<PAGE>
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, 1998
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 1-8158
VARCO INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)
California 95-0472620
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
743 North Eckhoff Street, Orange, Ca 92868
(Address of principal executive offices)
(Zip code)
(714) 978-1900
(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
---- ----
64,636,094
(Number of shares of Common Stock outstanding at October 31, 1998)
<PAGE>
PART I-FINANCIAL INFORMATION
Item 1. Financial Statements.
Pursuant to General Instruction D to Form 10-Q, the Condensed
Consolidated Statements of Cash Flows, Condensed Consolidated Balance Sheets and
Condensed Consolidated Statements of Income of Varco International, Inc., (the
"Company") and its subsidiaries included in the registrant's Third Quarter
Report to Shareholders for the three months ended September 30, 1998, filed as
Exhibit 19 hereto are incorporated herein by reference. Such financial
statements should be read in light of the following:
Adjustments. The financial statements contained in Exhibit 19 hereto
include all adjustments which in the opinion of management are of a normal
recurring nature, considered necessary to present fairly the results of
operations for the interim periods presented.
Basic net income per share is based upon an average of 64,475,227 and
63,772,226 shares outstanding for the three months ended September 30, 1998, and
1997 respectively. Diluted net income per share is based upon an average of
65,484,416 and 65,294,778 shares outstanding for the three months ended
September 30, 1998, and 1997 respectively.
Basic net income per share is based upon an average of 64,387,168 and
63,502,903 shares outstanding for the nine months ended September 30, 1998, and
1997 respectively. Diluted net income per share is based upon an average of
65,396,357 and 65,025,455 shares outstanding for the nine months ended September
30, 1998, and 1997 respectively.
Inventories. The Company estimates the components of inventory at
September 30, 1998, and December 31, 1997, to be as follows:
<TABLE>
<CAPTION>
September 30, 1998 December 31, 1997
<S> <C> <C>
Raw Materials $ 6,891,000 $ 6,118,000
Work in Process 50,441,000 43,495,000
Finished Goods 127,463,000 95,063,000
LIFO Reserves (13,038,000) (12,705,000)
------------ ------------
$171,757,000 $131,971,000
============ ============
</TABLE>
Fixed Assets. Fixed assets are stated net of accumulated depreciation
of $73,637,000 at September 30, 1998, and $62,469,000 at December 31, 1997.
Common Stock and Additional Paid-In-Capital. On September 30, 1998,
the Company Common Stock account was $54,845,000 and Additional Paid-In-Capital
accounts were $99,814,000.
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Pursuant to General Instruction D to Form 10-Q, Management's
Discussion and Analysis of Financial Condition and Results of Operations
contained in the registrant's Third Quarter Report to Shareholders for the three
months ended September 30, 1998, filed as Exhibit 19 hereto, is incorporated
herein by reference.
PART II-OTHER INFORMATION
Item 2. Changes in Securities
In July 1992 the Company sold $50.0 million aggregate principal amount of its
8.95% Senior Notes Due June 30, 1999 (the "Senior Notes") to a group of ten
institutional investors pursuant to a Note Agreement dated as of July 1, 1992
(as amended, the "Note Agreement"). The remaining $10.0 million principal
balance of the Senior Notes is payable on June 30, 1999.
The Note Agreement prohibits any "Restricted Payment" subsequent to July 17,
1992 unless after giving effect thereto, (i) the aggregate amount of all
Restricted Payments subsequent to such date would not exceed $5,000,000 plus the
cumulative sum of 50% of the Company's consolidated net income (or minus 100% in
the case of a deficit) subsequent to March 31, 1992 and (ii) the Company could
incur at least $1.00 of additional indebtedness under the Note Agreement
covenant limiting indebtedness. The term "Restricted Payment" includes (a) any
dividend (other than dividends payable in shares of capital stock) or other
distributions on any shares of capital stock of the Company; (b) any purchase,
redemption or other acquisition of any shares of the capital stock of the
Company or any rights or options to purchase or acquire such shares; and (c) any
"Restricted Investment", which is generally defined as any investment other than
an investment in a subsidiary of the Company or an investment in certain
designated government or rated securities. In addition, the Company may
purchase, redeem or otherwise acquire shares of its capital stock or make
Restricted Investments from the net cash proceeds of the substantially
concurrent sales of shares of capital stock or from the sale of securities
convertible into such shares upon conversion.
On June 27, 1997 the Company entered into a seven-year unsecured revolving
credit agreement with three banks (the "Credit Agreement"). The Credit Agreement
provides for a credit facility of $65.0 million, inclusive of a $20.0 million
letter of credit sub-facility. The maximum available under the Credit Agreement
is reduced in equal quarterly amounts over the last four years of the Credit
Agreement.
The Credit Agreement prohibits any "Restricted Junior Payment" unless (1) at the
time thereof no default exists under the Credit Agreement or will be caused
thereby and (2) the cumulative amount of all Restricted Junior Payments
subsequent to June 27, 1997, would not exceed the sum of $5,000,000 plus 25% of
the Company's consolidated net income arising after June 30, 1997. "Restricted
Junior Payment" is generally defined as (1) any dividend or other distribution
on any class of the Company's capital stock, except a dividend payable solely in
shares of that class; (2) any redemption, purchase or other acquisition for
value of any shares of any class of the capital stock of the Company; (3) any
payment made to retire or obtain the surrender of any outstanding
<PAGE>
warrants, options or similar rights to acquire any shares of any class of the
capital stock of the Company; and (4) any payment on the Senior Notes other than
regularly scheduled payments of principal and interest thereon.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
11 Statement re computation of per share earnings for the three months
and nine months ended September 30, 1998 and 1997.
19 Varco International, Inc. Third Quarter Report to Shareholders, Three
Months Ended September 30, 1998.
27 Financial Data Schedule
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the quarter for which this
report is filed.
<PAGE>
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.
VARCO INTERNATIONAL, INC.
Date: November 11, 1998 By: /s/ Richard A. Kertson
---------------------------
Vice President-Finance
and Chief Financial Officer
Date: November 11, 1998 By: /s/ Donald L. Stichler
---------------------------
Vice President,
Controller-Treasurer
and Secretary
<PAGE>
EXHIBIT INDEX
11 Statement re computation of per share earnings for the three months and nine
months ended September 30, 1998 and 1997.
19 Varco International, Inc. Third Quarter Report to Shareholders, Three Months
Ended September 30, 1998.
27 Financial Data Schedule
<PAGE>
VARCO INTERNATIONAL, INC.
Statement Re Computation of Per Share Earnings Exhibit 11
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, 1998 September 30, 1998
--------------------------------------
A. CALCULATION OF ADJUSTED EARNINGS
<S> <C> <C>
Net Income After Tax $14,964,000 $49,678,000
<CAPTION>
Total Number Average Number Stock Option Shares Used
Number of of Shares after of Shares Equivalent To Calculate
Days Weighing Outstanding Shares Diluted EPS
-----------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
B. CALCULATION OF AVERAGE SHARES OUTSTANDING
Common Stock Outstanding from time-to-time during:
Three Months Ended September 30, 1998 92 5,931,720,895 64,475,227 1,009,189 65,484,416
Nine Months Ended September 30, 1998 273 17,577,696,988 64,387,168 1,009,189 65,396,357
</TABLE>
C. CALCULATION OF EARNINGS PER SHARE
Income Per Share = Net Income After Tax
------------------------
Total Shares Outstanding
Diluted Income Per Share =
Three Months Ended September 30, 1998 14,964,000 = $0.23
----------
65,484,416
Nine Months Ended September 30, 1998 49,678,000 = $0.76
----------
65,396,357
Basic Income Per Share
Three Months Ended September 30, 1998 14,964,000 = $0.23
----------
64,475,227
Nine Months Ended September 30, 1998 49,678,000 = $0.77
----------
64,387,168
<PAGE>
VARCO INTERNATIONAL, INC.
Statement Re Computation of Per Share Earnings
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, 1997 September 30, 1997
---------------------------------------
A. CALCULATION OF ADJUSTED EARNINGS
<S> <C> <C>
Net Income After Tax $13,401,000 $31,555,000
<CAPTION>
Total Number Average Number Stock Option Shares Used
Number of of Shares after of Shares Equivalent To Calculate
Days Weighing Outstanding Shares Diluted EPS
-------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
B. CALCULATION OF AVERAGE SHARES OUTSTANDING
Common Stock Outstanding from time-to-time during:
Three Months Ended September 30, 1997 92 5,867,044,764 63,772,226 1,522,552 65,294,778
Nine Months Ended September 30, 1997 273 17,336,292,640 63,502,903 1,522,552 65,025,455
</TABLE>
C. CALCULATION OF EARNINGS PER SHARE
Income Per Share = Net Income After Tax
------------------------
Total Shares Outstanding
Diluted Income Per Share =
Three Months Ended September 30, 1997 13,401,000 = $0.21
----------
65,294,778
Nine Months Ended September 30, 1997 31,555,000 = $0.49
----------
65,025,455
Basic Income Per Share
Three Months Ended September 30, 1997 13,401,000 = $0.21
----------
63,772,226
Nine Months Ended September 30, 1997 31,555,000 = $0.50
----------
63,502,903
<PAGE>
EXHIBIT 19
VARCO International, Inc.
1998 Third Quarter Report
Varco
<PAGE>
TO OUR SHAREHOLDERS
The impact of low oil prices on our industry is becoming increasingly severe. A
year ago oil prices were a little over $20 per barrel, while today they are
about $14. As a result, oil companies are cutting their exploration and
production spending and drilling activity is declining. During September of
last year there were 2,210 rigs drilling worldwide; for the same month this year
there were 1,693, a decline of 23 per cent. Although offshore drilling has
not fallen as sharply, (there were 567 rigs under contract in September of this
year versus 606 a year ago), rigs have been re-employed at lower day rates as
contracts have expired.
The most immediate effect of these conditions on Varco is reflected in
incoming orders. For the most recent three months, order receipts totaled
$146.7 million (less cancellations of $50.5 million for a net total of $96.2
million), versus $266.5 million in the third quarter of 1997 and $193.6 million
in the second quarter of this year. Over the past several quarters we have
indicated that the most influential factor in our growth has been orders for
equipment to be installed on new offshore rigs, particularly those capable of
drilling in deep water. Conversely, the recent decline in orders has resulted
primarily from the absence of commitments for new rig construction, as oil
companies have reduced budgets and become less concerned about rig availability.
However, our backlog remains strong -- $502 million at September 30, nearly
all of which is deliverable over the next 5 quarters. As a result, we
anticipate that revenues will exceed incoming orders over that period as the
backlog is worked down. Therefore, if industry conditions remain weak through
next year, we will not experience their full impact until late 1999.
Revenues for the third quarter continued to demonstrate substantial year-to-
year growth, totaling $190.9 million versus $140.4 million for the third quarter
of last year. Although Net Income of $15.0 million, $.23 per share, was higher
than the $13.4 million, $.21 per share, for the third quarter of 1997, our
Operating Profit (Earnings Before Interest and Taxes) margin was lower. In the
most recent quarter, profit margins were negatively impacted mainly by:
increased manufacturing costs resulting from inefficiencies related to the rapid
growth of the past several quarters; low margins on two recently introduced new
products; and the decline in high margin rental revenue as drilling activity has
fallen. Some of these factors are primarily related to market conditions and
others are more susceptible to our control. We are optimistic that we can
demonstrate improvement on those in the latter category.
Our primary challenge over the next several quarters remains the on-time
delivery and installation of equipment on the offshore rigs currently under
construction, and the continuing field support of that equipment as the rigs are
placed in operation. We are the major supplier of drilling equipment for these
new generation rigs, and we believe that as they demonstrate the advantages of
this new technology, our opportunities to upgrade existing rigs will be
enhanced.
The softer industry outlook which has unfolded over the course of the year has
surprised virtually all industry analysts and is a disappointment to us. While
many of these analysts believe the downturn will be relatively short lived and
we are hopeful that will be the case, we have learned that forecasting is all
but impossible in our industry. However, we have been successful in difficult
markets before and we will continue to follow those strategies which have served
us well in the past.
We appreciate your continued support.
/s/ GEORGE I. BOYADJIEFF
- ------------------------
George I. Boyadjieff
Chairman and
Chief Executive Officer
November 11, 1998
<PAGE>
Condensed Consolidated Balance Sheets
(unaudited)
<TABLE>
<CAPTION>
September 30, December 31,
(in thousands) 1998 1997
- -----------------------------------------------------------------------
<S> <C> <C>
Current Assets
Cash and cash equivalents $ 29,748 $ 39,827
Receivables (net) 166,245 142,324
Inventories 171,757 131,971
Other 21,474 17,396
- -----------------------------------------------------------------------
Total Current Assets 389,224 331,518
Property, plant and equipment at cost
less accumulated depreciation 89,073 73,862
Rental equipment less accumulated
depreciation 13,853 18,213
Cost in excess of net assets acquired 33,895 34,609
Other assets 16,755 12,927
- -----------------------------------------------------------------------
Total Assets $542,800 $471,129
=======================================================================
Current Liabilities
Accounts payable $ 49,102 $ 53,394
Customer deposits 106,160 79,068
Other liabilities 57,278 52,905
Current portion of long-term debt 9,922 10,000
- -----------------------------------------------------------------------
Total Current Liabilities 222,462 195,367
Long-term debt 9,520
Other non-current liabilities 13,776 13,043
- -----------------------------------------------------------------------
Total Liabilities 236,238 217,930
Shareholders' Equity
Common Stock and additional
paid-in capital 154,659 151,222
Retained earnings 151,903 101,977
- -----------------------------------------------------------------------
Total Shareholders' Equity 306,562 253,199
- -----------------------------------------------------------------------
Total Liabilities and
Shareholders' Equity $542,800 $471,129
=======================================================================
</TABLE>
Varco International, Inc. and Subsidiaries
<PAGE>
Condensed Consolidated Statements of Cash Flows
(unaudited)
<TABLE>
<CAPTION>
Nine Months Ended September 30,
(in thousands) 1998 1997
- ----------------------------------------------------------------------
<S> <C> <C>
Operating Activities
Net income $ 49,678 $ 31,557
Depreciation and amortization 16,058 12,187
Increase (decrease) in operating
cash flows:
Receivables (23,921) (34,151)
Inventories (39,786) (31,236)
Additions to rental equipment (2,279) (7,631)
Transfers from rental equipment 2,457
Accounts payable (4,292) 10,055
Customer deposits 27,092 67,222
Taxes payable 1,024 759
Other (2,464) 7,568
- ----------------------------------------------------------------------
Net cash from operating activities 23,567 56,330
- ----------------------------------------------------------------------
Investing Activities
Property plant and
equipment purchases (25,779) (20,097)
Proceeds from equipment sales 245 1,227
- ----------------------------------------------------------------------
Net cash (used in) investing activities (25,534) (18,870)
- ----------------------------------------------------------------------
Financing Activities
Decrease in long-term debt (10,000) (10,000)
Increase in long-term debt 17,000
Proceeds from issuance of
Common Stock 1,888 2,725
Deferred issue costs (347)
- ----------------------------------------------------------------------
Net cash from (used in) financing activities (8,112) 9,378
- ----------------------------------------------------------------------
Net change in cash and cash equivalents (10,079) 46,838
- ----------------------------------------------------------------------
Cash and cash equivalents at
beginning of year 39,827 5,794
- ----------------------------------------------------------------------
Cash and cash equivalents at
end of quarter $ 29,748 $ 52,632
======================================================================
</TABLE>
Varco International, Inc. and Subsidiaries
<PAGE>
Condensed Consolidated Statements of Income
(unaudited)
<TABLE>
<CAPTION>
(in thousands, Three Months Ended September 30, Nine Months Ended September 30,
except per share data) 1998 1997 1998 1997
- ----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues
Net sales $182,464 $128,607 $509,259 $338,382
Rental income 8,169 11,644 28,091 32,405
Other income 271 157 956 326
- ----------------------------------------------------------------------------------------------
190,904 140,408 538,306 371,113
- ----------------------------------------------------------------------------------------------
Costs and Expenses
Cost of sales 128,329 84,815 346,733 229,919
Cost of rental income 2,859 3,369 9,164 9,544
Selling, general and
administrative
expenses 27,549 24,899 80,491 65,081
Research and
development costs 9,208 5,524 25,116 14,560
Interest expense 385 990 1,471 3,099
- ----------------------------------------------------------------------------------------------
168,330 119,597 462,975 322,203
- ----------------------------------------------------------------------------------------------
Income before income taxes 22,574 20,811 75,331 48,910
Provision for income taxes 7,610 7,410 25,653 17,355
- ----------------------------------------------------------------------------------------------
Net income $ 14,964 $ 13,401 $ 49,678 $ 31,555
==============================================================================================
Basic income per share $ .23 $ .21 $ .77 $ .50
==============================================================================================
Shares used in basic income
per share calculation 64,475 63,772 64,387 63,503
============================================================================================
Diluted income per share $ .23 $ .21 $ .76 $ .49
============================================================================================
Shares used in diluted income
per share calculation 65,484 65,295 65,396 65,025
============================================================================================
</TABLE>
Note: These statements are condensed and do not contain disclosures required by
generally accepted accounting principles. Reference should be made to the
financial statements contained in the Annual Report to Shareholders for the year
ended December 31, 1997.
Varco International, Inc. and Subsidiaries
<PAGE>
Management's Discussion and Analysis of Financial Condition and Results of
Operations
General Industry Conditions
The business of the Company depends primarily upon the level of worldwide
drilling activity, particularly offshore drilling activity. The level of
drilling activity can be influenced by numerous factors, including economic and
political conditions, the prices of oil and gas, finding and development costs
of oil companies, development of alternative energy sources, availability of
equipment and materials, availability of new onshore and offshore acreage or
concessions, and new and continued governmental regulations regarding
environmental protection, taxation, price controls and product allocations.
Since November of 1997 the price of oil has declined significantly. For the
three quarters ended September 30, 1998, the price of oil (West Texas
Intermediate at Cushing Price) has averaged approximately $15.98, $14.73 and
$13.85 per barrel, respectively, as compared to an average of $20.62 per barrel
for the full year 1997. At the beginning of November 1998, the price of oil was
approximately $14.15 per barrel. These lower prices have resulted in lower cash
flows and curtailed exploration and production spending for oil companies and
lower rig day rates and cash flows for drilling contractors, the Company's
customers.
Worldwide drilling activity, as measured by the average number of active
drilling rigs, decreased approximately 21% in the third quarter of 1998 to an
average of approximately 1,727 from an average of approximately 2,198 during the
same period in 1997. North American drilling activity decreased approximately
24% as compared to last year. International drilling activity was not impacted
as much as North America drilling activity. International activity decreased
approximately 10% to an average of approximately 728 rigs as compared to 809 in
the third quarter of 1997.
Offshore drilling activity has not declined as much as the overall rig count,
as reflected by rig utilization (mobile offshore rigs under contract as a
percent of available rigs). For September of 1998, utilization averaged 88%, as
compared to 95% in September of 1997. More recently, offshore drilling activity
has shown some signs of weakening. Along with the decline in rig utilization,
rig day rates have fallen below the peak rates which prevailed in the first half
of 1998.
Results of Operations
Set forth below are the net orders and revenues for the Company's five operating
Divisions:
<TABLE>
<CAPTION>
Three Months Ended September 30, Nine Months Ended September 30,
1998 1997 1998 1997
- --------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net Orders
Varco Systems $ 45,704 $ 81,976 $224,106 $174,260
VarcoBJ 21,200 24,024 78,908 70,999
M/D Totco 23,277 23,649 92,429 69,858
Shaffer 49,880 128,190 226,902 247,883
Rigtech 6,601 8,613 17,412 16,473
Cancellations (50,510) (63,510)
- --------------------------------------------------------------------------------------
Total $ 96,152 $266,452 $576,247 $579,473
======================================================================================
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Three Months Ended September 30, Nine Months Ended September 30,
1998 1997 1998 1997
- --------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues
Varco Systems $ 63,013 $ 45,158 $186,819 $110,255
VarcoBJ 23,286 17,832 67,210 45,763
M/D Totco 28,336 23,061 75,182 62,060
Shaffer 71,907 52,119 190,869 146,504
Rigtech 4,091 2,081 17,270 6,205
- --------------------------------------------------------------------------------------
Total $190,633 $140,251 $537,350 $370,787
======================================================================================
</TABLE>
The decline in order bookings in the third quarter of 1998 as compared to the
same period of 1997 is primarily the result of a significant reduction in orders
associated with upgrading and construction of offshore drilling rigs. The
relatively large dollar value of such orders which is attributable to the Varco
Systems and Shaffer Divisions accounts for the greater year-to-year decline in
these Divisions.
The Company's increased revenue levels in the 1998 periods as compared to 1997
are generally due to the shipment of equipment associated with the upgrading and
construction of offshore drilling rigs, particularly floating rigs that are
capable of drilling in water depths exceeding 3,000 feet. Each such rig
creates significant potential for the high dollar value products provided by the
Shaffer and Varco Systems Divisions as well as the products of the other
Divisions.
On August 6, 1998 a customer announced that it was terminating the
construction of a deep water drillship and had reached agreement with the oil
company for cancellation of its five-year drilling contract. As a result, the
customer cancelled orders totaling approximately $38.3 million. In addition the
Company experienced other cancellations totaling approximately $12.2 million.
Of the total cancellations approximately $25.9 million were incurred by Varco
Systems; $14.5 million by Shaffer; and the balance was distributed among the
remaining Divisions. As a result of low oil prices and the downturn in drilling
activity, the Company anticipates that it will experience additional
cancellations. While the Company cannot predict the potential dollar value of
any such cancellations, it does not expect that the cancellation rate will
increase.
At September 30, 1998 the Company's backlog of unshipped orders was
approximately $501.8 million as compared to $462.9 million at December 31, 1997
and $395.6 million at September 30, 1997. Orders for new rigs and major upgrades
generally include the Company's longer lead-time products. The Company expects
that most of the September 30, 1998 backlog will be shipped by the end of 1999.
At September 30, 1998 the Company had received $106.2 million in customer cash
deposits related to orders currently included in backlog. In accordance with
industry practice, orders and commitments generally are cancelable by customers
at any time.
Gross margins (net sales and rental income less costs of sales and rental
income) as a percentage of net sales and rental income decreased year-over-year.
For the third quarter of 1998 gross margins were 31.2%, compared to 37.1% for
the same period in 1997 and they were 33.7% and 35.4% in the first nine months
of 1998 and 1997, respectively. Third quarter 1998
<PAGE>
gross margins were negatively impacted by high initial cost and retrofit cost on
newer products at Shaffer and M/D Totco; higher manufacturing costs and
increased manufacturing inefficiencies; and to the decline in rental income
which carries a higher gross margin than other revenues. New products and
retrofit costs accounted for approximately half of the year-over-year decline
and higher manufacturing costs and lower rental income each accounted for
approximately one quarter of the shortfall. The lower 1998 nine-month margins
reflect the impact of the third quarter declines.
The Company believes that new product development is a significant factor for
the future of the Company. During the first nine months of 1998 the Company
spent $25.1 million or 4.7% of revenues on new product development. This
compares to $14.6 million or 3.9% of revenues during the same period in 1997.
The Company expects to maintain research and development costs between four and
five percent of revenues.
The increase in selling, general and administrative expenses compared to 1997
is primarily a result of activity related to the increased revenues. As a
percent of revenues, selling, general and administrative expenses are down year-
to-year. For the first nine months of 1998 this percent was 15.0% and it was
14.4% for the third quarter of 1998. As a percent of revenues, selling, general
and administrative expenses were 17.5% and 17.7% for the first nine months and
third quarter of 1997, respectively.
Overall Company employment at September 30, 1998 was 3,232 (including 316
temporary employees) which compares to 2,594 (including 369 temporary employees)
a year ago. The September 1998 employment level is down from the June 30, 1998
level of 3,340, primarily at the M/D Totco Division and related to the decline
in the rental business.
The effective tax rate for the first nine months of 1998 was 34.1% as compared
to 35.5% for the first nine months of 1997. The lower effective tax rate in 1998
is due to the elimination in 1998 of the Company's valuation allowance on
deferred tax assets. The Company now believes that it is more likely than not
that all of its deferred tax assets will be realized.
Liquidity and Capital Resources
September 30, 1998 cash and cash equivalents were $29.7 million as compared to
the December 31, 1997 balance of $39.8 million. This decline was due to
increased working capital requirements during the first half of 1998 and to the
June 30, 1998 Senior Note payment.
In July 1992 the Company sold $50.0 million aggregate principal amount of its
8.95% Senior Notes Due June 30, 1999 (the "Senior Notes") to a group of ten
institutional investors pursuant to a Note Agreement dated as of July 1, 1992
(the "Note Agreement"). The remaining $10.0 million principal balance of the
Senior Notes is payable June 30, 1999.
On June 27, 1997 the Company entered into a seven-year unsecured revolving
credit agreement with three banks (the "Credit Agreement"). The Credit Agreement
provides for a credit facility of $65.0 million, inclusive of a $20.0 million
letter of credit sub-facility. The maximum available under the Credit Agreement
is reduced in equal quarterly amounts over the last four years of the Credit
Agreement. At September 30, 1998 there were no advances and $4.7 million in
letters of credit outstanding under this facility. Both the Note Agreement and
the Credit Agreement restrict the payment of dividends (other than dividends
payable solely in shares of Common Stock) on, and repurchases of, Common Stock.
Under the terms of the Credit
<PAGE>
Agreement, which is generally the more restrictive of these, the amount
available for the payment of dividends on, and repurchases of, Common Stock is
limited to $5.0 million plus 25% of the Company's consolidated net income
arising after September 30, 1997, computed on a cumulative basis.
On November 6, 1997 the Board of Directors of the Company declared a two-for-
one stock split of its Common Stock, payable in the form of a 100% stock
dividend on December 4, 1997 to shareholders of record at the close of business
on November 20, 1997.
At September 30, 1998 the Company's working capital was $166.8 million as
compared to $136.2 million at December 31, 1997 and its current ratio was 1.75
to 1.0 as compared to 1.70 to 1.0 at December 31, 1997. The preceding changes
are primarily due to an increase in inventory and receivables during the first
nine months of 1998. The Company's capital expenditures during the first nine
months of 1998 were $25.8 million as compared to $20.1 million for the first
nine months of 1997. The Company's current plans for capital expenditures in the
next fifteen months are approximately $25.0 to $30.0 million. Such amounts
include any capitalizable costs associated with the Year 2000 Issue. The Company
anticipates that its September 30, 1998 cash and cash equivalents and its
existing credit facility will be sufficient to meet its capital expenditures and
operating cash needs and the principal payment on the Senior Notes in 1999.
Year 2000 Compliance
The Year 2000 Issue is the result of computer programs that use only two digits
to identify a year rather than four. If not corrected, computer applications
could fail or create erroneous results before, during and after the Year 2000.
The Company is continuing to assess the impact that the Year 2000 Issue may
have on its information technology ("IT") systems and its operations and has
identified the following four key areas of its business that may be affected:
Products. The Company has developed detailed testing procedures for each of
its products that have a date reference. Compliance testing of the Company's
products, in accordance with these procedures, is approximately 75% complete
with all products expected to be completely tested by December 31, 1998. The
most extensive testing is in the M/D Totco Division, which develops software for
control systems and drilling applications. Based upon the evaluation and
testing completed, the Company believes that its currently supported products,
as opposed to discontinued and obsolete products, are Year 2000 compliant.
The Company has mailed to its customers a list of compliant products and has
advised customers which products needed to be upgraded or replaced for Year 2000
compliance.
Internal Business Systems. The Year 2000 Issue could affect the systems,
transaction processing, computer applications and devices used by the Company to
operate and monitor all major aspects of its business, including financial
systems, customer services, materials requirement planning, master production
scheduling, networks and telecommunications systems. The Company has completed
its assessment phase and believes that is has identified substantially all of
the major systems,
<PAGE>
software applications and related equipment used in connection with its internal
operations that must be modified or upgraded in order to minimize the
possibility of a material disruption to its business. The Company is currently
in its remediation phase of modifying and upgrading all affected systems and
expects to complete this phase by the beginning of the third quarter of 1999.
The Company estimates that it will be Year 2000 compliant by the end of the
third quarter of 1999. However, any unforeseen problems which occur during the
testing phase may adversely effect the Company's Year 2000 readiness.
Third-Party Suppliers and Customers. The Company relies directly and
indirectly, on external systems utilized by its suppliers for products used in
the manufacture of its products. The Company has recently requested
confirmation from its suppliers of their Year 2000 compliance. The Company has
received replies from approximately 10% to 15% of its suppliers. Although these
responses indicate that Year 2000 compliance will be achieved, there can be no
assurance that suppliers will resolve all Year 2000 Issues with their systems in
a timely manner. Any failure of third parties to resolve their Year 2000 Issues
in a timely manner could result in the material disruption of the business of
the Company. Any such disruption could have an adverse effect on the Company's
operations.
The Company does not intend to canvas its customer to insure that customers
are Year 2000 compliant. While the Company does not believe that non-compliance
by our customers would significantly impact their ability to continue their
drilling operations and their ability to purchase drilling equipment, any
disruption to the drilling process caused by non-compliance could negatively
impact the Company's revenues.
Facility Systems. Facility systems such as manufacturing equipment, heating,
sprinklers, test equipment and security systems may also be affected by the Year
2000 Issue. The Company has recently commenced an assessment of the impact of
all such systems on its facilities and does not anticipate any material impact
on the Company's operations.
The Company does not separately track internal cost incurred on the Year 2000
Issue. The Company has estimated that approximately 15% to 20% of its IT
personnel's time is spent on the Year 2000 issue. As of September 30, 1998 no
significant amounts have been accrued or paid to third parties relating to this
issue. The Company has estimated that approximately $3 to $4 million will be
paid, over the next 9 to 12 months to third parties for software, hardware and
consultation.
The Company recognizes the need for developing contingency plans to address
the Year 2000 issues that may pose a significant risk to its on-going
operations. Such plans could include the implementation of manual procedures to
compensate for system deficiencies. During the remediation phase of the
internal business systems, the Company will be evaluating potential failures and
attempt to develop responses in a timely manner. However, there can be no
assurance that any contingency plans evaluated and potentially implemented by
the Company would be adequate to meet the Company's needs without materially
impacting its operations, that any such plan would be successful or that the
Company's results of operations would not be materially and adversely affected
by the delays and inefficiencies inherent in conducting operations in an
alternative manner.
<PAGE>
Cautionary Statement Pursuant to the Private Securities Litigation Reform Act
of 1995
In accordance with the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995, the Company notes that the statements in this
Quarterly Report, which are forward-looking and which provide other than
historical information, involve risks and uncertainties that may impact the
Company's results of operations. These forward-looking statements include, among
others, statements concerning the Company's general business strategies,
customer orders and cancellations, backlog, operating trends, industry trends,
manufacturing capacity, expectations for funding capital expenditures and
operations in future periods and plans, objectives and estimated cost of Year
2000 compliance. The Company also continues to face many risks and uncertainties
including: changes in the prices of oil and natural gas, changes in capital
spending by companies in the oil and gas industry for exploration, development
and equipment, management of higher manufacturing rates, competitive pressures,
technological and structural changes in the industry, litigation and
environmental laws. The risks and uncertainties inherent in these forward-
looking statements could cause actual results to differ materially from those
expressed in or implied by these statements.
Profile
Varco International, Inc. is a leading manufacturer of products used in the
oil and gas well drilling industry worldwide. The Company also leads in the
development of new technology and equipment to enhance the safety and
productivity of the drilling process. Operating through five divisions, the
Company's products include: integrated systems for rotating and handling the
various sizes and types of pipe used on a drilling rig; conventional pipe
handling tools, hoisting equipment and rotary equipment; drilling rig
instrumentation; pressure control and motion compensation equipment; and solids
control equipment and systems.
Investor Contact
Richard A. Kertson
Vice President - Finance
Varco International, Inc.
743 North Eckhoff Street
Orange, California 92868
Tel (714) 978-1900
Fax (714) 937-5029
E-mail: [email protected]
Web site: http://www.varco.com
V A R C O
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<PAGE>
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<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS OF THE REGISTRANT INCLUDED IN ITS THIRD QUARTER REPORT TO
SHAREHOLDERS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1998 AND IS QUALIFIED IN
ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
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<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JUL-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 29,748,000
<SECURITIES> 0
<RECEIVABLES> 168,781,000
<ALLOWANCES> (2,536,000)
<INVENTORY> 171,757,000
<CURRENT-ASSETS> 389,224,000
<PP&E> 162,710,000
<DEPRECIATION> (73,637,000)
<TOTAL-ASSETS> 542,800,000
<CURRENT-LIABILITIES> 222,462,000
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<COMMON> 154,659,000
<OTHER-SE> 151,903,000
<TOTAL-LIABILITY-AND-EQUITY> 542,800,000
<SALES> 190,633,000
<TOTAL-REVENUES> 190,904,000
<CGS> 131,188,000
<TOTAL-COSTS> 158,737,000
<OTHER-EXPENSES> 9,208,000
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 385,000
<INCOME-PRETAX> 22,574,000
<INCOME-TAX> 7,610,000
<INCOME-CONTINUING> 14,964,000
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