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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 June 30, 2002
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 August
9, 2002 was 101,350,438.
INDEX
PAGE NO.
--------
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Three Months and Six Months ended June 30, 2002 and 2001........1
CONSOLIDATED BALANCE SHEETS
As of June 30, 2002 and December 31, 2001...............................2
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Six Months ended June 30, 2002 and 2001.........................3
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS..............................4
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations..........................................9
Item 3. Qualitative and Quantitative Market Risk Disclosures..............16
PART II - OTHER INFORMATION
Items 1-6.................................................................17
SIGNATURES....................................................................18
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SMITH INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited, in thousands except per share data)
Three Months Ended Six Months Ended
June 30, June 30,
----------------------------- -----------------------------
2002 2001 2002 2001
----------- ----------- ----------- -----------
Revenues .................................... $ 801,038 $ 872,389 $ 1,628,415 $ 1,737,700
Costs and expenses:
Costs of revenues ......................... 564,783 613,453 1,150,658 1,232,675
Selling expenses .......................... 127,753 128,541 258,812 251,717
General and administrative expenses ....... 34,622 35,106 70,617 68,602
Goodwill amortization ..................... -- 3,941 -- 7,772
----------- ----------- ----------- -----------
Total costs and expenses .......... 727,158 781,041 1,480,087 1,560,766
----------- ----------- ----------- -----------
Operating income ............................ 73,880 91,348 148,328 176,934
Interest expense, net ....................... 9,892 10,738 19,908 21,081
----------- ----------- ----------- -----------
Income before income taxes and minority
interests ................................. 63,988 80,610 128,420 155,853
Income tax provision ........................ 19,306 26,087 38,951 50,892
----------- ----------- ----------- -----------
Income before minority interests ............ 44,682 54,523 89,469 104,961
Minority interests .......................... 17,760 16,841 33,817 33,061
----------- ----------- ----------- -----------
Net income .................................. $ 26,922 $ 37,682 $ 55,652 $ 71,900
=========== =========== =========== ===========
Basic earnings per share:
Net income ................................ $ 0.27 $ 0.38 $ 0.56 $ 0.72
=========== =========== =========== ===========
Net income, excluding impact of
goodwill amortization .................. $ 0.27 $ 0.40 $ 0.56 $ 0.77
=========== =========== =========== ===========
Diluted earnings per share:
Net income ............................... $ 0.27 $ 0.37 $ 0.56 $ 0.71
=========== =========== =========== ===========
Net income, excluding impact of
goodwill amortization ................. $ 0.27 $ 0.40 $ 0.56 $ 0.76
=========== =========== =========== ===========
Weighted average shares outstanding (adjusted for impact of two-for-one stock split effective July 2002):
Basic ..................................... 98,944 99,820 98,892 99,754
Diluted ................................... 100,272 101,034 100,071 101,010
The accompanying notes are an integral part of these
consolidated financial statements.
1
SMITH INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands except par value data)
June 30, December 31,
2002 2001
----------- -----------
(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents ........................................... $ 45,980 $ 44,683
Receivables, net .................................................... 712,567 752,165
Inventories ......................................................... 633,090 653,151
Deferred tax assets, net ............................................ 25,149 35,414
Prepaid expenses and other .......................................... 43,303 37,618
----------- -----------
Total current assets ........................................ 1,460,089 1,523,031
----------- -----------
Property, Plant and Equipment, net .................................... 497,698 488,497
Goodwill, net ......................................................... 580,972 574,550
Other Assets .......................................................... 170,158 149,750
----------- -----------
Total Assets .......................................................... $ 2,708,917 $ 2,735,828
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Short-term borrowings and current portion of long-term debt ......... $ 66,014 $ 148,693
Accounts payable .................................................... 239,281 284,502
Accrued payroll costs ............................................... 57,059 81,803
Income taxes payable ................................................ 43,253 41,143
Other ............................................................... 96,116 109,863
----------- -----------
Total current liabilities ................................... 501,723 666,004
----------- -----------
Long-Term Debt ........................................................ 568,801 538,842
Deferred Tax Liabilities .............................................. 49,417 40,504
Other Long-Term Liabilities ........................................... 58,481 51,027
Minority Interests .................................................... 510,497 490,292
Commitments and Contingencies
STOCKHOLDERS' EQUITY:
Preferred stock, $1 par value; 5,000 shares authorized; no shares
issued or outstanding in 2002 or 2001 ............................. -- --
Common stock, $1 par value; 150,000 shares authorized; 101,350 shares
issued in 2002 (50,594 shares issued in 2001, on a pre-split basis) 101,350 50,594
Additional paid-in capital .......................................... 342,453 389,989
Retained earnings ................................................... 618,106 562,454
Accumulated other comprehensive income .............................. (12,781) (24,748)
Less - Treasury securities, at cost; 2,384 common shares in 2002
(1,192 common shares in 2001, on a pre-split basis) .............. (29,130) (29,130)
----------- -----------
Total stockholders' equity .................................. 1,019,998 949,159
----------- -----------
Total Liabilities and Stockholders' Equity ............................ $ 2,708,917 $ 2,735,828
=========== ===========
The accompanying notes are an integral part of these
consolidated financial statements.
2
SMITH INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)
Six Months Ended
June 30,
----------------------------
2002 2001
---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income .......................................................... $ 55,652 $ 71,900
Adjustments to reconcile net income to net cash provided by operating
activities, excluding the net effects of acquisitions:
Depreciation and amortization ..................................... 43,200 44,937
Minority interests ................................................ 33,817 33,061
Provision for losses on receivables ............................... 6,110 1,303
Gain on disposal of property, plant and equipment ................. (3,730) (3,302)
Foreign currency translation (gains) losses ....................... (1,021) 571
Changes in operating assets and liabilities:
Receivables ....................................................... 40,560 (42,608)
Inventories ....................................................... 24,599 (54,063)
Accounts payable .................................................. (47,678) (3,517)
Other current assets and liabilities .............................. (35,828) 12,179
Other non-current assets and liabilities .......................... (2,680) (9,143)
---------- ----------
Net cash provided by operating activities ........................... 113,001 51,318
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of businesses, net of cash acquired ..................... (5,049) (46,396)
Purchases of property, plant and equipment .......................... (50,630) (56,820)
Proceeds from disposal of property, plant and equipment ............. 10,644 9,264
Other ............................................................... -- (1,325)
---------- ----------
Net cash used in investing activities ............................... (45,035) (95,277)
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt ............................ 706 273,724
Principal payments of long-term debt ................................ (53,365) (201,899)
Net change in short-term borrowings ................................. (1,053) (41,838)
Proceeds from exercise of stock options ............................. 2,293 5,455
Minority interest partners contributions (distributions) ............ (15,600) 12,000
---------- ----------
Net cash provided by (used in) financing activities ................. (67,019) 47,442
---------- ----------
Effect of exchange rate changes on cash ............................. 350 (89)
---------- ----------
Increase in cash and cash equivalents ............................... 1,297 3,394
Cash and cash equivalents at beginning of period .................... 44,683 36,544
---------- ----------
Cash and cash equivalents at end of period .......................... $ 45,980 $ 39,938
========== ==========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for interest .............................................. $ 21,339 $ 17,450
Cash paid for income taxes .......................................... $ 23,736 $ 37,503
The accompanying notes are an integral part of these
consolidated financial statements.
3
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 2001 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.
2. RECENT ACCOUNTING PRONOUNCEMENTS
In July 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 146, "Accounting for
Costs Associated with Exit or Disposal Activities," which is effective for
fiscal periods after December 31, 2002. SFAS No. 146 requires companies to
recognize costs associated with restructurings, discontinued operations, plant
closings, or other exit or disposal activities, when incurred rather than at the
date a plan is committed to. The Company plans to adopt the standard as of the
effective date and will implement its provisions on a prospective basis.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." SFAS No. 145 eliminates SFAS No. 4 and as a result, gains and
losses from extinguishment of debt should be classified as extraordinary items
only if they meet the criteria in APB Opinion No. 30. SFAS No. 145 amends SFAS
No. 13, "Accounting for Leases," to eliminate an inconsistency between the
required accounting for sale-leaseback transactions and the required accounting
for certain lease modifications that have economic effects that are similar to
sale-leaseback transactions. SFAS No. 145 also updates and amends existing
authoritative pronouncements to make various technical corrections, clarify
meanings, or describe their applicability under changed conditions. The Company
does not expect that the adoption of SFAS No. 145 will have a material impact on
its consolidated 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.
On January 1, 2002, the Company adopted SFAS No. 144, "Accounting for
the Impairment or Disposal of Long-Lived Assets." The adoption of SFAS No. 144
did not impact the Company's financial position or results of operations.
The Company has also adopted SFAS No. 142, "Goodwill and Other
Intangible Assets," which addresses financial accounting and reporting for
goodwill and other intangible assets. Effective January 1, 2002, goodwill and
certain intangibles are no longer amortized to earnings but are tested for
impairment under SFAS No. 142. During the first quarter of 2002, the Company
completed the transitional impairment test required by the standard, the results
of which did not impact the Company's financial position or results of
operations. The accompanying Consolidated Statements of Operations provide
relevant disclosures related to recorded goodwill amortization and the after-tax
impact which would have resulted from the adoption of SFAS No. 142 as of January
1, 2001.
4
3. STOCK SPLIT
On June 6, 2002, the Company's Board of Directors approved a
two-for-one stock split, effected in the form of a stock dividend. Stockholders
of record as of June 20, 2002 were entitled to the dividend, which was
distributed on July 8, 2002.
The June 30, 2002 consolidated balance sheet includes the
reclassification of $50.7 million from additional paid-in capital to the common
stock account, in order to reflect the transaction. Additionally, all amounts
included in the financial statements related to weighted average shares
outstanding and earnings per share amounts have been adjusted for all periods
presented for the stock split.
4. NON-RECURRING CHARGES
During the first quarter of 2002, the Company recognized non-recurring
charges totaling $7.9 million, or $3.4 million net of taxes and minority
interests. The first quarter charge included a $4.3 million provision for losses
on receivables in Argentina attributable to local economic events. The provision
was necessitated by Argentinean legislation, which required the Company to
settle certain U.S. dollar-denominated transactions in pesos. The remainder of
the charge related to restructuring efforts undertaken in response to
activity-level declines, the primary component of which is severance costs
incurred in connection with employee terminations.
From a presentation standpoint, $5.8 million of the charges are
included in general and administrative expenses, $1.7 million are reflected in
selling expenses and the remainder are recorded in cost of revenues.
5. 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 Six Months Ended
June 30, June 30,
--------------------------- ---------------------------
2002 2001 2002 2001
---------- ---------- ---------- ----------
Basic EPS:
Net income ............................. $ 26,922 $ 37,682 $ 55,652 $ 71,900
========== ========== ========== ==========
Weighted average number of common
shares outstanding ................... 98,944 99,820 98,892 99,754
========== ========== ========== ==========
Basic EPS .............................. $ 0.27 $ 0.38 $ 0.56 $ 0.72
========== ========== ========== ==========
Diluted EPS:
Net income ............................. $ 26,922 $ 37,682 $ 55,652 $ 71,900
========== ========== ========== ==========
Weighted average number of common
shares outstanding ................... 98,944 99,820 98,892 99,754
Dilutive effect of stock options ....... 1,328 1,214 1,179 1,256
---------- ---------- ---------- ----------
100,272 101,034 100,071 101,010
========== ========== ========== ==========
Diluted EPS ............................ $ 0.27 $ 0.37 $ 0.56 $ 0.71
========== ========== ========== ==========
5
6. 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 Six Months Ended
June 30, June 30,
--------------------------- ----------------------------
2002 2001 2002 2001
---------- ---------- ---------- ----------
Net income .............................................. $ 26,922 $ 37,682 $ 55,652 $ 71,900
Changes in unrealized fair value
of derivatives, net ................................... 1,750 (287) 1,785 (2,316)
Currency translation adjustments ........................ 10,649 (765) 10,182 (5,563)
---------- ---------- ---------- ----------
Comprehensive income .................................... $ 39,321 $ 36,630 $ 67,619 $ 64,021
========== ========== ========== ==========
As of June 30, 2002, accumulated other comprehensive income in the
accompanying Consolidated Balance Sheet includes $12.7 million of cumulative
currency translation losses and $0.9 million of cumulative pension liability
adjustments, partially offset by $0.8 million of cumulative changes in the
unrealized fair value of derivatives.
7. INVENTORIES
Inventories are stated at the lower of cost or market. Cost is
determined by the first-in, first-out ("FIFO"), last-in, first-out ("LIFO") or
average cost methods. Inventory costs, consisting of materials, labor and
factory overhead, are as follows (in thousands):
June 30, December 31,
2002 2001
----------- ------------
Raw materials ................................ $ 42,267 $ 50,821
Work-in-process .............................. 59,344 65,008
Products purchased for resale ................ 160,241 154,787
Finished goods ............................... 395,785 406,143
----------- -----------
657,637 676,759
Reserves to state certain domestic inventories
($295,758 in 2002 and $300,868 in 2001,
respectively) on a LIFO basis .............. (24,547) (23,608)
----------- -----------
$ 633,090 $ 653,151
=========== ===========
6
8. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consists of the following (in thousands):
June 30, December 31,
2002 2001
---------- ------------
Land ............................................. $ 32,642 $ 28,390
Buildings ........................................ 117,061 100,888
Machinery and equipment .......................... 484,237 482,045
Rental tools ..................................... 251,823 243,913
---------- ----------
885,763 855,236
Less-Accumulated depreciation .................... 388,065 366,739
---------- ----------
$ 497,698 $ 488,497
========== ==========
9. DEBT
The following summarizes the Company's outstanding debt (in thousands):
June 30, December 31,
2002 2001
----------- ------------
Current:
Short-term borrowings .................... $ 50,095 $ 50,156
Current portion of long-term debt ........ 15,919 98,537
----------- -----------
$ 66,014 $ 148,693
=========== ===========
Long-Term:
Notes, net of unamortized discounts ...... $ 499,542 $ 532,555
Revolving credit facilities .............. 64,500 81,700
Term loans and other ..................... 20,678 23,124
----------- -----------
584,720 637,379
Less current portion of long-term debt ... (15,919) (98,537)
----------- -----------
$ 568,801 $ 538,842
=========== ===========
In the second quarter of 2002, the Company repurchased and retired
$30.0 million of its 6.75 percent public notes maturing in 2011. In connection
with the transaction, the Company recorded $0.5 million of termination costs
related to the repurchase, consisting primarily of the prorata portion of
unamortized discount and issuance costs associated with the 6.75 percent notes.
Subsequent to June 30, 2002, the Company replaced its $200.0 million
revolving credit facility, which was scheduled to expire in December 2002, with
a new three-year, $400.0 million facility provided by a syndicate of nine
financial institutions. The revolving credit agreement (the "Agreement") allows
for the election of interest at a base rate, or a Eurodollar rate ranging from
LIBOR plus 62.5 to 75.0 basis points depending on amounts drawn under the
facility. The Agreement also requires the payment of a quarterly commitment fee
on the unutilized portion of the facility and compliance with certain customary
covenants, including maintenance of specified debt-to-total capitalization and
interest coverage ratios, as defined.
The outstanding balance under the revolving credit facilities as of
June 30, 2002 has been reclassified to long-term in the accompanying
Consolidated Balance Sheet.
7
Principal payments of long-term debt for the twelve-month periods
ending subsequent to June 30, are as follows (in thousands):
2003 ............................................................ $ 90,674
2004 ............................................................ 17,617
2005 ............................................................ 75,281
2006 ............................................................ 8,692
Thereafter ...................................................... 376,537
--------
$568,801
========
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 aggregates its operations into two
reportable segments: Oilfield Products and Services and Distribution.
The following table presents financial information for each reportable
segment (in thousands):
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------ ------------------------------
2002 2001 2002 2001
----------- ----------- ----------- -----------
Revenues:
Oilfield Products and Services ....... $ 583,658 $ 585,485 $ 1,176,528 $ 1,166,976
Distribution ......................... 217,380 286,904 451,887 570,724
----------- ----------- ----------- -----------
$ 801,038 $ 872,389 $ 1,628,415 $ 1,737,700
=========== =========== =========== ===========
Operating Income:
Oilfield Products and Services ....... $ 76,376 $ 85,841 $ 152,315 $ 166,242
Distribution ......................... (881) 6,913 (813) 13,684
General corporate .................... (1,615) (1,406) (3,174) (2,992)
----------- ----------- ----------- -----------
$ 73,880 $ 91,348 $ 148,328 $ 176,934
=========== =========== =========== ===========
June 30, December 31,
2002 2001
----------- ------------
Goodwill:
Oilfield Products and Services........................... $ 543,651 $ 537,509
Distribution........................................ 37,321 37,041
----------- -----------
$ 580,972 $ 574,550
=========== ===========
The change in goodwill during the first six months of 2002 primarily
reflects the impact of an acquisition and, to a lesser extent, revisions to
preliminary purchase price allocations associated with the Oilfield Products and
Services segment.
11. CONTINGENCIES
The Company is a party to various legal and environmental matters
arising in the ordinary course of business. In the opinion of management, after
considering established reserves and contractual indemnifications obtained,
these matters are not expected to have a material adverse effect on the
Company's consolidated financial position or results of operations. In the
unlikely event that the parties providing the environmental indemnifications do
not fulfill their obligations, such event could result in the recognition of up
to $25.0 million related to indemnified liabilities, potentially impacting
earnings and cash flows in future periods.
8
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 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 and petrochemical industries 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, valve, tool, 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 year-over-year decline in the worldwide rig count relates to lower
North American activity levels, particularly in the United States. Drilling
activity in the U.S. market is heavily influenced by natural gas fundamentals,
as 85 percent of the U.S. rig count is currently natural gas-directed. After
bottoming in late March 2002, activity levels in the United States have
rebounded 25 percent due, in part, to declining natural gas production which has
resulted in a significant increase in natural gas drilling activity. Although
the U.S. rig count is currently at the highest level experienced in 2002,
various factors including political and regional instabilities, oil and natural
gas storage levels, commodity prices and depletion rates, will likely influence
activity levels on a going forward basis. The Company's business outlook,
however, 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. Further
weakness in the global economic environment could result in a substantial
decline in worldwide drilling activity, adversely impacting the Company's future
financial results.
Management also believes the increasing complexity of drilling programs
has resulted in a shift in exploration and production spending toward
value-added, technology-based products, which reduce operators' overall drilling
costs. The Company continues to focus on investing in the development of
technology-based products that considerably improve the drilling process through
increased efficiency and rates of penetration and reduced formation damage.
Management believes the overall savings realized by the use of the Company's
premium products, such as polycrystalline diamond drill bits, diamond-enhanced
three-cone drill bits and synthetic drilling fluids, compensate for the higher
costs of these products over their non-premium counterparts.
9
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 discussion 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 June 30, Six Months Ended June 30,
-------------------------------------------- --------------------------------------------
2002 2001 2002 2001
-------------------- -------------------- --------------------- --------------------
Amount % Amount % Amount % Amount %
----------- ----- ----------- ------ ----------- ------- ----------- ------
Financial Data:
Revenues:
M-I ............................ $ 401,642 50 $ 392,403 45 $ 798,298 49 $ 784,672 45
Smith Bits ..................... 77,146 10 101,695 12 166,624 10 204,482 12
Smith Services ................. 104,870 13 91,387 10 211,606 13 177,822 10
----------- --- ----------- --- ----------- --- ----------- ---
Oilfield Products and Services 583,658 73 585,485 67 1,176,528 72 1,166,976 67
Distribution ................... 217,380 27 286,904 33 451,887 28 570,724 33
----------- --- ----------- --- ----------- --- ----------- ---
Total .................. $ 801,038 100 $ 872,389 100 $ 1,628,415 100 $ 1,737,700 100
=========== === =========== === =========== === =========== ===
Revenues by Area:
United States .................. $ 384,933 48 $ 468,434 54 $ 776,881 48 $ 892,984 51
Canada ......................... 62,130 8 87,595 10 150,349 9 213,698 12
Non-North America .............. 353,975 44 316,360 36 701,185 43 631,018 37
----------- --- ----------- --- ----------- --- ----------- ---
Total .................. $ 801,038 100 $ 872,389 100 $ 1,628,415 100 $ 1,737,700 100
=========== === =========== === =========== === =========== ===
Operating Income:
Oilfield Products and Services . $ 76,376 13 $ 85,841 15 $ 152,315 13 $ 166,242 14
Distribution ................... (881) * 6,913 2 (813) * 13,684 2
General corporate .............. (1,615) * (1,406) * (3,174) * (2,992) *
----------- --- ----------- --- ----------- --- ----------- ---
Total .................. $ 73,880 9 $ 91,348 10 $ 148,328 9 $ 176,934 10
=========== === =========== === =========== === =========== -==
Market Data:
M-I Average Worldwide Rig Count:
United States ......... 940 46 1,427 53 909 42 1,370 50
Canada ................ 144 7 245 9 265 12 367 13
Non-North America ..... 981 47 1,026 38 991 46 1,026 37
===== === ===== === ===== === ===== ===
Total ......... 2,065 100 2,698 100 2,165 100 2,763 100
===== === ===== === ===== === ===== ===
*not meaningful
10
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 reported revenues of $401.6 million for the second quarter of 2002, two
percent above the prior year quarter. The revenue improvement over the prior
year period is attributable to incremental revenues from ten acquisitions
completed during the prior twelve-month period. Excluding the impact of
acquisitions, revenues declined six percent, as lower U.S. energy consumption
contributed to a 34 percent decline in the U.S. rig count. On a geographic
basis, the base business revenue reduction was reported in the United States.
For the six-month period, M-I's revenues totaled $798.3 million, a two percent
increase over the amounts reported in the first half of 2001. Excluding the
impact of acquisitions, revenues declined seven percent reflecting the reduction
in North American activity levels which declined 32 percent between the
corresponding periods. M-I Fluids' significant exposure to the U.S. deepwater
market, which is more revenue-intensive and less susceptible to short-term
variations in energy prices, accounts for the favorable comparison between base
business revenues and the change in rig count for both periods presented.
Smith Bits manufactures and sells three-cone and diamond drill bits
primarily for use in the oil and gas industry. For the three months ended June
30, 2002, Smith Bits' revenues totaled $77.1 million, 24 percent below the prior
year quarter. Excluding the impact of the mining bit operations, which were
contributed to an unconsolidated joint venture in October 2001, revenues were 21
percent lower than the prior year period. On a geographic basis, the quarterly
revenue reduction was reported in the United States and Latin America, as
reduced drilling activity led to lower demand for petroleum three-cone bits. For
the six-month period, Smith Bits reported revenues of $166.6 million, a 19
percent decline from the comparable prior year period. After excluding the
impact of the mining bit operations, revenues were 14 percent below the first
half of 2001 and compared favorably to the change in the average rig count
between the corresponding periods. The significant decline in U.S. drilling
activity resulted in lower sales volumes for petroleum three-cone bits,
accounting for the base business revenue variance.
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' second quarter 2002 revenues were $104.9 million, an
increase of 15 percent over the prior year quarter. Incremental revenues from
acquisitions completed in the last half of 2001 accounted for the reported
revenue improvement. Excluding the impact of acquisitions, base business
revenues decreased five percent, reflecting lower demand for drilling-related
products and services in the U.S. market. For the first half of 2002, Smith
Services reported revenues of $211.6 million, an increase of 19 percent over the
comparable prior year period. Excluding the impact of acquisitions, revenues
were relatively flat period-to-period as higher drill pipe sales served to
offset the effect of lower U.S. activity levels on the underlying base business.
Operating Income
Operating income for the Oilfield Products and Services segment
declined $9.5 million from the second quarter of 2001. Excluding the impact of
goodwill amortization recorded in the prior year period, operating income
declined $13.0 million on relatively flat revenues, reflecting a shift in mix
from higher-margin drill bit sales to products with lower comparable margins. On
a year-to-date basis, segment operating income declined $13.9 million from the
amounts reported in the first half of 2001. The impact of goodwill amortization
resulting from the adoption of SFAS No. 142 was offset by the recognition of
$7.0 million in non-recurring charges in the first quarter of 2002, primarily
related to establishing reserves for local Argentina receivables. The majority
of the reduction in operating income from the first half of 2001 relates to the
shift in revenue mix discussed above, which contributed to a one percentage
point deterioration in gross profit margins. To a lesser extent, the recognition
of certain costs to consolidate the manufacturing and engineering operations of
M-I SWACO also contributed to the reduction in operating income on a six-month
basis.
11
Distribution Segment
Revenues
Wilson markets pipe, valve, tool, 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 totaled
$217.4 million in second quarter 2002, a decline of 24 percent from the prior
year quarter. Approximately three-quarters of the revenue decrease relates to
the significant decline in drilling activity in the United States and Canada. To
a lesser extent, the continued weakness in downstream and industrial markets
resulted in a reduction in customer spending levels. In the first six months of
2002, Wilson reported revenues totaling $451.9 million, a decline of 21 percent
from the first half of 2001. The majority of the revenue variance from the prior
year period was reported in the energy branch operations and was split
relatively equally between the United States and Canada. The year-to-date
revenue comparison was impacted, to a lesser extent, by reduced spending for
major maintenance programs and projects by industrial and petrochemical
customers.
Operating Income
Wilson's operating income decreased $7.8 million from the second
quarter of 2001. The variance primarily reflects the effect of lower sales
volumes on gross profit levels, partially offset by a reduction in
variable-based operating expenses associated with the revenue decline. Operating
income, as a percentage of sales, decreased three percentage points from the
second quarter of 2001, as lower sales volumes impacted coverage of fixed sales
and administrative support costs. On a year-to-date basis, segment operating
income declined $14.5 million from the amounts reported in the first six months
of 2001. The decrease in operating income from the first half of 2001 relates to
the impact of the revenue decline on gross profit, partially offset by the
reduction in variable costs associated with the lower volumes. The decrease in
Wilson's overall sales volumes on coverage of sales and administrative support
costs contributed to a three percentage point reduction in operating margins
from the prior year period.
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 June 30, Six Months Ended June 30,
------------------------------------------- -----------------------------------------------
2002 2001 2002 2001
------------------ ------------------ -------------------- -------------------
Amount % Amount % Amount % Amount %
-------- --- -------- --- ---------- --- ---------- ---
Revenues ..................... $801,038 100 $872,389 100 $1,628,415 100 $1,737,700 100
-------- --- -------- --- ---------- --- ---------- ---
Gross profit ................. 236,255 29 258,936 30 477,757 29 505,025 29
Operating expenses ........... 162,375 20 167,588 20 329,429 20 328,091 19
-------- --- -------- --- ---------- --- ---------- ---
Operating income ............. 73,880 9 91,348 10 148,328 9 176,934 10
Interest expense, net ........ 9,892 1 10,738 1 19,908 1 21,081 1
-------- --- -------- --- ---------- --- ---------- ---
Operating income ............. 63,988 8 80,610 9 128,420 8 155,853 9
Income tax provision ......... 19,306 3 26,087 3 38,951 3 50,892 3
-------- --- -------- --- ---------- --- ---------- ---
Income before minority
interests .................. 44,682 5 54,523 6 89,469 5 104,961 6
Minority interests ........... 17,760 2 16,841 2 33,817 2 33,061 2
-------- --- -------- --- ---------- --- ---------- ---
Net income ................... $ 26,922 3 $ 37,682 4 $ 55,652 3 $ 71,900 4
======== === ======== === ========== === ========== ===
12
Consolidated revenues totaled $801.0 million for the three months ended
June 30, 2002, an eight percent decline from the prior year quarter. The revenue
decline related to lower sales volumes in the Company's Distribution operations,
reflecting the impact of lower North American activity levels, as well as
reduced customer spending in the U.S. downstream and industrial markets. The
current year revenues were influenced by the completion of 15 acquisitions in
the last half of 2001. Excluding incremental revenues from acquisitions, base
business revenues fell 14 percent from the prior year quarter as reduced North
American drilling activity impacted demand for the Company's products and
services. Revenues for the first half of 2002 were $1.6 billion, a six percent
decline from the comparable period of the prior year. The revenue reduction was
reported in the Company's Distribution operations, which are concentrated in
North America, and were impacted by the significant decline in drilling activity
in the United States and Canada. Excluding the impact of acquired and divested
operations, revenues were 12 percent below the amounts reported in the first
half of 2001, reflecting the 32 percent reduction in North American drilling
activity between the corresponding periods.
Gross profit equaled $236.3 million, or 29 percent of revenues, in the
second quarter of 2001. Lower sales volumes in the Distribution segment combined
with a shift from higher to lower-margin products in the Oilfield segment
resulted in a $22.7 million decline from amounts reported in the prior year
quarter. Gross profit margins were 20 basis points below the prior year period,
with the product mix shift from Distribution revenues to higher-margin Oilfield
revenues, partially masking the margin deterioration reported in the Oilfield
segment. Gross profit for the six-month period totaled $477.8 million, or 29
percent of revenues. Gross profit margins were comparable with amounts reported
in the first half of 2001, with the lower gross profit levels primarily
attributable to the reduction in Distribution revenues.
Operating expenses decreased $5.2 million, or three percent from the
second quarter of 2001. The majority of the period-to-period expense reduction
relates to the adoption of SFAS No. 142, which resulted in the elimination of
$3.9 million in goodwill amortization. The remainder of the decrease is due to
lower incentive-based requirements and the effect of cost-reduction efforts
initiated in response to activity declines which were, for the most part, offset
by incremental expenses from acquired operations. Operating expenses for the
six-month period increased $1.3 million over prior year amounts, as incremental
expenses related to acquisitions completed in the last half of 2001 more than
offset the reduction in variable-related expenses attributable to lower base
business volumes.
Net interest expense, which represents interest expense less interest
income, totaled $9.9 million for the second quarter of 2002. Net interest
expense decreased $0.8 million from the prior year period as lower interest
rates more than offset the impact of increased floating-rate borrowings, which
were utilized to finance prior year acquisitions. For the six-month period, net
interest expense declined $1.2 million, also attributable to the effect of lower
interest rates on the Company's floating-rate borrowings.
The effective tax rate for the second quarter and six-month periods
approximated 30 percent, which is lower than both the prior year's rate and the
U.S. statutory rate. The effective tax rate 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 tax rate was two percentage points below the prior year periods, which
is related to the higher proportion of U.S. partnership earnings in M-I and the
current year elimination of goodwill amortization, a portion of which was not
deductible for tax purposes.
Minority interests reflect the portion of the results of majority-owned
operations, which are applicable to the minority interest partners. Minority
interests increased $0.9 million over the prior year quarter and were $0.8
million above the amounts reported in the first half of 2001. The variance in
both periods is related to the acquisition of a majority interest in United
Engineering Services, which occurred in the fourth quarter of 2001.
13
LIQUIDITY AND CAPITAL RESOURCES
General
At June 30, 2002, cash and cash equivalents totaled $46.0 million. Cash
flows provided by operations totaled $113.0 million in the first half of 2002
compared to $51.3 million in the prior year period. The improvement in operating
cash flow is attributable to the significant decline in North American drilling
activity, which favorably impacted working capital levels, particularly the
required investment in accounts receivable and product inventory.
Cash flows used in investing activities in the first six months of 2002
totaled $45.0 million, which primarily consisted of investments in property,
plant and equipment, net of cash proceeds arising from certain asset disposals.
This compares to cash used for investing activities of $95.3 million in the
first half of 2001, with the difference primarily attributable to the lower
level of acquisition activity during the current year period. Net capital
expenditures decreased year-over-year as lower drilling activity has led to a
reduction in discretionary capital spending.
In the first half of 2002, cash generated from operations exceeded cash
used in investing activities, resulting in a $53.7 million reduction in
outstanding debt levels. Cash flows used in financing activities, which totaled
$67.0 million for the six months ended June 30, 2002, were also impacted by cash
distributions to a minority partner which totaled $15.6 million during the
period.
The Company's primary internal source of liquidity is cash flow
generated from operations. Cash flow generated by 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. Subsequent to June 30, 2002, the Company replaced its
$200.0 million revolving credit facilities, which were due to expire in December
2002, with a three-year, $400.0 million facility provided by a syndicate of nine
financial institutions. As of June 30, 2002, after taking into consideration the
current facility in place, the Company had $335.5 million of funds available
under U.S. revolving credit facilities to fund future operating or investing
needs of its worldwide operations. The Company also has revolving credit
facilities in place outside the United States, which are generally used to
finance local operating needs. At June 30, 2002, borrowing capacity of $46.1
million was available under the non-U.S. borrowing facilities.
External sources of liquidity include debt and equity financing in the
public capital markets, if needed. Management 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.
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.
Contingencies
The Company is a party to various legal and environmental matters
arising in the ordinary course of business. In the opinion of management, after
considering established reserves and contractual indemnifications obtained,
these matters are not expected to have a material adverse effect on the
Company's consolidated financial position or results of operations. In the
unlikely event that the parties providing the environmental indemnifications do
not fulfill their obligations, such event could result in the recognition of up
to $25.0 million related to indemnified liabilities, potentially impacting
earnings and cash flows in future periods.
14
Critical Accounting Policies and Estimates
The discussion and analysis of financial condition and results of
operations are based upon the Company's consolidated 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 on-going
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 2001
Annual Report on Form 10-K, the Company has described the critical accounting
policies that require management's most significant judgements and estimates.
There have been no material changes in these critical accounting policies.
Recent Accounting Pronouncements
In July 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 146, "Accounting for
Costs Associated with Exit or Disposal Activities," which is effective for
fiscal periods after December 31, 2002. SFAS No. 146 requires companies to
recognize costs associated with restructurings, discontinued operations, plant
closings, or other exit or disposal activities, when incurred rather than at the
date a plan is committed to. The Company plans to adopt the standard as of the
effective date and will implement its provisions on a prospective basis.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." SFAS No. 145 eliminates SFAS No. 4 and as a result, gains and
losses from extinguishment of debt should be classified as extraordinary items
only if they meet the criteria in APB Opinion No. 30. SFAS No. 145 amends SFAS
No. 13, "Accounting for Leases," to eliminate an inconsistency between the
required accounting for sale-leaseback transactions and the required accounting
for certain lease modifications that have economic effects that are similar to
sale-leaseback transactions. SFAS No. 145 also updates and amends existing
authoritative pronouncements to make various technical corrections, clarify
meanings, or describe their applicability under changed conditions. The Company
does not expect that the adoption of SFAS No. 145 will have a material impact on
its consolidated 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.
On January 1, 2002, the Company adopted SFAS No. 144, "Accounting for
the Impairment or Disposal of Long-Lived Assets." The adoption of SFAS No. 144
did not impact the Company's financial position or results of operations.
The Company has also adopted SFAS No. 142, "Goodwill and Other
Intangible Assets," which addresses financial accounting and reporting for
goodwill and other intangible assets. Effective January 1, 2002, goodwill and
certain intangibles are no longer amortized to earnings but are tested for
impairment under SFAS No. 142. During the first quarter of 2002, the Company
completed the transitional impairment test required by the standard, the results
of which did not impact the Company's financial position or results of
operations. The accompanying Consolidated Statements of Operations provide
relevant disclosures related to recorded goodwill amortization and the
after-tax impact which would have resulted from the adoption of SFAS No. 142
as of January 1, 2001.
15
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.
16
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
At the Annual Meeting of Stockholders on April 24, 2002, stockholders
of the Company elected all nominated directors and approved an amendment to the
Smith International, Inc. 1989 Long-Term Incentive Compensation Plan by the
votes shown below.
For Withheld Abstain
---------- -------- -------
Election of directors:
G. Clyde Buck ........... 42,443,568 3,472 215,818
Loren K. Carroll ........ 42,443,219 3,821 216,167
Wallace S. Wilson ....... 42,437,285 9,755 222,101
For Against Abstain
---------- --------- -------
Approval of an amendment to the
Smith International, Inc. 1989 Long-Term
Incentive Compensation Plan...................... 30,716,189 6,648,147 31,532
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit 99.1 Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
filed herewith.
Exhibit 99.2 Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
filed herewith.
(b) Reports on Form 8-K
The Registrant filed reports on Form 8-K during the quarterly period
ended June 30, 2002. All filings were reported under "Item 5. Other
Events" and disclosed the following:
1. Form 8-K dated April 4, 2002 relating to a press release
commenting on first quarter 2002 outlook and earnings release and
conference call information.
2. Form 8-K dated April 15, 2002 relating to changes in registrant's
certifying accountant.
3. Form 8-K dated May 2, 2002 relating to a press release announcing
the Company's results for the first quarter of 2002.
4. Form 8-K dated June 6, 2002 relating to a press release announcing
a 2-for-1 common stock split to be effected in the form of a stock
dividend.
5. Form 8-K dated June 24, 2002 relating to a certificate of adjusted
purchase price or number of shares dated June 21, 2002.
17
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: August 13, 2002 By: /s/ Douglas L. Rock
---------------- -----------------------------------------------
Douglas L. Rock
Chairman of the Board, Chief Executive
Officer, President and Chief Operating Officer
Date: August 13, 2002 By: /s/ Margaret K. Dorman
---------------- -----------------------------------------------
Margaret K. Dorman
Senior Vice President,
Chief Financial Officer and Treasurer
(Principal Accounting Officer)
18
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
Exhibit 99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
filed herewith.
Exhibit 99.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
filed herewith.
19