UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended September 30, 2001
OR
[ ] 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 95-3822631
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
411 NORTH SAM HOUSTON PARKWAY, SUITE 600
HOUSTON, TEXAS 77060
(Address of principal executive offices) (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 [X] No [ ]
The number of shares outstanding of the Registrant's common stock as of November
8, 2001 was 49,399,451.
INDEX
PAGE NO.
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PART I - FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Three Months and Nine Months ended September 30, 2001 and 2000....................................2
CONSOLIDATED BALANCE SHEETS
As of September 30, 2001 and December 31, 2000............................................................3
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Nine Months ended September 30, 2001 and 2000.....................................................4
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS................................................................5
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations..............11
Item 3. Qualitative and Quantitative Market Risk Disclosures...............................................17
PART II - OTHER INFORMATION
Items 1-6..................................................................................................18
SIGNATURES.....................................................................................................19
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
1
SMITH INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited, in thousands except per share data)
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- ---------------------------
2001 2000 2001 2000
------------ ------------ ------------ ------------
REVENUES .................................... $ 909,682 $ 718,470 $ 2,647,382 $ 2,001,131
COSTS AND EXPENSES:
Costs of Revenues ......................... 636,626 523,118 1,869,301 1,469,961
Selling Expenses .......................... 132,735 107,060 384,452 302,158
General and Administrative Expenses ....... 36,574 31,269 105,176 87,414
Goodwill Amortization ..................... 3,966 2,804 11,738 8,144
------------ ------------ ------------ ------------
Total Costs and Expenses .......... 809,901 664,251 2,370,667 1,867,677
------------ ------------ ------------ ------------
INCOME BEFORE INTEREST AND TAXES ............ 99,781 54,219 276,715 133,454
INTEREST EXPENSE, NET ....................... 10,653 8,554 31,734 26,077
------------ ------------ ------------ ------------
INCOME BEFORE INCOME TAXES AND MINORITY
INTERESTS ................................. 89,128 45,665 244,981 107,377
INCOME TAX PROVISION ........................ 28,941 15,131 79,833 36,219
------------ ------------ ------------ ------------
INCOME BEFORE MINORITY INTERESTS ............ 60,187 30,534 165,148 71,158
MINORITY INTERESTS .......................... 18,121 10,060 51,182 24,387
------------ ------------ ------------ ------------
NET INCOME .................................. $ 42,066 $ 20,474 $ 113,966 $ 46,771
============ ============ ============ ============
EARNINGS PER SHARE:
Basic ..................................... $ 0.84 $ 0.41 $ 2.29 $ 0.94
============ ============ ============ ============
Diluted ................................... $ 0.84 $ 0.41 $ 2.26 $ 0.93
============ ============ ============ ============
WEIGHTED AVERAGE SHARES
OUTSTANDING:
Basic ..................................... 49,831 49,750 49,862 49,550
Diluted ................................... 50,210 50,387 50,400 50,231
The accompanying notes are an integral part of these consolidated
financial statements.
2
SMITH INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands except par value data)
September 30, December 31,
2001 2000
------------- -------------
(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents ................................................. $ 45,263 $ 36,544
Receivables, net .......................................................... 774,326 654,420
Inventories ............................................................... 655,480 560,027
Deferred tax assets, net .................................................. 25,488 29,462
Prepaid expenses and other ................................................ 40,970 29,550
------------- -------------
Total current assets .............................................. 1,541,527 1,310,003
------------- -------------
PROPERTY, PLANT AND EQUIPMENT, NET .......................................... 448,776 409,048
GOODWILL, NET ............................................................... 479,935 453,947
OTHER ASSETS ................................................................ 137,288 122,289
------------- -------------
TOTAL ASSETS ................................................................ $ 2,607,526 $ 2,295,287
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Short-term borrowings and current portion of long-term debt ............... $ 83,634 $ 165,951
Accounts payable .......................................................... 308,624 280,820
Accrued payroll costs ..................................................... 67,152 62,934
Income taxes payable ...................................................... 46,249 23,747
Other ..................................................................... 126,458 109,352
------------- -------------
Total current liabilities ......................................... 632,117 642,804
------------- -------------
LONG-TERM DEBT .............................................................. 532,532 374,716
DEFERRED TAX LIABILITIES .................................................... 47,662 44,659
OTHER LONG-TERM LIABILITIES ................................................. 42,567 37,945
MINORITY INTERESTS .......................................................... 437,704 377,682
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY:
Preferred stock, $1 par value; 5,000 shares authorized; no shares
issued or outstanding in 2001 or 2000 ................................... -- --
Common stock, $1 par value; 150,000 shares authorized; 50,592 shares
issued in 2001 (50,419 in 2000) ......................................... 50,592 50,419
Additional paid-in capital ................................................ 390,228 382,248
Retained earnings ......................................................... 524,275 410,309
Accumulated comprehensive loss ............................................ (21,021) (17,793)
Less - treasury securities, at cost; 1,192 shares in 2001 (656 in 2000) ... (29,130) (7,702)
------------- -------------
Total shareholders' equity ........................................ 914,944 817,481
------------- -------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY .................................. $ 2,607,526 $ 2,295,287
============= =============
The accompanying notes are an integral part of these consolidated
financial statements.
3
SMITH INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)
Nine Months Ended
September 30,
------------------------------
2001 2000
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ............................................................... $ 113,966 $ 46,771
Adjustments to reconcile net income to net cash provided by Operating
activities, excluding the net effects of acquisitions:
Depreciation and amortization .......................................... 68,108 59,600
Minority interests ..................................................... 51,182 24,387
Provision for losses on receivables .................................... 2,064 2,149
Gain on disposal of property, plant and equipment ...................... (5,463) (5,234)
Foreign currency translation losses .................................... 516 1,290
Changes in operating assets and liabilities:
Receivables ............................................................ (81,993) (108,550)
Inventories ............................................................ (47,741) (31,275)
Accounts payable ....................................................... (634) 18,848
Other current assets and liabilities ................................... 32,878 25,914
Other non-current assets and liabilities ............................... (9,997) (5,238)
------------ ------------
Net cash provided by operating activities ................................ 122,886 28,662
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of businesses, net of cash acquired .......................... (97,119) (40,111)
Purchases of property, plant and equipment ............................... (88,313) (66,779)
Proceeds from disposal of property, plant and equipment .................. 14,856 11,757
Other .................................................................... (2,084) --
------------ ------------
Net cash used in investing activities .................................... (172,660) (95,133)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt ................................. 290,742 83,062
Principal payments of long-term debt ..................................... (213,252) (25,214)
Net change in short-term borrowings ...................................... (14,982) 913
Purchases of treasury stock .............................................. (21,428) --
Proceeds from exercise of stock options .................................. 5,463 17,564
Contribution by minority interest partner ................................ 12,000 --
------------ ------------
Net cash provided by financing activities ................................ 58,543 76,325
------------ ------------
Effect of exchange rate changes on cash .................................. (50) (312)
------------ ------------
Increase in cash and cash equivalents .................................... 8,719 9,542
Cash and cash equivalents at beginning of period ......................... 36,544 24,127
------------ ------------
Cash and cash equivalents at end of period ............................... $ 45,263 $ 33,669
============ ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for interest ................................................... $ 35,654 $ 26,044
Cash paid for income taxes ............................................... $ 45,126 $ 15,746
The accompanying notes are an integral part of these consolidated
financial statements.
4
SMITH INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION OF INTERIM FINANCIAL STATEMENTS
The accompanying unaudited consolidated financial statements of Smith
International, Inc. and subsidiaries (the "Company") have been prepared pursuant
to the rules and regulations of the Securities and Exchange Commission (the
"Commission"). Accordingly, certain information and footnote disclosures
normally included in financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted. These financial
statements should be read in conjunction with the audited financial statements
and accompanying notes included in the Company's 2000 Annual Report on Form 10-K
and other current filings with the Commission.
The unaudited consolidated financial statements reflect all adjustments
(consisting only of normal recurring adjustments) which the Company considers
necessary for a fair presentation of the interim periods. All significant
intercompany balances and transactions have been eliminated in the accompanying
financial statements. Results for the interim periods are not necessarily
indicative of results for the year. Certain prior year amounts have been
reclassified to conform to current year presentation.
2. RECENT ACCOUNTING PRONOUNCEMENTS
In August 2001, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets," which is effective for the
Company beginning January 1, 2002. SFAS No. 144 supersedes SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," and the accounting and reporting provisions relating to the
disposal of a segment of a business of Accounting Principles Board Opinion No.
30. The Company does not anticipate that the adoption of SFAS No. 144 will have
a material impact on its financial position or results of operations.
In July 2001, the FASB released SFAS No. 143, "Accounting for Asset
Retirement Obligations," which is required to be adopted by the Company no later
than January 1, 2003. SFAS No. 143 addresses the financial accounting and
reporting for retirement obligations and costs associated with tangible
long-lived assets. The Company is currently reviewing the provisions of SFAS No.
143 to determine the standard's impact, if any, on its financial statements upon
adoption.
The FASB issued SFAS No. 141, "Business Combinations," in July 2001,
which is effective for business combinations initiated after June 30, 2001. SFAS
No. 141 eliminates the pooling-of-interest method of accounting for business
combinations and modifies the application of the purchase accounting method. The
FASB also issued SFAS No. 142, "Goodwill and Other Intangible Assets," in July
2001 which addresses financial accounting and reporting for goodwill and other
intangible assets. Under SFAS No. 142, goodwill and some intangibles will no
longer be amortized to earnings but will be tested for impairment. While most
provisions of SFAS No. 142 are effective for the Company beginning January 1,
2002, goodwill and intangible assets acquired subsequent to June 30, 2001 are
subject immediately to the provisions of the statement. Although the Company
continues to evaluate the impact of this recently issued standard, the adoption
of SFAS No. 142 will result in the elimination of $15.7 million of goodwill
amortization recognized in fiscal 2001, or $9.2 million net of taxes and
minority interests.
The Company adopted SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," effective January 1, 2001. SFAS No. 133
requires that the Company record derivatives on the balance sheet at fair value
and establishes criteria for designation and effectiveness of hedging
relationships. The nature of the Company's business activities involves the
management of various financial and market risks, including those related to
changes in currency exchange rates and interest rates. The Company occasionally
employs derivative financial instruments such as foreign exchange contracts,
foreign exchange options and interest rate swap contracts to mitigate or
eliminate certain of those risks. The Company does not enter into derivative
instruments for speculative purposes.
The adoption of SFAS No. 133 on January 1, 2001 did not have a material
impact on the Company's financial position or results of operations. During the
three-month and nine-month periods ended September 30, 2001, the Company
recorded the change in fair market value related to fair value hedges, which
included foreign exchange contracts, to general and administrative expenses in
the accompanying consolidated statement of operations. These amounts were not
material. Additionally, the Company recorded the change in value related to cash
flow hedges, which included foreign exchange contracts and interest rate swaps,
to accumulated other
5
comprehensive income. During the first nine months of 2001, changes in foreign
exchange rates and interest rates resulted in an adjustment of $0.2 million to
accumulated other comprehensive income in the accompanying consolidated balance
sheet. Of this amount, $0.1 million is expected to be recognized in the
statement of operations during the next 12 months, offset by the effect of
changes in the underlying basis of the hedged transactions.
3. BUSINESS COMBINATIONS
During the six months ended June 30, 2001, the Company completed two
acquisitions for aggregate cash consideration of $46.4 million. The January 2001
acquisition of substantially all of the U.S. net assets of Van Leeuwen Pipe and
Tube Corporation ("Van Leeuwen"), a leading provider of pipe, valves and
fittings to the refining, petrochemical and power generation industries,
accounted for the majority of the acquisition consideration for the six-month
period. This transaction was financed with amounts borrowed under a short-term
loan facility which was subsequently repaid with proceeds from the Company's
public debt offering (see Note 8).
During the three months ended September 30, 2001, the Company completed
eight acquisitions for aggregate cash consideration of $50.7 million. On July 2,
2001, the Company acquired Star Tool Company ("Star Tool"), which provides
fishing and rental tool services for customers in the U.S. Permian Basin market.
Star Tool, which generated revenues of approximately $18.0 million during the
twelve-month period ended September 30, 2001, has been integrated into the Smith
Services operations. On August 22, 2001, M-I acquired BW Group plc ("BW Group"),
an Aberdeen, Scotland-based provider of drilling and completion fluids to the
North Sea market. BW Group reported revenues of approximately $22.0 million
during the twelve-month period ended September 30, 2001. These two transactions
accounted for the majority of the acquisition consideration for the three-month
period and were financed with borrowings under credit facilities.
These acquisitions have been recorded using the purchase method of
accounting and, accordingly, the acquired operations have been included in the
results of operations since the dates of acquisition. The purchase price was
allocated to the net assets acquired based upon their estimated fair market
values at the dates of acquisition. The excess of the purchase price over the
estimated fair value of the net tangible assets and identifiable intangible
assets acquired has been recorded as goodwill. For acquisitions completed during
the first six months of 2001, goodwill is being amortized on a straight-line
basis over 20 years. Goodwill recorded from acquisitions completed subsequent to
June 30, 2001, in the amount of approximately $31.5 million, is not subject to
amortization, in accordance with the provisions of SFAS No. 142.
The balances included in the consolidated balance sheet as of September
30, 2001 related to these acquisitions are based upon preliminary information
and are subject to change when additional information concerning final asset and
liability valuations is obtained. Material changes in the preliminary
allocations are not anticipated by management.
The following unaudited pro forma supplemental information presents
consolidated results of operations as if the Company's significant current and
prior year acquisitions had occurred on January 1, 2000. The unaudited pro forma
data is based on historical information and does not include estimated cost
savings; therefore, it does not purport to be indicative of the results of
operations had the combinations been in effect at the dates indicated or of
future results for the combined entities (in thousands, except per share
amounts):
Nine Months Ended
September 30,
-------------------------------
2001 2000
------------- -------------
Revenues ................... $ 2,688,294 $ 2,227,914
Net income ................. 114,235 44,973
Earnings per share:
Basic ............ $ 2.29 $ 0.91
Diluted .......... 2.27 0.90
6
The following schedule summarizes investing activities related to the
current year acquisitions included in the consolidated statements of cash flows
(in thousands):
Fair value of tangible assets, net of cash acquired ................ $ 113,410
Goodwill and other intangible assets recorded ...................... 36,746
Total liabilities assumed .......................................... (53,037)
------------
Cash paid for acquisition of businesses, net of cash acquired ...... $ 97,119
============
On a segment basis, $35.4 million of goodwill and other intangible
assets relates to the Oilfield Products and Services group, and $1.3 million of
goodwill and other intangible assets is associated with the Distribution
segment.
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 which could have occurred if additional
shares were issued for stock option exercises under the treasury stock method.
Certain outstanding employee stock options were not included in the computation
of diluted earnings per common share as the exercise price was greater than the
average market price for the Company's stock during the corresponding period.
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,
----------------------------- -----------------------------
2001 2000 2001 2000
------------ ------------ ------------ ------------
Basic EPS:
Net income .................................. $ 42,066 $ 20,474 $ 113,966 $ 46,771
============ ============ ============ ============
Weighted average number of common
shares outstanding ........................ 49,831 49,750 49,862 49,550
============ ============ ============ ============
Basic EPS ................................... $ 0.84 $ 0.41 $ 2.29 $ 0.94
============ ============ ============ ============
Diluted EPS:
Net income .................................. $ 42,066 $ 20,474 $ 113,966 $ 46,771
============ ============ ============ ============
Weighted average number of common
shares outstanding ........................ 49,831 49,750 49,862 49,550
Dilutive effect of stock options ............ 379 637 538 681
------------ ------------ ------------ ------------
50,210 50,387 50,400 50,231
============ ============ ============ ============
Diluted EPS ................................. $ 0.84 $ 0.41 $ 2.26 $ 0.93
============ ============ ============ ============
7
5. COMPREHENSIVE INCOME
Comprehensive income encompasses net income and changes in the
components of accumulated other comprehensive income during the periods
presented. Accumulated other comprehensive income consists of currency
translation adjustments and changes in the unrealized fair value of certain
derivative financial instruments. The Company's comprehensive income is as
follows (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------- ------------------------------
2001 2000 2001 2000
------------ ------------ ------------ ------------
Net income ............................. $ 42,066 $ 20,474 $ 113,966 $ 46,771
Changes in unrealized fair value
of derivatives, net .................. 2,497 -- 181 --
Currency translation adjustments ....... 2,154 (3,778) (3,409) (8,208)
------------ ------------ ------------ ------------
Comprehensive income ................... $ 46,717 $ 16,696 $ 110,738 $ 38,563
============ ============ ============ ============
As of September 30, 2001, accumulated comprehensive loss in the
accompanying consolidated balance sheet includes $21.2 million of cumulative
currency translation losses, offset by $0.2 million of cumulative changes in
unrealized fair value of derivatives.
6. INVENTORIES
Inventories are stated at the lower of cost or market. Cost is
determined by the first-in, first-out ("FIFO") method for the majority of the
Company's inventories. The remaining inventories are costed under the last-in,
first-out ("LIFO") or average cost methods. Inventory costs, consisting of
materials, labor and factory overhead, are as follows (in thousands):
September 30, December 31,
2001 2000
------------- -------------
Raw materials ........................................ $ 47,808 $ 46,923
Work-in-process ...................................... 65,332 57,167
Products purchased for resale ........................ 173,356 139,591
Finished goods ....................................... 393,025 341,117
------------- -------------
679,521 584,798
Reserves to state certain domestic inventories
($323,576 in 2001 and $273,811 in 2000)
on a LIFO basis .................................... (24,041) (24,771)
------------- -------------
$ 655,480 $ 560,027
============= =============
7. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consists of the following (in thousands):
September 30, December 31,
2001 2000
------------- -------------
Land .............................. $ 27,515 $ 24,683
Buildings ......................... 94,315 91,432
Machinery and equipment ........... 446,389 401,624
Rental tools ...................... 239,242 225,962
------------- -------------
807,461 743,701
Less-accumulated depreciation ..... (358,685) (334,653)
------------- -------------
$ 448,776 $ 409,048
============= =============
8
8. DEBT
The following summarizes the Company's outstanding debt (in thousands):
September 30, December 31,
2001 2000
------------- -------------
Current:
Short-term borrowings ........................ $ 60,915 $ 75,394
Current portion of long-term debt ............ 22,719 90,557
------------- -------------
$ 83,634 $ 165,951
============= =============
Long-Term:
Notes, net of unamortized discounts .......... $ 462,906 $ 259,529
Bank revolvers payable ....................... 76,000 190,386
Term loans and other ......................... 16,345 15,358
------------- -------------
555,251 465,273
Less current portion of long-term debt ....... (22,719) (90,557)
------------- -------------
$ 532,532 $ 374,716
============= =============
During the first quarter of 2001, the Company completed a public
offering of $250.0 million of 6.75 percent senior notes which mature in February
2011. The Company received net proceeds of $246.7 million from the offering,
which was used to repay short-term borrowings and indebtedness under revolving
credit agreements.
Principal payments of long-term debt for the twelve-month periods
ending subsequent to September 30, 2002 are as follows (in thousands):
2003 ............... $ 95,690
2004 ............... 10,476
2005 ............... 10,476
2006 ............... 10,476
Thereafter ......... 405,414
------------
$ 532,532
============
9. SHAREHOLDERS' EQUITY
During the current fiscal year, the Company's Board of Directors
authorized a share buyback program which allows for the repurchase of up to five
million shares of common stock, subject to regulatory issues, market
considerations and other factors. During the third quarter of 2001, the Company
repurchased 536,200 shares of common stock at an aggregate cost of $21.4
million. The acquired shares have been added to the Company's treasury stock
holdings, which equaled 1,192,054 shares at September 30, 2001, and may be used
for acquisitions or other corporate purposes. Future repurchases under the
program may be executed from time to time in the open market or in privately
negotiated transactions.
9
10. 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 has two reportable segments: Oilfield
Products and Services and Distribution.
The following table presents financial information for each reportable
segment (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------------- --------------------------------
2001 2000 2001 2000
------------- ------------- ------------- -------------
Revenues:
Oilfield Products and Services ....... $ 622,203 $ 485,760 $ 1,789,179 $ 1,333,253
Distribution ......................... 287,479 232,710 858,203 667,878
------------- ------------- ------------- -------------
$ 909,682 $ 718,470 $ 2,647,382 $ 2,001,131
============= ============= ============= =============
Income before interest and taxes:
Oilfield Products and Services ....... $ 93,975 $ 51,343 $ 260,217 $ 125,813
Distribution ......................... 7,344 4,231 21,028 11,834
General corporate .................... (1,538) (1,355) (4,530) (4,193)
------------- ------------- ------------- -------------
$ 99,781 $ 54,219 $ 276,715 $ 133,454
============= ============= ============= =============
11. SUBSEQUENT EVENTS
Subsequent to September 30, 2001, the Company has acquired three
business operations for total cash consideration of $144.7 million.
M-I, the operations owned jointly by the Company and Schlumberger
Limited, acquired the SulfaTreat Company ("SulfaTreat") and the oilfield and
industrial screen operations of Madison Filter Belgium S.A. ("Madison") for cash
consideration of $128.5 million. SulfaTreat, a natural-gas production services
company headquartered in the United States, generated revenues of approximately
$12.0 million during the twelve-month period ended September 30, 2001. Madison,
which includes United Wire Ltd. based in Scotland and Southwestern Wire Cloth,
Inc. based in the United States, manufactures and markets screens for oilfield
shakers and provides screening products for use in a broad range of industrial
markets. Madison reported revenues of approximately $61.0 million during the
twelve-month period ended September 30, 2001.
On October 10, 2001, the Company acquired a majority interest in United
Engineering Services LLC ("UES"), an engineering and manufacturing services
company incorporated in Oman. UES generated revenues of approximately $55.0
million during the twelve-month period ended September 30, 2001 and has been
integrated into the Smith Services operations.
The acquisitions will be accounted for by the purchase method and,
accordingly, included in the results of operations as of the respective dates of
acquisition. The above acquisitions were financed with a combination of
borrowings under revolving credit agreements, proceeds from a $75.0 million
floating rate note offering and minority partner contributions. The notes accrue
interest based on a floating rate, subject to quarterly adjustments, equal to
LIBOR plus 112.5 basis points. Interest on the notes is payable quarterly
beginning January 15, 2002.
Additionally, the Company completed the formation of a joint venture
with Sandvik AB to design, manufacture and market roller-cone and specialty
drill bits used in the mining and construction industry. The Company will
account for its interest in the joint venture under the equity method of
accounting. The assets contributed by the Company to the joint venture generated
revenues of approximately $5.8 million and $16.3 million in the three-month and
nine-month periods ended September 30, 2001, respectively.
10
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.
The following discussion should be read in conjunction with the Consolidated
Financial Statements of the Company and the related notes thereto included
elsewhere in this Form 10-Q and the Consolidated Financial Statements of the
Company and the related notes thereto and the related "Management's Discussion
and Analysis of Financial Condition and Results of Operations" included in the
Company's Annual Report on Form 10-K.
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, three-cone and diamond drill bits, 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 branch network providing pipe, valves, fittings, mill, safety and
other maintenance products.
The Company's worldwide operations are largely driven by the level of
exploration and production activity in major energy producing areas and the
depth and drilling conditions of these projects. Drilling activity levels are
primarily influenced by energy prices but may also be affected by expectations
related to the worldwide supply of and demand for oil and natural gas, finding
and development costs, decline and depletion rates, political actions and
uncertainties, environmental concerns, capital expenditure plans of exploration
and production companies and the overall level of global economic growth and
activity.
The Company's oilfield segment is primarily driven by the level of
exploration and production activity in international markets, which has remained
relatively stable during the current year. North American drilling activity,
however, peaked during July 2001 and has subsequently declined approximately 22
percent from those levels due to the impact of lower natural gas prices.
Significant exposure to the U.S. deepwater market, which is more
revenue-intensive and less susceptible to short-term variations in energy
prices, has limited the impact of the activity decline on sales volumes to date.
However, a continued deterioration in the U.S. or other major world economies
could further impact North American activity levels or activity in international
markets. A substantial decline in activity levels could result in lower demand
for the Company's products and services, and adversely impact future financial
results.
11
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, Smith Bits and Smith Services. The Distribution segment includes the Wilson
business unit. The revenue information below has been summarized by business
unit in order to provide additional information in analyzing the Company's
operations (dollars in thousands).
Three Months Ended September 30, Nine Months Ended September 30,
------------------------------------------- -------------------------------------------
2001 2000 2001 2000
-------------------- -------------------- -------------------- --------------------
Amount % Amount % Amount % Amount %
----------- ----- ----------- ----- ----------- ----- ----------- -----
Revenues:
M-I .................................. $ 412,364 45 $ 326,446 45 $ 1,197,036 45 $ 888,648 44
Smith Bits ........................... 105,135 12 84,018 12 309,617 12 235,448 12
Smith Services ....................... 104,704 11 75,296 10 282,526 11 209,157 10
----------- ----- ----------- ----- ----------- ----- ----------- -----
Oilfield Products and Services ..... 622,203 68 485,760 67 1,789,179 68 1,333,253 66
Wilson ............................... 287,479 32 232,710 33 858,203 32 667,878 34
----------- ----- ----------- ----- ----------- ----- ----------- -----
Total ........................ $ 909,682 100 $ 718,470 100 $ 2,647,382 100 $ 2,001,131 100
=========== ===== =========== ===== =========== ===== =========== =====
Revenues by Area:
United States ........................ $ 480,125 53 $ 358,935 50 $ 1,373,109 52 $ 985,533 49
Export ............................... 30,009 3 28,240 4 98,723 4 85,283 4
Non-United States .................... 399,548 44 331,295 46 1,175,550 44 930,315 47
----------- ----- ----------- ----- ----------- ----- ----------- -----
Total ........................ $ 909,682 100 $ 718,470 100 $ 2,647,382 100 $ 2,001,131 100
=========== ===== =========== ===== =========== ===== =========== =====
Income Before Interest and Taxes:
Oilfield Products and Services ....... $ 93,975 15 $ 51,343 11 $ 260,217 15 $ 125,813 9
Distribution ......................... 7,344 3 4,231 2 21,028 3 11,834 2
General corporate .................... (1,538) * (1,355) * (4,530) * (4,193) *
----------- ----- ----------- ----- ----------- ----- ----------- -----
Total ........................ $ 99,781 11 $ 54,219 8 $ 276,715 10 $ 133,454 7
=========== ===== =========== ===== =========== ===== =========== =====
*not meaningful
Oilfield Products and Services Segment
Revenues
M-I provides drilling and completion fluid systems, engineering and
technical services to the oil and gas industry through its M-I Fluids division.
M-I's SWACO division manufactures and markets equipment and services for solids
control, separation, pressure control, rig instrumentation and waste management.
M-I's revenues rose $85.9 million, or 26 percent, from the third quarter of 2000
and $308.4 million, or 35 percent, from the first nine months of 2000. The
majority of the revenue improvement over the prior year periods reflects
increased demand for base-fluid products and fluid processing and waste
management services as a result of higher worldwide exploration and development
activity. The favorable revenue variances also reflects the impact of the
acquisitions of Sweco and other operations completed over the past 12 months,
and improved pricing for product and services. After excluding the impact of
acquired operations, M-I's revenues in the third quarter and first nine months
of 2001 were 19 percent and 26 percent above the prior year periods,
respectively, compared to corresponding increases in the M-I worldwide rig count
of 15 percent and 24 percent. On a geographic basis, the majority of the growth
in base business revenues was reported in the United States, Europe/Africa and
Latin America.
12
Smith Bits manufactures and sells three-cone and diamond drill bits
primarily for use in the oil and gas industry. Smith Bits' revenues increased
$21.1 million, or 25 percent, from the third quarter 2000 and $74.2 million, or
32 percent, from the first nine months of 2000. On a combined basis, petroleum
three-cone and diamond bit revenues rose 28 percent over the level reported for
the three months ended September 30, 2001. When compared to the prior year
periods, the revenue increases on a percentage basis exceeded the average rig
count increases in all geographic areas due to recent product introductions,
increased market penetration and improved pricing. The majority of the growth
from year-to-year is attributable to the improved drilling activity levels in
the United States and Europe/Africa. Smith Bits' mining bit operations, which
were contributed to a newly-formed joint venture with Sandvik AB in October 2001
and will no longer be consolidated, generated approximately $5.8 million and
$16.3 million of revenues in the current year quarter and nine-month period,
respectively.
Smith Services manufactures and markets products and services used in
the oil and gas industry for drilling, workover, well completion and well
re-entry. Smith Services' revenues increased $29.4 million, or 39 percent, from
the third quarter of 2000 and $73.4 million, or 35 percent, from the first nine
months of 2000. After excluding the effect of the acquisition of Star Tool
Company and the divestiture of the directional operations, revenues for the
current year periods were 39 percent over levels reported in the previous year
periods. The significant increase in base business revenues is attributable to
higher worldwide exploration and production activity levels, new contract awards
and favorable product and service pricing. Smith Services' revenues increased
over prior year levels in all geographic areas, with the majority of the
improvement reported in the United States. While revenues rose in all product
and service groups, increased demand for tubular products and inspection
services as well as higher reported drill pipe revenues related to an alliance
with a specialty drill pipe manufacturer, contributed the majority of the
year-over-year base growth.
Income Before Interest and Taxes
Income before interest and taxes for the Oilfield Products and Services
segment increased $42.6 million, or 83 percent, from the third quarter of 2000
and $134.4 million, or 107 percent, from the first nine months of 2000. The
significant improvement in income before interest and taxes resulted from the
increase in reported revenues, and to a lesser extent, higher operating margins.
Operating margins for the current year periods rose by four percentage points
and six percentage points, respectively, over the three-month and nine-month
periods ended September 30, 2000, attributable primarily to improved gross
profit margins. Gross profit margins in the current year periods reflect the
favorable effect of higher sales and production volumes and improved pricing.
The balance of the operating margin improvement is attributable to the impact of
higher revenue levels on fixed cost coverage related to sales and administrative
support expenses.
Distribution Segment
Revenues
Wilson markets pipe, valves, fittings, 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. Wilson's
revenues increased $54.8 million, or 24 percent, from the third quarter of 2000
and $190.3 million, or 28 percent, from the first nine months of 2000. Excluding
the impact of the Van Leeuwen operations, acquired in early 2001, revenues were
7 percent and 11 percent, respectively, above the same periods last year. The
majority of the base revenue increase was reported in the energy branch
operations in the United States, reflecting the improvement in activity levels.
Income Before Interest and Taxes
Wilson's income before interest and taxes increased $3.1 million, or 74
percent, from the third quarter of 2000 and $9.2 million, or 78 percent, from
the first nine months of 2000. The increases over the prior year period reflect
the impact of the higher revenue levels and, to a lesser extent, the approximate
one percentage point improvement in operating margins. The effect of improved
gross margins in the U.S. energy branches in the current year periods was
impacted by the higher proportion of industrial and downstream revenues, which
traditionally generate lower gross profit margins.
13
Consolidated Results
For the periods indicated, the following table summarizes the results
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,
--------------------------------------- ---------------------------------------
2001 2000 2001 2000
------------------ ------------------ ------------------ ------------------
Amount % Amount % Amount % Amount %
---------- ----- ---------- ----- ---------- ----- ---------- -----
Revenues ............................... $ 909,682 100 $ 718,470 100 $2,647,382 100 $2,001,131 100
---------- ----- ---------- ----- ---------- ----- ---------- -----
Gross profit ........................... 273,056 30 195,352 27 778,081 29 531,170 27
Operating expenses ..................... 173,275 19 141,133 20 501,366 19 397,716 20
---------- ----- ---------- ----- ---------- ----- ---------- -----
Income before interest and taxes ....... 99,781 11 54,219 7 276,715 10 133,454 7
Interest expense, net .................. 10,653 1 8,554 1 31,734 1 26,077 2
---------- ----- ---------- ----- ---------- ----- ---------- -----
Income before income
taxes and minority interests ......... 89,128 10 45,665 6 244,981 9 107,377 5
Income tax provision ................... 28,941 3 15,131 2 79,833 3 36,219 2
---------- ----- ---------- ----- ---------- ----- ---------- -----
Income before minority
interests ............................ 60,187 7 30,534 4 165,148 6 71,158 3
Minority interests ..................... 18,121 2 10,060 1 51,182 2 24,387 1
---------- ----- ---------- ----- ---------- ----- ---------- -----
Net income ............................. $ 42,066 5 $ 20,474 3 $ 113,966 4 $ 46,771 2
========== ===== ========== ===== ========== ===== ========== =====
Consolidated revenues rose $191.2 million, or 27 percent, from the
third quarter of 2000 and $646.3 million, or 32 percent, from the first nine
months of 2000. The majority of the revenue growth over prior year levels is
attributable to the Company's base business operations. Excluding the impact of
acquired and divested operations, revenues increased 18 percent and 23 percent,
respectively, over the prior year quarter and year-to-date levels, and compares
to corresponding increases in the M-I worldwide rig count of 15 percent and 24
percent. Higher exploration and production activity levels in the current year
periods favorably impacted each of the Company's operations, with improved
pricing in the oilfield operations also contributing to the growth. The majority
of the revenue increase from year-to-year was reported in the United States and
the North Sea area.
Gross profit increased $77.7 million, or 40 percent, from the third
quarter of 2000 and $246.9 million, or 47 percent, from the first nine months of
2000. While the majority of the gross profit increase is attributable to the
higher revenue levels, improved gross margins attributable to higher volumes and
improved pricing in the oilfield operations also contributed to the favorable
variance. Consolidated gross profit margins equaled 30 percent in the third
quarter of 2001 and 29 percent on a current year-to-date basis, an increase of
approximately three percentage points over both prior year periods.
Operating expenses, consisting of selling, general and administrative
expenses, increased $32.1 million from the third quarter of 2000 and $103.7
million from the first nine months of 2000. The majority of the overall
operating expense increase is due to the higher base business volumes, which
contributed to a 12 percent increase in personnel levels from the prior year
quarter. Incremental operating expenses associated with operations acquired
collectively accounted for more than 35 percent of the increase over the prior
year periods. Operating expenses as a percentage of revenues declined one
percentage point from the comparable periods in 2000 reflecting higher fixed
cost coverage related to the overall sales and administrative functions.
Net interest expense, which represents interest expense less interest
income, was $2.1 million above the third quarter of 2000 and $5.7 million over
the first nine months of 2000 due to an increase in outstanding debt. On a
year-to-date basis, average debt levels increased approximately $134.0 million
from the prior year period in connection with the financing of acquisitions.
14
The effective tax rate approximated 33 percent for the first nine
months of 2001, which is below the prior year rate and the U.S. statutory rate.
The effective tax rate in 2001 is lower than the U.S. statutory rate due to the
impact of M-I's U.S. partnership earnings for which the minority partner is
directly responsible for their related income taxes. The Company properly
consolidates the pre-tax income related to the minority partner's share of U.S.
partnership earnings but excludes the related tax provision. The effective rate
for the three months ended September 30, 2001 was 32.5 percent which is below
the prior period rate primarily due to a favorable shift in the geographic mix
of pre-tax income towards lower rate jurisdictions.
Minority interests reflect the portion of the results of majority-owned
operations which are applicable to the minority interest partners. Minority
interests increased $8.1 million from the third quarter of 2000 and $26.8
million from the first nine months of 2000 due to the higher profitability of
the M-I joint venture.
LIQUIDITY AND CAPITAL RESOURCES
General
Cash and cash equivalents equaled $45.3 million at September 30, 2001,
which is $8.7 million above the level reported at December 31, 2000. Cash flows
provided by operations were $122.9 million in the first nine months of 2001, an
increase of $94.2 million from the amount reported in the same period of 2000.
The improvement in cash generated from operations primarily reflects the higher
profitability levels of the overall business, with the activity-driven growth in
working capital accounts remaining relatively consistent between periods.
Cash flows utilized in investing activities in the first nine months of
2001 included $73.5 million of investments in net property, plant and equipment
which consists of routine additions of capital equipment as well as $6.0 million
related to the construction of a new office facility. During the nine month
period ended September 30, 2001, the Company acquired treasury stock aggregating
$21.4 million, reflected in financing activities, and purchased publicly-traded
securities of a majority owned subsidiary which is included in investing
activities. Although cash flows from operations were sufficient to finance the
above during the first nine months of 2001, the Company completed ten
acquisitions for aggregate cash consideration of $97.1 million which required
borrowings under new and existing credit agreements.
The Company's primary internal source of liquidity is cash flow
generated from operations. External sources of liquidity include debt and, if
needed, equity financing. In February 2001, the Company completed a public
offering of $250.0 million of 6.75 percent senior notes which was used to repay
short-term borrowings and the majority of the Company's indebtedness under
revolving credit agreements. The Company's revolving lines of credit facilities,
which are available for operating and financing needs, had additional borrowing
capacity of $156.0 million at September 30, 2001. The Company believes funds
generated from 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.
Subsequent to September 30, 2001, the Company has acquired three
businesses for total cash consideration of $144.7 million, financed with a
combination of borrowings under revolving credit agreements, proceeds from a
$75.0 million floating rate note offering and minority partner contributions.
M-I, the operations owned jointly by the Company and Schlumberger Limited,
acquired the SulfaTreat Company ("SulfaTreat") and the oilfield and industrial
screen operations of Madison Filter Belgium S.A. ("Madison") for cash
consideration of $128.5 million. SulfaTreat, a natural-gas production services
company headquartered in the United States, generated revenues of approximately
$12.0 million during the twelve-month period ended September 30, 2001. Madison,
which includes United Wire Ltd. based in Scotland and Southwestern Wire Cloth,
Inc. based in the United States, manufactures and markets screens for oilfield
shakers and provides screening products for use in a broad range of industrial
markets. Madison reported revenues of approximately $61.0 million during the
twelve-month period ended September 30, 2001. Additionally, on October 10, 2001,
the Company acquired a majority interest in United Engineering Services LLC
("UES"), an engineering and manufacturing services company incorporated in Oman.
UES generated revenues of approximately $55.0 million during the twelve-month
period ended September 30, 2001 and has been integrated into the Smith Services
operations.
15
Management continues to evaluate opportunities to acquire products or
businesses complementary to the Company's operations. These 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.
NEW ACCOUNTING AND REGULATORY PRONOUNCEMENTS
In August 2001, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets," which is effective for the
Company beginning January 1, 2002. SFAS No. 144 supersedes SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," and the accounting and reporting provisions relating to the
disposal of a segment of a business of Accounting Principles Board Opinion No.
30. The Company does not anticipate that the adoption of SFAS No. 144 will have
a material impact on its financial position or results of operations.
In July 2001, the FASB released SFAS No. 143, "Accounting for Asset
Retirement Obligations," which is required to be adopted by the Company no later
than January 1, 2003. SFAS No. 143 addresses the financial accounting and
reporting for retirement obligations and costs associated with tangible
long-lived assets. The Company is currently reviewing the provisions of SFAS No.
143 to determine the standard's impact, if any, on its financial statements upon
adoption.
The FASB issued SFAS No. 141, "Business Combinations," in July 2001,
which is effective for business combinations initiated after June 30, 2001. SFAS
No. 141 eliminates the pooling-of-interest method of accounting for business
combinations and modifies the application of the purchase accounting method. The
FASB also issued SFAS No. 142, "Goodwill and Other Intangible Assets," in July
2001 which addresses financial accounting and reporting for goodwill and other
intangible assets. Under SFAS No. 142, goodwill and some intangibles will no
longer be amortized to earnings but will be tested for impairment. While most
provisions of SFAS No. 142 are effective for the Company beginning January 1,
2002, goodwill and intangible assets acquired subsequent to June 30, 2001 are
subject immediately to the provisions of the statement. Although the Company
continues to evaluate the impact of this recently issued standard, the adoption
of SFAS No. 142 will result in the elimination of $15.7 million of goodwill
amortization recognized in fiscal 2001, or $9.2 million net of taxes and
minority interests.
The Company adopted SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," effective January 1, 2001. SFAS No. 133
requires that the Company record derivatives on the balance sheet at fair value
and establishes criteria for designation and effectiveness of hedging
relationships. The nature of the Company's business activities involves the
management of various financial and market risks, including those related to
changes in currency exchange rates and interest rates. The Company occasionally
employs derivative financial instruments such as foreign exchange contracts,
foreign exchange options and interest rate swap contracts to mitigate or
eliminate certain of those risks. The Company does not enter into derivative
instruments for speculative purposes.
The adoption of SFAS No. 133 on January 1, 2001 did not have a material
impact on the Company's financial position or results of operations. During the
three-month and nine-month periods ended September 30, 2001, the Company
recorded the change in fair market value related to fair value hedges, which
included foreign exchange contracts, to general and administrative expenses in
the accompanying consolidated statement of operations. These amounts were not
material. Additionally, the Company recorded the change in value related to cash
flow hedges, which included foreign exchange contracts and interest rate swaps,
to accumulated other comprehensive income. During the first nine months of 2001,
changes in foreign exchange rates and interest rates resulted in an adjustment
of $0.2 million to accumulated other comprehensive income in the accompanying
consolidated balance sheet. Of this amount, $0.1 million is expected to be
recognized in the statement of operations during the next 12 months, offset by
the effect of changes in the underlying basis of the hedged transactions.
16
ITEM 3. QUALITATIVE AND QUANTITATIVE MARKET RISK DISCLOSURES
The Company is exposed to certain market risks arising from
transactions that are entered into in the normal course of business. These
risks, which are primarily related to interest rate changes and fluctuations in
foreign exchange rates, are not considered to be material to the Company. During
the reporting period, no events or transactions have occurred which would
materially change the information disclosed in the Company's Annual Report on
Form 10-K.
17
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
4.1 Amendment to Rights Agreement dated June 8, 2000, by
and among the Company and First Chicago Trust Company
of New York (the "Rights Agent") and effective as of
October 1, 2001.
10.1 Supplemental Executive Retirement Plan as amended and
restated effective January 2, 2001.
(b) Reports on Form 8-K
The Registrant filed reports on Form 8-K during the quarterly
period ended September 30, 2001. All filings were reported
under "Item 5. Other Events" and disclosed the following:
1. Form 8-K dated July 2, 2001 relating to a press
release announcing the acquisition of Star Tool
Company and a press release announcing the earnings
release and conference call information for the
second quarter of 2001.
2. Form 8-K dated July 18, 2001 relating to a press
release announcing the Company's results for the
second quarter of 2001.
3. Form 8-K dated July 26, 2001 relating to a press
release announcing the Company's stock repurchase
program.
18
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 14, 2001 By: /s/ Douglas L. Rock
----------------------- ----------------------------------------
Douglas L. Rock
Chairman of the Board, Chief Executive
Officer, President and Chief Operating
Officer
Date: November 14, 2001 By: /s/ Margaret K. Dorman
----------------------- ----------------------------------------
Margaret K. Dorman
Senior Vice President and
Chief Financial Officer
(Principal Accounting Officer)
19
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
------ -----------
4.1 Amendment to Rights Agreement
10.1 Supplemental Executive Retirement Plan
21