<PAGE> 1
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
1-8514
SMITH INTERNATIONAL, INC.
(Exact name of Registrant as specified in its charter)
DELAWARE 95-3822631
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification
Number)
16740 HARDY STREET
HOUSTON, TEXAS 77032
(Address of principal executive offices) (Zip Code)
(281) 443-3370
(Registrant's telephone number, including area code)
NOT APPLICABLE
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
------------ -----------
The number of shares outstanding of the Registrant's common stock as of November
11, 1998 was 48,791,483.
<PAGE> 2
INDEX
<TABLE>
<CAPTION>
Page No.
--------
<S> <C>
PART I: FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
Consolidated Statements of Operations -
For the Three and Nine Months Ended September 30, 1998 and 1997 .............. 1
Consolidated Balance Sheets -
As of September 30, 1998 and December 31, 1997 ............................... 2
Consolidated Statements of Cash Flows -
For the Nine Months Ended September 30, 1998 and 1997 ........................ 3
Notes to Consolidated Financial Statements ....................................... 4
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS ......................................... 9
PART II: OTHER INFORMATION
ITEMS 1 - 6 ................................................................................... 15
SIGNATURES ................................................................................................... 16
</TABLE>
<PAGE> 3
SMITH INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ ------------------------
1998 1997 1998 1997
---------- ---------- ---------- ----------
(Restated) (Restated)
<S> <C> <C> <C> <C>
REVENUES .................................. $ 520,209 $ 561,854 $1,656,891 $1,580,076
COSTS AND EXPENSES:
Costs of Revenues ....................... 365,644 393,726 1,147,604 1,109,932
Selling Expenses ........................ 84,283 80,921 257,313 229,542
General and Administrative Expenses ..... 18,313 21,795 60,914 65,170
Merger and Restructuring Costs .......... -- -- 55,000 --
---------- ---------- ---------- ----------
Total Costs and Expenses ........... 468,240 496,442 1,520,831 1,404,644
---------- ---------- ---------- ----------
INCOME BEFORE INTEREST AND TAXES ......... 51,969 65,412 136,060 175,432
INTEREST EXPENSE, NET ..................... 11,388 7,845 30,314 20,725
---------- ---------- ---------- ----------
INCOME BEFORE INCOME TAXES AND
MINORITY INTERESTS ...................... 40,581 57,567 105,746 154,707
INCOME TAX PROVISION ...................... 12,515 15,639 34,151 41,111
---------- ---------- ---------- ----------
INCOME BEFORE MINORITY INTERESTS ......... 28,066 41,928 71,595 113,596
MINORITY INTERESTS ........................ 4,013 9,534 21,457 28,271
---------- ---------- ---------- ----------
NET INCOME ................................ $ 24,053 $ 32,394 $ 50,138 $ 85,325
========== ========== ========== ==========
EARNINGS PER SHARE:
Basic ................................... $ 0.50 $ 0.68 $ 1.05 $ 1.80
========== ========== ========== ==========
Diluted ................................. $ 0.50 $ 0.67 $ 1.04 $ 1.78
========== ========== ========== ==========
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic ................................... 48,129 47,537 47,833 47,486
Diluted ................................. 48,411 48,133 48,258 48,058
</TABLE>
The accompanying notes are an integral part of these financial statements.
1
<PAGE> 4
SMITH INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PAR VALUE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
----------- -----------
(Restated)
ASSETS
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents ..................................................... $ 27,537 $ 37,109
Receivables, net .............................................................. 464,759 510,984
Inventories, net .............................................................. 503,081 467,963
Deferred tax assets, net ...................................................... 40,755 27,329
Prepaid expenses and other .................................................... 38,094 29,968
----------- -----------
Total current assets ........................................................ 1,074,226 1,073,353
----------- -----------
PROPERTY, PLANT AND EQUIPMENT, NET .............................................. 363,077 312,663
OTHER ASSETS .................................................................... 102,448 76,898
GOODWILL, NET ................................................................... 293,581 209,585
----------- -----------
TOTAL ASSETS .................................................................... $ 1,833,332 $ 1,672,499
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Short-term borrowings and current portion of long-term debt ................... $ 347,151 $ 91,523
Accounts payable .............................................................. 152,243 204,771
Accrued payroll costs ......................................................... 53,381 56,152
Accrued merger and restructuring costs ........................................ 30,976 --
Income taxes payable .......................................................... 38,810 27,003
Other ......................................................................... 93,028 93,923
----------- -----------
Total current liabilities ................................................. 715,589 473,372
----------- -----------
LONG-TERM DEBT .................................................................. 415,471 371,579
OTHER LONG-TERM LIABILITIES ..................................................... 42,301 48,798
MINORITY INTERESTS .............................................................. 9,726 206,705
SHAREHOLDERS' EQUITY:
Preferred Stock, $1 par value; 5,000 shares authorized; no shares
issued or outstanding in 1998 or 1997 ....................................... -- --
Common Stock, $1 par value; 60,000 shares authorized; 48,785 shares
issued and outstanding in 1998 (48,216 in 1997, as restated) ................ 48,785 48,216
Additional paid-in capital .................................................... 322,921 296,222
Retained earnings ............................................................. 296,854 246,809
Cumulative translation adjustments ............................................ (10,613) (11,500)
Less - treasury securities, at cost; 656 common shares in 1998 and 1997 ....... (7,702) (7,702)
----------- -----------
Total shareholders' equity ................................................ 650,245 572,045
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY ...................................... $ 1,833,332 $ 1,672,499
=========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
2
<PAGE> 5
SMITH INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
For the Nine Months
Ended September 30,
-----------------------
1998 1997
--------- ---------
(Restated)
CASH FLOWS FROM OPERATING ACTIVITIES:
<S> <C> <C>
Net income ......................................................................... $ 50,138 $ 85,325
Adjustments to reconcile net income to net cash provided
by operating activities, excluding the net effects of acquisitions:
Depreciation and amortization ................................................... 51,696 41,321
Minority interests .............................................................. 21,457 28,271
Provision for losses on receivables ............................................. 1,788 1,956
Gain on disposal of property, plant and equipment ............................... (7,001) (5,421)
Foreign currency translation (gains) losses ..................................... 757 (72)
Reserve for merger and restructuring costs, net of tax benefit .................. 37,217 --
Changes in operating assets and liabilities:
Receivables ..................................................................... 43,099 (94,624)
Inventories, net ................................................................ (32,970) (32,555)
Accounts payable ................................................................ (55,419) (17,109)
Other current assets and liabilities ............................................ (35,024) 9,798
Other non-current assets and liabilities ........................................ (28,790) (8,700)
--------- ---------
Net cash provided by operating activities ........................................... 46,948 8,190
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of businesses, net of cash acquired ..................................... (22,732) (53,440)
Property, plant and equipment additions ............................................. (93,033) (78,352)
Proceeds from disposal of property, plant and equipment ............................. 12,747 9,895
--------- ---------
Net cash used in investing activities ............................................... (103,018) (121,897)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt ............................................ 62,532 323,830
Repayments of long-term debt ........................................................ (20,008) (246,157)
Net increase in short-term borrowings ............................................... 854 3,952
Proceeds from exercise of stock options ............................................. 378 1,665
Contributions from minority interest partner, net ................................... 2,712 19,440
Other ............................................................................... -- (1,474)
--------- ---------
Net cash provided by financing activities ........................................... 46,468 101,256
--------- ---------
Effect of exchange rate changes on cash ............................................. 30 (319)
--------- ---------
Decrease in cash and cash equivalents ............................................... (9,572) (12,770)
Cash and cash equivalents at beginning of period, as restated ....................... 37,109 35,318
--------- ---------
Cash and cash equivalents at end of period .......................................... $ 27,537 $ 22,548
========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for interest .............................................................. $ 31,915 $ 23,127
Cash paid for income taxes .......................................................... $ 36,604 $ 31,739
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
<PAGE> 6
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 restated audited financial
statements and accompanying notes included in the Company's Form 8-K filing
dated August 31, 1998 and other current filings with the Commission.
The consolidated financial statements for the periods ended September
30, 1997 and as of December 31, 1997 have been restated to include the accounts
of Wilson Industries, Inc. ("Wilson"). On April 30, 1998, the Company acquired
all of the equity interests in Wilson in a transaction accounted for as a
pooling of interests.
The unaudited consolidated financial statements reflect all adjustments
(consisting of normal recurring adjustments and pooling adjustments) which the
Company considers necessary for a fair presentation of the interim periods. All
significant intercompany balances and transactions have been eliminated in the
accompanying financial statements. Results for the interim periods are not
necessarily indicative of results for the year.
Certain prior year amounts have been reclassified to conform to the
current year presentation.
2) ACQUISITIONS
On April 30, 1998, the Company merged with Wilson, a Houston, Texas
based company which primarily provides products and services to the
international petroleum and petrochemical industries. In connection with the
merger, the Company issued a total of 7.9 million of its shares in exchange for
all of the outstanding shares of common stock of Wilson. The transaction has
been accounted for as a pooling of interests and, accordingly, the financial
statements for the periods preceding the acquisition have been restated to
include the accounts of Wilson. No adjustments were necessary in order to
conform the accounting policies of Wilson except for certain reclassification
entries.
The revenues and net income amounts included in the accompanying
statements of operations are disclosed in the following table with Wilson's
amounts for the periods prior to the merger presented separately (in thousands)
(unaudited):
<TABLE>
<CAPTION>
For the Three Months Ended For the Nine Months
September 30, Ended September 30,
------------------------ ------------------------
1998 1997 1998 1997
---------- ---------- ---------- ----------
(Restated) (Restated)
<S> <C> <C> <C> <C>
Revenues:
Company ..................... $ 520,209 $ 396,629 $1,451,614 $1,137,276
Wilson ...................... -- 165,225 205,277 442,800
---------- ---------- ---------- ==========
Combined .................. $ 520,209 $ 561,854 $1,656,891 $1,580,076
========== ========== ========== ==========
Net Income:
Company ..................... $ 24,053 $ 27,264 $ 44,483 $ 72,306
Wilson ...................... -- 5,130 5,655 13,019
---------- ---------- ---------- ----------
Combined .................. $ 24,053 $ 32,394 $ 50,138 $ 85,325
========== ========== ========== ==========
</TABLE>
4
<PAGE> 7
On May 27, 1998, the Company acquired all of the outstanding shares of
Safeguard Disposal Systems, Inc. ("Safeguard"), a company engaged in the rental
of vacuum and collection systems used in the oil and gas industry. The Company
issued stock and cash consideration totaling $36.7 million in exchange for the
equity interests of Safeguard and M-I L.L.C. ("M-I") acquired other
Safeguard-related assets for $4.8 million. Subsequent to the acquisition date,
the Company contributed the Safeguard assets to M-I partly in exchange for a
$16.6 million contribution from the former minority interest partner.
On August 31, 1998, the Company acquired the remaining 36 percent
interest in M-I previously held by Halliburton Company ("Halliburton"). The
Company issued a $265.0 million non-interest bearing promissory note to
Halliburton in exchange for their minority ownership interest. The discounted
value of the note, which matures on April 28, 1999, is recorded as Short-term
Borrowings in the accompanying Balance Sheet.
In addition to these acquisitions, the Company has acquired other
operations during the current year. The current year acquisitions were purchased
in exchange for cash consideration of $22.7 million, consisting of cash payments
and contingent consideration under earn-out arrangements, which was financed
with borrowings against available lines of credit.
The above acquisitions have been recorded using the purchase method of
accounting and, accordingly, the acquired operations have been included in the
results of operations since their respective acquisition dates. The purchase
price was allocated to the net assets acquired based upon their estimated fair
market values at the dates of acquisition. The excess of the purchase price over
the estimated fair value of the net assets acquired amounted to approximately
$87.7 million, which has been recorded as goodwill.
The balances included in the Consolidated Balance Sheets related to
these acquisitions are based upon preliminary information and are subject to
change when additional information concerning final asset and liability
valuations is obtained. Material changes in the preliminary allocations are not
anticipated by management.
The unaudited pro forma supplemental information for the nine months
ended September 30, 1998 and 1997 is presented below (in thousands, except per
share amounts):
<TABLE>
<CAPTION>
For the Nine Months
Ended September 30,
------------------------------
1998 1997
------------- -------------
<S> <C> <C>
Revenues .......................... $ 1,667,187 $ 1,640,297
Net income ........................ $ 55,071 $ 98,787
Earnings per share:
Basic ........................... $ 1.15 $ 2.08
Diluted ......................... $ 1.14 $ 2.06
</TABLE>
The unaudited pro forma supplemental information is based on historical
information and does not include estimated cost savings; therefore, it does not
purport to be indicative of the results of operations had the combinations been
in effect at the dates indicated or of future results for the combined entities.
The following schedule summarizes investing activities related to
current year acquisitions included in the Consolidated Statements of Cash Flows
for the nine months ended September 30, 1998:
<TABLE>
<S> <C>
Fair value of assets, net of cash acquired ...................... $ 24,780
Goodwill recorded ............................................... 87,749
Less: Total liabilities assumed ................................ (46,737)
Less: Contribution from former minority interest partner ....... (16,560)
Less: Common stock issued for consideration .................... (26,500)
--------
Acquisition of businesses, net of cash acquired ................. $ 22,732
========
</TABLE>
5
<PAGE> 8
3) EARNINGS PER SHARE
During 1997, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 128 "Earnings Per Share", which requires dual
presentation of basic and diluted earnings per share ("EPS") data. Basic 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.
For purposes of the earnings per share calculation, the 7.9 million
shares issued in connection with the Wilson acquisition have been treated as if
they had been issued and outstanding for all periods presented.
The following schedule reconciles the income and shares used in the
basic and diluted EPS computations (in thousands, except per share data):
<TABLE>
<CAPTION>
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
------------------ ------------------
1998 1997 1998 1997
------- ------- ------- -------
BASIC EPS (Restated) (Restated)
<S> <C> <C> <C> <C>
Net income ...................................................... $24,053 $32,394 $50,138 $85,325
======= ======= ======= =======
Weighted average number of common
shares outstanding ............................................ 48,129 47,537 47,833 47,486
------- ------- ------- -------
Basic earnings per share ........................................ $ 0.50 $ 0.68 $ 1.05 $ 1.80
======= ======= ======= =======
DILUTED EPS
Net income ...................................................... $24,053 $32,394 $50,138 $85,325
======= ======= ======= =======
Weighted average number of common
shares outstanding ............................................ 48,129 47,537 47,833 47,486
Dilutive effect of stock options ................................ 282 596 425 572
------- ------- ------- -------
48,411 48,133 48,258 48,058
------- ------- ------- -------
Diluted earnings per share ...................................... $ 0.50 $ 0.67 $ 1.04 $ 1.78
======= ======= ======= =======
</TABLE>
4) COMPREHENSIVE INCOME
In 1998, the Company adopted SFAS No. 130 "Reporting Comprehensive
Income", which requires companies to display comprehensive income and its
components in the financial statements. Comprehensive income, which encompasses
net income and currency translation adjustments, is as follows (in thousands):
<TABLE>
<CAPTION>
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
-------------------- --------------------
1998 1997 1998 1997
-------- -------- -------- --------
(Restated) (Restated)
<S> <C> <C> <C> <C>
Net income ....................................... $ 24,053 $ 32,394 $ 50,138 $ 85,325
Currency translation adjustments, net of tax ..... 1,257 (2,219) 620 (4,578)
-------- -------- -------- --------
Comprehensive income ............................. $ 25,310 $ 30,175 $ 50,758 $ 80,747
======== ======== ======== ========
</TABLE>
6
<PAGE> 9
5) MERGER AND RESTRUCTURING COSTS
During the second quarter of 1998, the Company recorded a $55 million
charge related to the acquisition and integration of the Wilson operations and
various restructuring efforts. A deferred tax benefit associated with the merger
and restructuring charge was also recorded during the second quarter and totaled
$14 million.
In connection with the Wilson acquisition, the Company recorded merger
costs of approximately $30 million which consisted of transaction costs,
including accounting, legal and investment banking costs, and amounts to
consolidate and integrate the existing Wilson operations. The consolidation and
integration portion of the charge consists of severance costs for Wilson
personnel, including payments under "change of control" agreements,
consolidation and relocation of existing Wilson manufacturing operations and the
write-down of assets which are impaired or have no future value.
Additionally, in order to lower costs and remain competitive in the
prevailing economic environment, management committed to several initiatives
during the second quarter of 1998 to restructure its worldwide operations. The
restructuring efforts will be substantially completed by the end of 1998 and
total approximately $25 million. A significant portion of this amount relates to
the closure of the Company's Supradiamant France facility and relocation of the
manufacturing operations. The charge also included amounts related to the
combination of the Smith Tool and Smith Diamond Technology business units and
the elimination of duplicate sales and management cost structures throughout the
world. The remainder of the charge related to management's evaluation of present
business conditions in the oil and gas industry and included costs to reduce the
workforce to appropriate levels and write-down assets which were impaired or had
no future value. The above restructuring efforts have resulted in the reduction
of 10 percent of the Company's combined workforce.
The majority of the charge has or will result in cash expenditures,
except for amounts related to the write-off of recorded assets, which
approximate $19 million.
6) INVENTORIES
Inventories are stated at the lower of cost or market. Cost is
determined by the first-in, first-out ("FIFO") method for the majority of the
Company's inventories. The remaining inventories are costed under the last-in,
first-out ("LIFO") or average cost methods. Inventory costs, consisting of
materials, labor and factory overhead, are as follows (in thousands):
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
--------- ---------
(Restated)
<S> <C> <C>
Raw materials ............................................. $ 47,553 $ 35,845
Work-in-process ........................................... 74,107 79,080
Products purchased for resale ............................. 73,747 91,159
Finished goods ............................................ 331,117 284,753
--------- ---------
526,524 490,837
Reserves to state certain domestic inventories
($195,039 and $191,448 in 1998 and restated 1997,
respectively) on a LIFO basis ......................... (23,443) (22,874)
--------- ---------
Inventories, net .......................................... $ 503,081 $ 467,963
========= =========
</TABLE>
7
<PAGE> 10
7) PROPERTY, PLANT AND EQUIPMENT, NET
Property, plant and equipment consists of the following (in thousands):
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
--------- ---------
(Restated)
<S> <C> <C>
Land ................................... $ 24,281 $ 24,219
Buildings .............................. 65,070 57,015
Rental tools ........................... 207,000 223,784
Machinery and equipment ................ 348,839 255,189
--------- ---------
645,190 560,207
Less-accumulated depreciation .......... (282,113) (247,544)
--------- ---------
Net property, plant and equipment ...... $ 363,077 $ 312,663
========= =========
</TABLE>
8) DEBT
The following summarizes the Company's outstanding debt (in thousands):
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
--------- ---------
Current: (Restated)
<S> <C> <C>
Short-term note payable ..................... $ 256,030 $ --
Short-term bank borrowings .................. 69,043 61,010
Current portion of long-term debt ........... 22,078 30,513
--------- ---------
$ 347,151 $ 91,523
========= =========
Long-term:
Notes, net of unamortized discount ........ $ 284,852 $ 299,880
Bank revolvers payable .................... 104,100 62,900
Term loans ................................ 48,597 39,312
--------- ---------
437,549 402,092
Less current portion of long-term debt .... (22,078) (30,513)
--------- ---------
Long-term debt ............................ $ 415,471 $ 371,579
========= =========
</TABLE>
In connection with the acquisition of the remaining 36 percent interest in
M-I, the Company issued a $265.0 million non-interest bearing promissory note to
Halliburton. The discounted value of the note, which matures on April 28, 1999,
is included above in short-term note payable.
8
<PAGE> 11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
The following "Management's Discussion and Analysis of Financial
Condition and Results of Operations" is provided to assist readers in
understanding the Company's financial performance during the periods presented
and significant trends which may impact the future performance of the Company.
On April 30, 1998, the Company acquired all of the outstanding stock of Wilson
Industries, Inc. ("Wilson") in a transaction accounted for as a pooling of
interests. Accordingly, the accompanying financial information gives effect to
the acquisition for all periods presented. The following discussion should be
read in conjunction with the Consolidated Financial Statements of the Company
and the related notes thereto.
The Company's primary business is the supply of premium products and
services to the oil and gas exploration, production and petrochemical
industries. The Company provides a comprehensive line of
technologically-advanced products and engineering services, including drilling
and completion fluid systems, solids-control equipment, waste-management
services, three-cone drill bits, diamond drill bits, fishing services, drilling
tools, underreamers, sidetracking systems and liner hangers. The Company also
operates an extensive network of supply branches through which it markets pipes,
valves, fittings and other capital and expendable 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 the price of oil and natural gas but may also be
affected by political actions and uncertainties, environmental concerns, capital
expenditure plans of exploration and production companies and the overall level
of global economic growth and activity.
The Company's results for the third quarter were impacted by the
continuing decline in U.S. drilling activity which decreased 18 percent from the
average rig count levels experienced in the first quarter of 1998. Moreover, the
U.S. rig count has deteriorated further in the fourth quarter and is currently 9
percent below the average drilling activity levels reported in the third quarter
of 1998. Although the long-term outlook for exploration and production activity
is favorable based upon expected growth in worldwide energy consumption, several
factors have, and may continue to, impact activity levels on a short-term basis.
The continuing decline in average crude oil prices in the third quarter, which
have decreased over 30 percent from average 1997 levels, has negatively impacted
U.S. land-based drilling activity. If crude oil prices remain at or below
current levels for a prolonged period of time, management believes demand for
products and services could continue to be adversely impacted in the U.S. and
certain other markets. Additionally, several countries in which the Company
operates, including Venezuela and Nigeria, are experiencing increased economic
and political instability. If the current environment continues, demand for
products and services may be impacted in those markets.
9
<PAGE> 12
RESULTS OF OPERATIONS
REVENUES
The Company operates through five business units which market products
and provide services throughout the world. The following table presents revenue
and average rig count information for the periods shown.
<TABLE>
<CAPTION>
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
---------------------------------- --------------------------------------
1998 1997 1998 1997
---------------------------------- --------------------------------------
Amount % Amount % Amount % Amount %
---------- -- ---------- -- ---------- -- ---------- --
(Restated) (Restated)
Revenues by Business Unit:
<S> <C> <C> <C> <C> <C> <C> <C> <C>
M-I - Fluids .................................. $ 209,436 40 $ 215,120 38 $ 664,905 40 $ 635,935 40
M-I - SWACO ................................... 39,185 8 34,089 6 112,374 7 93,499 6
Wilson Supply ................................. 117,057 22 148,348 27 381,280 23 397,729 25
Smith Bits .................................... 71,769 14 85,224 15 242,948 15 240,752 15
Smith Drilling & Completions .................. 82,762 16 79,073 14 255,384 15 212,161 14
---------- -- ---------- -- ---------- -- ---------- --
Total ................................. $ 520,209 100 $ 561,854 100 $1,656,891 100 $1,580,076 100
========== === ========== === ========== === ========== ===
Revenues by Area:
U.S ........................................... $ 242,126 47 $ 305,892 54 $ 807,340 49 $ 836,954 53
Export ........................................ 42,703 8 38,892 7 134,127 8 110,849 7
Non-U.S ....................................... 235,380 45 217,070 39 715,424 43 632,273 40
---------- -- ---------- -- ---------- -- ---------- --
Total ................................. $ 520,209 100 $ 561,854 100 $1,656,891 100 $1,580,076 100
========== === ========== === ========== === ========== ===
Average Active Rig Count:
U.S ........................................... 794 992 875 927
Canada ........................................ 205 398 280 350
Non-North America ............................. 728 811 779 811
---------- ---------- ---------- ----------
Total ................................. 1,727 2,201 1,934 2,088
========== ========== ========== ==========
</TABLE>
M-I-FLUIDS
M-I-Fluids, a division of M-I L.L.C. ("M-I"), provides drilling fluid
and completion fluid systems, engineering and technical services to the oil and
gas industry. M-I-Fluids revenues decreased $5.7 million, or 3 percent, from the
third quarter of 1997 and increased $29.0 million, or 5 percent, over the first
nine months of 1997. The revenue decline from the third quarter of the prior
year related to lower volumes associated with the impact of weak oil prices on
U.S. activity levels. Excluding the U.S., which was impacted by a significant
decline in the rig count, M-I-Fluids reported revenue growth across all
geographic areas as compared to the first nine months of the prior year. The
majority of the variance for the nine month period related to incremental
revenues from acquisitions.
M-I-SWACO
M-I-SWACO, a division of M-I, manufactures and markets equipment and
services for solids control, pressure control, rig instrumentation and waste
management. M-I-SWACO revenues increased $5.1 million and $18.9 million from the
third quarter and first nine months of 1997, respectively. The majority of the
revenue growth in both periods presented was reported in the U.S. and
Europe/Africa which benefited from incremental revenues from operations acquired
in the last 12 months. SWACO's revenues for the nine month period were also
impacted by increased demand for fluid processing equipment and services.
10
<PAGE> 13
WILSON SUPPLY
Wilson Supply ("Supply") markets pipe, valves and other capital and
expendable maintenance products to the petroleum and petrochemical industries
primarily through an extensive network of U.S. supply branches. Supply's
revenues decreased $31.3 million, or 21 percent, from the third quarter of 1997
and decreased $16.4 million, or 4 percent, from the first nine months of 1997.
On a geographic basis, the revenue variance for both periods was reported in the
U.S., which was adversely impacted by a decline in drilling activity levels. The
quarter-to-quarter revenue decrease related to lower branch and tubular sales
associated with the lower activity levels. For the nine month period, lower
tubular revenues associated with a decline in unit sales and increased
competitive pricing pressures accounted for the reported variance.
SMITH BITS
Smith Bits manufactures and sells three-cone and diamond bits primarily
for use in the oil and gas industry. The unit's MegaDiamond and Supradiamant
subsidiaries manufacture polycrystalline diamond and cubic boron nitride
materials which are used in drill bits and in other specialized cutting tools.
In July 1998, the Company consolidated the previously separate Smith Tool and
Smith Diamond Technology business units and formed Smith Bits. Smith Bits
revenues decreased $13.5 million, or 16 percent, from the third quarter of 1997
and increased $2.2 million, or 1 percent, from the first nine months of 1997.
The revenue decline for the three month period related to lower North American
activity levels which resulted in decreased unit sales of petroleum three-cone
bits. The impact of the decline in unit sales was partially offset by improved
pricing. For the nine month period, increased volumes in the Eastern Hemisphere
offset the revenue decline reported in the U.S.
SMITH DRILLING & COMPLETIONS
Smith Drilling & Completions manufactures and markets products and
services used in the oil and gas industry for drilling, workover, well
completion and well re-entry. Smith Drilling & Completions' revenues increased
$3.7 million, or 5 percent, over the third quarter of 1997 and $43.2 million, or
20 percent, from the first nine months of 1997. For the third quarter of 1998,
the unit reported strong revenue growth outside North America primarily due to
the addition of the Houston Engineers' operations, which were acquired in
connection with the Wilson acquisition. For the nine month period,
almost half of the revenue increase related to incremental revenues from
acquisitions with strong base business growth across all geographic areas
accounting for the remainder.
11
<PAGE> 14
For the periods indicated, the following table summarizes the results
of the Company and presents these results as a percentage of total revenues:
<TABLE>
<CAPTION>
For the Three Months Ended For the Nine Months Ended
September 30, September 30,
-------------------------------------- --------------------------------------
1998 1997 1998 1997
-------------------------------------- --------------------------------------
Amount % Amount % Amount % Amount %
---------- --- ---------- --- ---------- --- ---------- ---
(Restated) (Restated)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues ............................... $ 520,209 100 $ 561,854 100 $1,656,891 100 $1,580,076 100
---------- ---------- ---------- --- ---------- ---
Gross profit ........................... 154,565 30 168,128 30 509,287 31 470,144 30
Operating expenses ..................... 102,596 20 102,716 18 373,227 23 294,712 19
---------- --- ---------- --- ---------- --- ---------- ---
Income before interest and taxes ....... 51,969 10 65,412 12 136,060 8 175,432 11
Interest expense, net .................. 11,388 2 7,845 1 30,314 2 20,725 1
---------- --- ---------- --- ---------- --- ---------- ---
Income before income taxes and
minority interests .................... 40,581 8 57,567 11 105,746 6 154,707 10
Income tax provision ................... 12,515 2 15,639 3 34,151 2 41,111 3
---------- --- ---------- --- ---------- --- ---------- ---
Income before minority interests ....... 28,066 6 41,928 8 71,595 4 113,596 7
Minority interests ..................... 4,013 1 9,534 2 21,457 1 28,271 2
---------- --- ---------- --- ---------- --- ---------- ---
Net income ............................. $ 24,053 5 $ 32,394 6 $ 50,138 3 $ 85,325 5
========== === ========== === ========== === ========== ===
</TABLE>
Total revenues decreased $41.6 million, or 7 percent, from the prior
year quarter and increased $76.8 million, or 5 percent, over the first nine
months of 1997. The revenue decline was reported in the U.S. and related to the
20 percent quarter-to-quarter decrease in the average U.S. rig count associated
with weak oil prices. Incremental revenues from acquisitions completed in the
last twelve months partially offset the impact of the lower U.S. revenues in the
quarter. For the first nine months of 1998, the Company reported growth across
all geographic areas excluding the U.S. operations, which were impacted by the
lower activity levels. Over half of the variance for the nine month period
related to incremental revenues from acquisitions. If drilling activity remains
at or below levels currently experienced in the fourth quarter, management
believes reduced customer spending may significantly impact reported revenues in
future periods.
Gross profit as a percentage of revenues remained at 30 percent in the
third quarter of both years. For the nine month period, gross profit margins
improved one percentage point due to the impact of price increases enacted
during the last half of 1997 and efficiencies associated with the higher
volumes.
Operating expenses, consisting of selling expenses, general and
administrative expenses and merger and restructuring costs, decreased $0.1
million from the third quarter of 1997 and increased $78.5 million over the
first nine months of 1997. The majority of the dollar variance for the nine
month period relates to the $55.0 million merger and restructuring charge
recorded in the second quarter of 1998 for costs associated with the acquisition
and integration of the Wilson operations and restructuring efforts. Incremental
costs associated with acquired operations also contributed to the increase in
operating expenses over the first nine months of the prior year.
During the second quarter of 1998, management evaluated the current
economic conditions in the oil and gas industry and committed to several
restructuring initiatives to lower costs and remain competitive in the present
environment. The merger and restructuring charge recorded in the second quarter
of 1998 includes $25 million of
12
<PAGE> 15
restructuring costs associated with the closure and relocation of a
manufacturing facility, combination of two separate business units and
elimination of the duplicate cost structure, reduction of personnel to
appropriate levels to correspond with expected demand and the write-off of
assets which, due to current industry and economic conditions, are impaired or
have no future value. The restructuring efforts, most of which were completed in
the third quarter, resulted in reduced employee-related costs. Additionally,
although headcount reductions associated with the relocation of the
manufacturing facility resulted in lower employee-related costs, increased
efficiencies have also resulted from the combination of the previously separate
manufacturing operations. At September 30, 1998, the remaining reserve for
restructuring expenditures approximated $9.8 million of which $4.6 million is
expected to result in future cash outlays.
Net interest expense, which represents interest expense less interest
income, increased $3.5 million from the third quarter of 1997 and $9.6 million
over the reported amounts for the first nine months of 1997. The increase
relates to the higher level of borrowings required to fund business acquisitions
and finance general working capital needs.
The effective tax rate for the first nine months of 1998 approximated
32 percent, which is higher than the 27 percent reported in the comparable
period of the prior year and lower than the U.S. statutory rate. The rate
exceeded the effective rate for the first nine months of 1997 as the prior year
benefited from U.S. net operating loss carryforwards, which were fully utilized
during 1997. The inclusion of non-deductible costs in the second quarter merger
and restructuring charge also contributed to the increase in the effective rate.
The effective tax rate was lower than the statutory rate as, prior to acquiring
the minority interest ownership in M-I, the Company properly consolidated the
pretax income related to the former minority interest partner's share of U.S.
partnership earnings but excluded the related taxes. The effective rate in the
fourth quarter is expected to increase above the statutory rate as a result of
acquiring Halliburton's ownership interest in M-I.
Minority interests represent the share of M-I's profits associated with
the former minority partner's interest in those operations and, to a lesser
extent, minority interests in investments in other joint ventures held by M-I.
Minority interests decreased $5.5 million and $6.8 million from the third
quarter and first nine months of 1997, respectively. The primary reason for the
decrease for the nine month period related to the recognition of M-I's portion
of the second quarter 1998 merger and restructuring charge. For both periods
presented, the impact of acquiring Halliburton's ownership interest in M-I also
contributed to the reported variances.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents decreased $9.6 million during the nine month
period and equaled $27.5 million at September 30, 1998. The Company's operations
generated $46.9 million of cash flows in the first nine months of 1998 which is
a $38.8 million increase over the amount provided in the comparable period of
the prior year. The effect of the decline in drilling activity on operations
favorably impacted receivables and accounted for the majority of the change from
the first nine months of the prior year. Although funding requirements for
capital expenditures and acquisitions declined significantly in the third
quarter of 1998, cash flows from operations for the nine month period were not
sufficient to fund year-to-date requirements resulting in increased borrowings
under available facilities.
The Company's primary internal source of liquidity is cash flow
generated from operations. External sources of liquidity include debt and, if
needed, equity financing. Various revolving line of credit facilities, which are
available for operating and financing needs, had additional borrowing capacity
of approximately $114.0 million at September 30, 1998. The Company believes
funds generated from operations, amounts available under existing credit
facilities, and external sources of liquidity will be sufficient to finance
capital expenditures and other working capital needs of the existing operations
for the foreseeable future.
Subsequent to September 30, 1998, the Company signed a Memorandum of
Understanding with Schlumberger Limited ("Schlumberger") related to the
combination of the M-I and Schlumberger Dowell Drilling Fluid operations under a
joint venture arrangement in which the Company would own 60 percent. The
Memorandum requires Schlumberger to contribute certain assets to the joint
venture and pay cash consideration of $280.0 million to the Company in exchange
for a 40 percent minority ownership interest in the combined operations. The
transaction is expected to close in the first
13
<PAGE> 16
quarter of 1999 and is subject to, among other conditions, approval by the Board
of Directors of both companies and various governmental and regulatory entities
in the U.S. and Europe. Although there are no assurances as to whether any
transaction will be agreed to by the parties or ultimately consummated, future
cash outlays may be required to combine and consolidate the previously separate
operations if finalized.
Aside from the potential transaction discussed above, management
continues to evaluate opportunities to acquire products or businesses
complimentary 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.
This document contains forward-looking statements within the meaning of
the Private Securities Litigation Reform Act of 1995 concerning the Company's
outlook for its operations, which are subject to certain risks, uncertainties
and assumptions. These forward-looking statements are identified by the use of
terms and phrases such as "expects", "believes", and similar terms and phrases.
Should one or more of these risks or uncertainties materialize, or should
underlying assumptions prove incorrect, actual results may vary materially from
those expected, estimated or projected.
NEW ACCOUNTING AND REGULATORY PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133 ("SFAS 133") "Accounting for
Derivative Instruments and Hedging Activities" effective for fiscal periods
beginning after June 15, 1999. This standard establishes accounting and
reporting standards requiring that every derivative instrument be recorded and
measured at its fair value. The Statement requires that changes in fair value be
recognized currently in earnings unless specific hedge accounting criteria are
met.
The impact of adopting SFAS 133 has not yet been quantified but is not
expected to have a material impact upon the Company's financial condition or
results of operations.
YEAR 2000
The Company is currently implementing modifications to its business
systems in order to achieve Year 2000 date conversion compliance. The following
supplements the Year 2000 disclosure included in the Company's 1997 Annual
Report on Form 10-K.
The Company's business systems are comprised of a mix of off-the-shelf
and internally-developed systems that vary greatly in size, complexity and
technical architecture. The Company's Year 2000 task force has performed a
complete review of all systems and has finalized the identification of the
critical and non-critical components within five defined groups. The necessary
changes in computer instructional code continue to be made by upgrading the
off-the-shelf software in which the application was created. Year 2000
compliance for the majority of the Company's enterprise applications was
achieved with the Oracle 10.7 implementation in the first quarter of 1998.
Although the Company continues to install new applications and upgrade existing
ones in order to bring applications for international locations into compliance,
migration or replacement plans are currently in place for systems that are not
Year 2000 compliant. At September 30, 1998, the Company estimates that the
implementation and testing process for both Information Technology ("IT") and
non-IT systems was approximately sixty percent complete. The Company currently
believes all significant systems will be Year 2000 compliant by mid-1999.
During the second quarter of 1998, the Company communicated with major
suppliers, financial institutions and others with whom it does business to
address conversion-related issues and is currently reviewing the responses
received. Although the Company has not yet determined the complete status of
Year 2000 compliance of its suppliers and financial institutions, a written
contingency program is being developed. Management continues to believe that
non-compliance by the Company's suppliers are insignificant but failure of its
financial institutions could have a material effect on the Company's financial
position or results of operations.
The estimated costs associated with achieving Year 2000 compliance are
not expected to have a material impact on the Company's financial condition or
results of operations.
14
<PAGE> 17
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
(2) Plan of Acquisition, Reorganization, Arrangement,
Liquidation or Succession.
2.1 Purchase and Sale Agreement dated August 20, 1998 between
Halliburton Energy Services, Inc., MIHC, Inc., Smith
International, Inc., Smith International Acquisition Corp.,
M-I Purchase Corp. and M-I L.L.C. filed as Exhibit 2.1 to
the Company's Form 8-K dated September 15, 1998 and
incorporated herein by reference.
(27) Financial Data Schedules.
27.1 Financial Data Schedule for the nine month period ended
September 30, 1998.
27.2 Restated Financial Data Schedule for the nine month period
ended September 30, 1997.
(b) Reports on Form 8-K
The Registrant filed a Form 8-K dated August 31, 1998
reporting under "Item 5. Other Events" the restatement of the
financial statements included in the Registrant's 1997 Annual
Report on Form 10-K for an acquisition accounted for as a pooling
of interests.
The Registrant filed a Form 8-K dated September 15, 1998,
reporting under "Item 2. Acquisition or Disposition of Assets" and
"Item 7. Financial Statements and Exhibits" required disclosure
related to the acquisition of the remaining 36 percent interest in
M-I from Halliburton.
15
<PAGE> 18
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SMITH INTERNATIONAL, INC.
Registrant
Date: November 13, 1998 By: /s/ Douglas L. Rock
--------------------- -------------------------------------
Douglas L. Rock
Chairman of the Board, Chief Executive
Officer, President and Chief Operating
Officer
Date: November 13, 1998 By: /s/ John J. Kennedy
--------------------- -------------------------------------
John J. Kennedy
Senior Vice President and
Chief Financial Officer
(Principal Accounting Officer)
16
<PAGE> 19
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- - ------ -----------
<S> <C>
(2) Plan of Acquisition, Reorganization, Arrangement, Liquidation or
Succession.
2.1 Purchase and Sale Agreement dated August 20, 1998 between
Halliburton Energy Services, Inc., MIHC, Inc., Smith
International, Inc., Smith International Acquisition Corp., M-I
Purchase Corp. and M-I L.L.C. filed as Exhibit 2.1 to the
Company's Form 8-K dated September 15, 1998 and incorporated
herein by reference.
(27) Financial Data Schedules.
27.1 Financial Data Schedule for the nine month period ended September
30, 1998.
27.2 Restated Financial Data Schedule for the nine month period ended
September 30, 1997.
</TABLE>
c
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 27,537
<SECURITIES> 0
<RECEIVABLES> 475,083
<ALLOWANCES> 10,324
<INVENTORY> 503,081
<CURRENT-ASSETS> 1,074,226
<PP&E> 645,190
<DEPRECIATION> 282,113
<TOTAL-ASSETS> 1,833,332
<CURRENT-LIABILITIES> 715,589
<BONDS> 415,471
0
0
<COMMON> 48,785
<OTHER-SE> 601,460
<TOTAL-LIABILITY-AND-EQUITY> 1,833,332
<SALES> 1,656,891
<TOTAL-REVENUES> 1,656,891
<CGS> 1,147,604
<TOTAL-COSTS> 1,147,604
<OTHER-EXPENSES> 373,227
<LOSS-PROVISION> 1,788
<INTEREST-EXPENSE> 30,314
<INCOME-PRETAX> 105,746
<INCOME-TAX> 34,151
<INCOME-CONTINUING> 50,138
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 50,138
<EPS-PRIMARY> 1.05
<EPS-DILUTED> 1.04
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 22,548
<SECURITIES> 0
<RECEIVABLES> 491,392
<ALLOWANCES> 8,422
<INVENTORY> 416,484
<CURRENT-ASSETS> 956,697
<PP&E> 529,453
<DEPRECIATION> 235,841
<TOTAL-ASSETS> 1,497,697
<CURRENT-LIABILITIES> 376,461
<BONDS> 340,317
0
0
<COMMON> 48,206
<OTHER-SE> 487,320
<TOTAL-LIABILITY-AND-EQUITY> 1,497,697
<SALES> 1,580,076
<TOTAL-REVENUES> 1,580,076
<CGS> 1,109,932
<TOTAL-COSTS> 1,109,932
<OTHER-EXPENSES> 294,712
<LOSS-PROVISION> 1,956
<INTEREST-EXPENSE> 20,725
<INCOME-PRETAX> 154,707
<INCOME-TAX> 41,111
<INCOME-CONTINUING> 85,325
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 85,325
<EPS-PRIMARY> 1.80
<EPS-DILUTED> 1.78
</TABLE>
