2005. The majority of the revenue
increase was, again, generated in markets outside of North America, primarily in the Europe/Africa
and Middle East regions, reflecting new contract awards and increased customer activity in
international offshore markets. Increased investment by exploration and production companies in
North American land-based drilling programs and the impact of price increases implemented in late
2005 also contributed to the revenue improvement.
Smith Technologies designs, manufactures and sells three-cone drill bits, diamond drill bits and
turbines for use in the oil and gas industry. Due to the nature of its product offerings, revenues
for these operations typically correlate more closely to the rig count than any of the Company’s
other businesses. Smith Technologies reported revenues of $205.4 million for the quarter ended
September 30, 2006, an increase of 33 percent over the comparable prior year period. The
year-over-year comparison was impacted by the inclusion of several large international export
orders in the third quarter of 2005. Excluding the impact of export orders, which may not occur
regularly throughout the year, revenues were approximately 39 percent above the level reported in
the prior year quarter. Approximately one-half of the revenue growth was reported in North
America, influenced by higher U.S. land-based drilling activity and improved pricing realization.
Excluding export orders, revenues generated in markets outside North America increased 50 percent,
reflecting growth in the Middle East, North Sea and the Former Soviet Union regions attributable to
a combination of new contract awards, increased demand for diamond bits and continued market
penetration. For the nine-month period, Smith Technologies reported revenues of $571.9 million, a
32 percent improvement over the comparable period of 2005, influenced by the increase in worldwide
activity levels and improved pricing in the premium North American market. In addition, revenue
growth outside of North America contributed 41 percent of the year-over-year growth, reflecting new
contract awards and market penetration.
Smith Services manufactures and markets products and services used in the oil and gas industry for
drilling, work-over, well completion and well re-entry. Revenues for Smith Services are relatively
balanced between North America and the international markets and are heavily influenced by the
complexity of drilling projects, which drive demand for a wider range of its product offerings.
For the quarter ended September 30, 2006, Smith Services’ revenues totaled $265.3 million, 49
percent above the prior year period. The year-over-year revenue growth was influenced, in part, by
increased demand for tubular products, primarily in the U.S. market. Excluding the impact of
tubular product sales, which are not highly correlated to drilling activity, business volumes
increased 29 percent above the prior year period. Two-thirds of the core business growth was
reported in the United States, largely reflecting increased customer demand for premium remedial
product and service lines. For the first nine months of 2006, Smith Services reported revenues of
$735.9 million, a 47 percent increase from the comparable prior year period. Excluding the impact
of increased tubular sales volumes, revenues were 30 percent above the level reported in the first
nine months of 2005, driven by increased demand for remedial product and service lines and, to a
lesser extent, improved pricing.
15
Operating Income
Operating income for the Oilfield Products and Services segment was $270.7 million, or 19.2 percent
of revenues, for the three months ended September 30, 2006. Segment operating margins were 3.1
percentage points above the prior year period. The margin expansion primarily reflects improved
gross margins attributable to the impact of higher business volumes on fixed cost coverage, and, to
a lesser extent, the effect of new customer pricing implemented during the first half of 2006. On
an absolute dollar basis, third quarter 2006 operating income increased $108.0 million, reflecting
the impact of higher business volumes on gross profit, partially offset by growth in variable-based
operating expenses, including additional investment in personnel and infrastructure to support the
expanding business base. For the nine-month period, Oilfield operating margins improved 3.0
percentage points, reflecting gross margin expansion related to the impact of a favorable business
mix period-to-period and increased coverage of fixed sales and administrative costs. On an
absolute dollar basis, nine-month operating income was $276.0 million above the comparable prior
year period, attributable to the impact of higher revenue volumes on the segment’s reported gross
profit, partially offset by growth in variable-based operating expenses associated with the
expanding business base.
Distribution Segment
Revenues
Wilson markets pipe, valves, fittings and mill, safety and other maintenance products to energy and
industrial markets, primarily through an extensive network of supply branches in the United States
and Canada. The segment has the most significant North American revenue exposure of any of the
Company’s operations with 96 percent of Wilson’s third quarter 2006 revenues generated in those
markets. Moreover, approximately 30 percent of Wilson’s revenues relate to sales to the industrial
and downstream energy sector, including petrochemical plants and refineries, whose spending is
largely influenced by the general state of the U.S. economic environment. Additionally, certain
customers in this sector utilize petroleum products as a base material and, accordingly, are
adversely impacted by increases in crude oil and natural gas prices. Distribution revenues were
$501.3 million for the third quarter of 2006, 25 percent above the comparable prior year period.
Approximately three-fourths of the year-over-year revenue growth was reported by the energy sector
operations, largely influenced by increased North American drilling and completion activity levels,
new contract awards and, to a lesser extent, additional line pipe project spending in the midstream
market. Industrial and downstream revenues grew 25 percent above the prior year level, reflecting
the impact of several large line pipe orders and increased customer project spending in the
engineering and construction sector. In the first nine months of 2006, Wilson reported revenues
totaling $1.4 billion, an increase of 24 percent from the first nine months of 2005. Two-thirds of
the revenue variance from the prior year period was generated by the upstream energy operations,
reflecting higher North American activity levels and the impact of new contract awards.
Operating Income
Operating income for the Distribution segment was $25.4 million, or 5.1 percent of revenues, for
the quarter ended September 30, 2006. Segment operating margins were 1.6 percentage points above
the prior year period, as improved fixed sales and administrative cost coverage in the energy
sector operations resulted in lower operating expenses as a percentage of revenues. On an absolute
dollar basis, third quarter 2006 operating income increased $11.4 million above the amount reported
in the prior year period, primarily reflecting the impact of higher business volumes on gross
profit. On a year-to-date basis, Distribution operating margins improved 1.5 percentage points
reflecting the impact of gross margin expansion and lower operating expenses as a percentage of
revenues. On an absolute dollar basis, segment operating income was $32.1 million above the amount
reported in the first nine months of 2005. The operating income variance reflects the impact of a
24 percent increase in revenue volumes on the segment’s reported gross profit, partially offset by
growth in variable-based operating expenses.
16
Consolidated Results
For the periods indicated, the following table summarizes the results of operations of the Company
and presents these results as a percentage of total revenues (dollars in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Three Months Ended September 30, |
|
|
Nine Months Ended September 30, |
|
| |
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
| |
|
Amount |
|
|
% |
|
|
Amount |
|
|
% |
|
|
Amount |
|
|
% |
|
|
Amount |
|
|
% |
|
Revenues |
|
$ |
1,914,184 |
|
|
|
100 |
|
|
$ |
1,410,162 |
|
|
|
100 |
|
|
$ |
5,334,568 |
|
|
|
100 |
|
|
$ |
4,048,563 |
|
|
|
100 |
|
| |
Gross profit |
|
|
618,213 |
|
|
|
32 |
|
|
|
424,604 |
|
|
|
30 |
|
|
|
1,689,829 |
|
|
|
31 |
|
|
|
1,209,154 |
|
|
|
30 |
|
Operating expenses |
|
|
330,488 |
|
|
|
17 |
|
|
|
253,189 |
|
|
|
18 |
|
|
|
919,526 |
|
|
|
17 |
|
|
|
734,185 |
|
|
|
18 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income |
|
|
287,725 |
|
|
|
15 |
|
|
|
171,415 |
|
|
|
12 |
|
|
|
770,303 |
|
|
|
14 |
|
|
|
474,969 |
|
|
|
12 |
|
Interest expense |
|
|
17,287 |
|
|
|
1 |
|
|
|
11,001 |
|
|
|
1 |
|
|
|
44,808 |
|
|
|
1 |
|
|
|
32,333 |
|
|
|
1 |
|
Interest income |
|
|
(830 |
) |
|
|
— |
|
|
|
(339 |
) |
|
|
— |
|
|
|
(2,123 |
) |
|
|
— |
|
|
|
(1,143 |
) |
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before
income taxes and
minority interests |
|
|
271,268 |
|
|
|
14 |
|
|
|
160,753 |
|
|
|
11 |
|
|
|
727,618 |
|
|
|
13 |
|
|
|
443,779 |
|
|
|
11 |
|
Income tax provision |
|
|
88,600 |
|
|
|
5 |
|
|
|
51,970 |
|
|
|
4 |
|
|
|
232,172 |
|
|
|
4 |
|
|
|
143,944 |
|
|
|
4 |
|
Minority interests |
|
|
49,743 |
|
|
|
2 |
|
|
|
29,279 |
|
|
|
2 |
|
|
|
136,472 |
|
|
|
2 |
|
|
|
86,119 |
|
|
|
2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
132,925 |
|
|
|
7 |
|
|
$ |
79,504 |
|
|
|
5 |
|
|
$ |
358,974 |
|
|
|
7 |
|
|
$ |
213,716 |
|
|
|
5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated revenues were $1.9 billion for the third quarter of 2006, 36 percent above the prior
year period. More than three-fourths of the revenue growth was attributable to increased demand
for Oilfield segment product offerings. Oilfield segment revenues grew 40 percent year-over-year
benefiting from higher activity levels, new contract awards and additional customer spending -
primarily in the U.S. and Europe/Africa regions. The Distribution operations, influenced by a
combination of increased North American drilling and completion activity and new contract awards,
reported a 25 percent increase from the prior year quarter contributing to the consolidated revenue
improvement. For the first nine months of 2006, consolidated revenues were $5.3 billion, 32
percent above the comparable 2005 period, with Oilfield segment business volumes contributing
approximately 80 percent of the revenue growth. Oilfield segment revenues rose 35 percent over
amounts reported in the prior year period with the increase relatively balanced between North
American and non-North American markets. The revenue improvement largely reflects higher global
activity levels and increased customer spending.
Gross profit totaled $618.2 million for the third quarter, 46 percent above the prior year period.
Gross profit increased $193.6 million over the prior year quarter, primarily reflecting higher
sales volumes in the Oilfield operations associated with improved worldwide activity levels. Gross
profit margins for the third quarter of 2006 were 32 percent of revenues, 220 basis points above
the margins reported in the comparable prior year period largely reflecting the impact of a
favorable business mix and improved pricing. For the nine-month period, gross profit totaled $1.7
billion, or 31 percent of revenues, 180 basis points above the gross profit margins reported in the
comparable prior year period. Gross margins were impacted by a favorable business mix in the
Oilfield segment, improved pricing and, to a lesser extent, a decreased proportion of Distribution
segment sales, which historically generate lower margins than the Oilfield operations. On an
absolute dollar basis, gross profit was $480.7 million above the nine-month period ended September
30, 2005, largely attributable to higher sales volumes in the Oilfield operations.
Operating expenses, consisting of selling, general and administrative expenses, increased $77.3
million from the prior year quarter; however, as a percentage of revenues, decreased 70 basis
points from the prior year quarter. Improved fixed cost coverage in the sales and administrative
functions accounted for the operating expense percentage decline. The majority of the absolute
dollar increase was attributable to variable-related costs associated with the improved business
volumes, including investment in personnel and infrastructure to support the expanding business
base. Compared to the first nine months of 2005, operating expenses increased $185.3 million,
primarily due to variable-related costs associated with the improved business volumes.
Net interest expense, which represents interest expense less interest income, equaled $16.5 million
in the third quarter of 2006. Net interest expense increased $5.8 million and $11.5 million from
the prior year quarter and first nine months of 2005, respectively. The variance in both periods
reflects higher average debt levels and, to a lesser extent, an increase in variable interest
rates.
17
The effective tax rate for the third quarter approximated 33 percent, which was above the 32
percent effective rate reported in the prior year period, but below the U.S. statutory rate. The
effective tax rate was lower than the U.S. statutory rate due to the impact of M-I SWACO’s U.S.
partnership earnings for which the minority partner is directly responsible for its related income
taxes. The Company properly consolidates the pretax income related to the minority partner’s share
of U.S. partnership earnings but excludes the related tax provision. The effective rate increased
30 basis points from the level reported in the third quarter of 2005, largely due to a lower
proportion of M-I SWACO’s U.S. partnership earnings. On a year-to-date basis, the effective tax
rate of 32 percent was comparable to the rate reported in the first nine months of 2005.
Minority interests reflect the portion of the results of majority-owned operations which are
applicable to the minority interest partners. Minority interests was $20.5 million and $50.4
million above amounts reported in the prior year quarter and first nine months of 2005,
respectively, primarily associated with improved profitability levels in the M-I SWACO joint
venture.
Liquidity and Capital Resources
General
At September 30, 2006, cash and cash equivalents equaled $82.3 million. During the first nine
months of 2006, the Company generated $149.0 million of cash flows from operations as compared to
the $173.3 million reported in the comparable prior year period. The continued improvement in
worldwide drilling activity during 2006 has driven increased working capital investment that more
than offset the impact of the year-over-year increase in overall profitability levels.
During the first nine months of 2006, cash flows used in investing activities totaled $388.2
million, consisting of amounts required to fund acquisitions and capital expenditures. Acquisition
funding, which primarily related to the purchase of Specialised Petroleum Services Group Limited
and Epcon Offshore AS, resulted in cash outflows of $224.3 million in the current year period.
Additionally, the Company invested $173.2 million in property, plant and equipment, net of cash
proceeds arising from certain asset disposals. The increase in cash used for investing activities
as compared to the first nine months of 2005 reflects the impact of higher acquisition funding
period-to-period and additional capital spending, including increased investment in waste
management rental equipment in support of new customer contracts.
Cash flows provided by financing activities totaled $257.8 million for the first nine months of
2006. Due to the higher business volumes, which impacted the required investment in working
capital, cash flows from operations were not sufficient to fund investing activities, share
repurchases and dividend payments. This resulted in incremental borrowings of $387.8 million
financed by the issuance of publicly-traded debt instruments and, to a lesser extent, the
utilization of capacity under existing credit facilities.
The Company’s primary internal source of liquidity is cash flow generated from operations. Cash
flow generated from operations is primarily influenced by the level of worldwide drilling activity,
which affects profitability levels and working capital requirements. Capacity under revolving
credit agreements is also available, if necessary, to fund operating or investing activities. As
of September 30, 2006, the Company had $330.5 million drawn and $4.5 million of letters of credit
issued under its U.S. revolving credit facilities, resulting in $65.0 million of capacity available
for future operating or investing needs. The Company also has revolving credit facilities in place
outside of the United States, which are generally used to finance local operating needs. At
September 30, 2006, the Company had available borrowing capacity of $95.5 million under the
non-U.S. borrowing facilities.
The Company’s external sources of liquidity include debt and equity financing in the public capital
markets, if needed. The Company carries an investment-grade credit rating with recognized rating
agencies, generally providing the Company with access to debt markets. The Company’s overall
borrowing capacity is, in part, dependent on maintaining compliance with financial covenants under
the various credit agreements. As of September 30, 2006, the Company was well within the covenant
compliance thresholds under its various loan indentures, as amended, providing the ability to
access available borrowing capacity. Management believes funds generated by operations, amounts
available under existing credit facilities and external sources of liquidity will be sufficient to
finance capital expenditures and working capital needs of the existing operations for the
foreseeable future.
On March 1, 2006, the Company’s Board of Directors increased the quarterly cash dividend to $0.08
per share, beginning with the April 2006 distribution. The current annualized payout under the
program of approximately $65 million is expected to be funded with future cash flows from
operations and, if necessary, amounts available under existing credit facilities. The level of
future dividend payments will be at the discretion of the Company’s Board of Directors and will
depend upon the Company’s financial condition, earnings, cash flows, compliance with certain debt
covenants and other relevant factors.
18
In October 2005, the Company’s Board of Directors authorized a share buyback program that allows
for the repurchase of up to 20.0 million shares of the Company’s common stock, subject to
regulatory issues, market considerations and other relevant factors. To date, the Company has
purchased 2.4 million shares under the current authorized buyback program. Future repurchases
under the program may be executed from time to time in the open market or in privately negotiated
transactions and will be funded with cash flows from operations or amounts available under existing
credit facilities.
Management continues to evaluate opportunities to acquire products or businesses complementary to
the Company’s operations. Additional acquisitions, if they arise, may involve the use of cash or,
depending upon the size and terms of the acquisition, may require debt or equity financing.
Commitments and Contingencies
Standby Letters of Credit
In the normal course of business with customers, vendors and others, the Company is contingently
liable for performance under standby letters of credit and bid, performance and surety bonds.
Certain of these outstanding instruments guarantee payment to insurance companies with respect to
certain liability coverages of the Company’s insurance captive. Excluding the impact of these
instruments, for which related liabilities are reflected in the accompanying consolidated condensed
balance sheet, the Company was contingently liable for approximately $49.8 million of standby
letters of credit and bid, performance and surety bonds at September 30, 2006. Management does not
expect any material amounts to be drawn on these instruments.
Litigation
Rose Dove Egle v. John M. Egle, et al.
In April 1997, the Company acquired all of the equity interests in Tri-Tech Fishing Services,
L.L.C. (“Tri-Tech”) in exchange for cash consideration of approximately $20.4 million (the
“Transaction”).
In August 1998, the Company was added as a defendant in a First Amended Petition filed in the 15th
Judicial District Court, Parish of Lafayette, Louisiana entitled Rose Dove Egle v. John M. Egle, et
al. In the amended petition, the plaintiffs alleged that, due to an improper conveyance of
ownership interest by the Tri-Tech majority partner prior to the Transaction, Smith purchased a
portion of its equity interest from individuals who were not legally entitled to their Tri-Tech
shares. The suit was tried in the first quarter of 2004, and a jury verdict of approximately $4.8
million was rendered in favor of the plaintiffs. The Company has appealed the verdict and does not
anticipate a ruling until the first quarter of 2007. Based upon the facts and circumstances and
the opinion of outside legal counsel, management believes that an unfavorable outcome on this
matter is not probable at this time. Accordingly, the Company has not recognized a loss provision
in the accompanying consolidated condensed financial statements.
Other
The Company is a defendant in various other legal proceedings arising in the ordinary course of
business. In the opinion of management, these matters will not have a material adverse effect on
the Company’s consolidated financial position or results of operations.
Environmental
The Company routinely establishes and reviews the adequacy of reserves for estimated future
environmental clean-up costs for properties currently or previously operated by the Company.
As of September 30, 2006, the Company’s environmental reserve totaled $9.4 million. This amount
reflects the future undiscounted estimated exposure related to identified properties, without
regard to indemnifications from former owners. While actual future environmental costs may differ
from estimated liabilities recorded at September 30, 2006, the Company does not believe that these
differences will have a material impact on the Company’s financial position or results of
operations.
During the first quarter of 2006, the Company settled a pending legal action which sought to
clarify certain contractual provisions of an environmental indemnification provided by M-I SWACO’s
former owners. The two parties executed a settlement agreement whereby the former owners agreed to
pay an outstanding receivable owed to the Company, assume all environmental liabilities associated
with two identified sites and reimburse the Company for certain future environmental remediation
costs. The impact of the settlement, which was recorded in the first quarter of 2006, was not
material to the Company’s financial condition or results of operations as of or for the nine months
ended September 30, 2006.
19
Critical Accounting Policies and Estimates
The discussion and analysis of financial condition and results of operations are based upon the
Company’s consolidated condensed financial statements, which have been prepared in accordance with
accounting principles generally accepted in the United States. The preparation of these financial
statements requires the Company to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues and expenses, and related disclosure of contingent assets and
liabilities. The Company evaluates its estimates on an ongoing basis, based on historical
experience and on various other assumptions that are believed to be reasonable under the
circumstances. Actual results may differ from these estimates under different assumptions or
conditions. In its 2005 Annual Report on Form 10-K, the Company has described the critical
accounting policies that require management’s most significant judgments and estimates. There have
been no material changes in these critical accounting policies.
Recent Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial
Accounting Standards (“SFAS”) No. 123r, “Share-Based Payment” (“SFAS No. 123r”), which replaces
SFAS No. 123 “Accounting for Stock-Based Compensation,” and supersedes Accounting Principles Board
Opinion No. 25 “Accounting for Stock Issued to Employees.” SFAS No. 123r provides for the
inclusion of share-based compensation expense in the consolidated financial statements, which is
determined based upon the grant date fair value of equity awards, and generally expensed over the
service period of the related award. Effective January 1, 2006, the Company adopted SFAS No. 123r
using the modified prospective method, resulting in the recognition of compensation expense for all
unvested stock options — totaling $15.0 million of future compensation expense, of which $9.5
million is expected to be recorded during the 2006 fiscal year.
In July 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes -
an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 clarifies the accounting for
uncertainty in income taxes recognized in an entity’s financial statements in accordance with SFAS
No. 109, “Accounting for Income Taxes”, and prescribes a consistent recognition threshold and
measurement attribute for financial statement recognition and disclosure of tax positions taken, or
expected to be taken, on a tax return. This interpretation is effective for fiscal years beginning
after December 15, 2006. We are currently evaluating the provisions of FIN 48 and have not yet
determined the impact, if any, on our consolidated condensed financial statements.
In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension
and Other Postretirement Plans — an amendment of FASB Statements No. 87, 88, 106, and 132(R)”
(“SFAS 158”). Effective December 31, 2006, SFAS 158 requires recognition of the funded status of
an entity’s defined benefit pension and other postretirement benefit plans as an asset or liability
in the Company’s consolidated balance sheet. Subsequent changes to the funded status are to be
recognized through stockholders’ equity as a component of comprehensive income. Additionally, for
fiscal years ending after December 31, 2008, SFAS 158 requires measurement of plan assets and
obligations as of the end of the employer’s fiscal year. We are currently evaluating the
provisions of SFAS 158 and have not yet determined the impact on our consolidated condensed
financial statements.
From time to time, new accounting pronouncements are issued by the FASB that are adopted by the
Company as of the specified effective date. Unless otherwise discussed, management believes the
impact of recently issued standards, which are not yet effective, will not have a material impact
on the Company’s consolidated condensed financial statements upon adoption.
20
Item 3. Quantitative and Qualitative Disclosures about Market Risk
The Company is exposed to certain market risks arising from transactions that are entered into in
the normal course of business which are primarily related to interest rate changes and fluctuations
in foreign exchange rates. During the reporting period, no events or transactions have occurred
which would materially change the information disclosed in the
Company’s 2005 Annual Report on Form 10-K.
Item 4. Controls and Procedures
Evaluation of disclosure controls and procedures. The Company maintains disclosure controls and
procedures designed to provide reasonable assurances that information required to be disclosed in
our filings under the Securities Exchange Act of 1934 is recorded, processed, summarized and
reported within the time frame specified in the Commission’s rules and regulations. Our principal
executive and financial officers have evaluated our disclosure controls and procedures and have
determined that such disclosure controls and procedures are effective as of the end of the period
covered by this report.
Changes in internal control over financial reporting. There has been no change in the Company’s
internal control over financial reporting during the quarter ended September 30, 2006 that has
materially affected, or is reasonably likely to materially affect, the Company’s internal control
over financial reporting.
21
PART II — OTHER INFORMATION
Item 1. Legal Proceedings
None.
Item 1A. Risk Factors
As of the date of this filing, except as noted below, there have been no material changes in
our Risk Factors as set forth in Item 1A to Part I of our Form 10-K for the year ended December 31,
2005.
The following risk factor is in addition to, and should be read in conjunction with, the risk
factors disclosed in our 2005 Annual Report on Form 10-K:
Our industry is experiencing more litigation involving claims of infringement of intellectual
property rights.
Over the past few years, our industry has experienced increased litigation related to the
infringement of intellectual property rights. We, as well as certain of our competitors, have been
named as defendants in various of these intellectual property matters, although we do not consider
any pending or threatened claim to be material. These types of claims are typically costly to
defend, involve monetary judgments that, in certain circumstances, are subject to being enhanced
and are often brought in venues which have proved to be favorable to plaintiffs. If we are
ultimately unsuccessful in defending alleged intellectual property claims, it could adversely
impact our results of operations and cash flows.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
During October 2005, the Company’s Board of Directors approved a repurchase program that
allows for the purchase of up to 20.0 million shares of the Company’s common stock, subject to
regulatory issues, market considerations and other relevant factors. During the third quarter of
2006, the Company repurchased 0.8 million shares of common stock under the program at an aggregate
cost of $33.1 million. The acquired shares have been added to the Company’s treasury stock
holdings.
A summary of the Company’s repurchase activity for the three months ended September 30, 2006
is as follows:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
Total Number of |
|
Number of Shares |
| |
|
|
|
|
|
|
|
|
|
Shares Purchased as |
|
that May Yet Be |
| |
|
Total Number |
|
Average Price Paid |
|
Part of Publicly |
|
Purchased Under |
| Period |
|
of Shares Purchased |
|
per Share |
|
Announced Program |
|
the Program |
July 1 — July 31
|
|
|
- |
|
|
$ |
- |
|
|
|
- |
|
|
|
18,421,200 |
|
August 1 — August 31
|
|
|
80,200 |
|
|
|
41.71 |
|
|
|
80,200 |
|
|
|
18,341,000 |
|
September 1 — September 30
|
|
|
759,200 |
|
|
|
39.20 |
|
|
|
759,200 |
|
|
|
17,581,800 |
|
| |
|
|
|
|
|
|
|
|
3rd Quarter 2006
|
|
|
839,400 |
|
|
$ |
39.44 |
|
|
|
839,400 |
|
|
|
17,581,800 |
|
Item 3. Defaults upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None.
22
Item 6. Exhibits
Exhibits designated with an “*” are filed, and with an “**” furnished, as an exhibit to this
Quarterly Report on Form 10-Q. Exhibits previously filed, as indicated below, are incorporated by
reference.
| |
|
|
| Exhibit |
|
|
| Number |
|
Description |
|
|
|
3.1
|
|
Restated Certificate of Incorporation of the Company, dated
July 26, 2005. Filed as Exhibit 3.4 to the Company’s
report on Form 10-Q for the quarter ended June 30, 2005 and
incorporated herein by reference. |
|
|
|
3.2
|
|
Restated Bylaws of the Company. Filed as Exhibit 3.3 to
the Company’s report on Form 10-K for the year ended
December 31, 2004 and incorporated herein by reference. |
|
|
|
31.1*
|
|
Certification of Chief Executive Officer pursuant to Rule
13a-14 or 15d-14 of the Securities Exchange Act of 1934, as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002. |
|
|
|
31.2*
|
|
Certification of Chief Financial Officer pursuant to Rule
13a-14 or 15d-14 of the Securities Exchange Act of 1934, as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002. |
|
|
|
32.1**
|
|
Certification pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002. |
23
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto duly authorized.
| |
|
|
|
|
| |
SMITH INTERNATIONAL, INC.
Registrant
|
|
| Date: November 9, 2006 |
By: |
/s/ Doug Rock
|
|
| |
|
Doug Rock |
|
| |
|
Chairman of the Board, Chief Executive Officer,
President and Chief Operating Officer
(principal executive officer) |
|
| |
| |
|
|
|
|
| |
|
|
| Date: November 9, 2006 |
By: |
/s/ Margaret K. Dorman
|
|
| |
|
Margaret K. Dorman |
|
| |
|
Senior Vice President,
Chief Financial Officer and Treasurer
(principal financial and accounting officer) |
|
| |
24
EXHIBIT INDEX
Exhibits designated with an “*” are filed, and with an “**” furnished, as an exhibit to this
Quarterly Report on Form 10-Q. Exhibits previously filed, as indicated below, are incorporated by
reference.
| |
|
|
| Exhibit |
|
|
| Number |
|
Description |
|
|
|
3.1
|
|
Restated Certificate of Incorporation of the Company, dated
July 26, 2005. Filed as Exhibit 3.4 to the Company’s
report on Form 10-Q for the quarter ended June 30, 2005 and
incorporated herein by reference. |
|
|
|
3.2
|
|
Restated Bylaws of the Company. Filed as Exhibit 3.3 to
the Company’s report on Form 10-K for the year ended
December 31, 2004 and incorporated herein by reference. |
|
|
|
31.1*
|
|
Certification of Chief Executive Officer pursuant to Rule
13a-14 or 15d-14 of the Securities Exchange Act of 1934, as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002. |
|
|
|
31.2*
|
|
Certification of Chief Financial Officer pursuant to Rule
13a-14 or 15d-14 of the Securities Exchange Act of 1934, as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002. |
|
|
|
32.1**
|
|
Certification pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002. |
25