<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, 1999
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
9, 1999 was 48,914,340.
<PAGE> 2
INDEX
<TABLE>
<CAPTION>
Page No.
--------
<S> <C> <C>
PART I: FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
Consolidated Statements of Operations -
For the Three and Nine Months Ended September 30, 1999 and 1998.................. 1
Consolidated Balance Sheets -
As of September 30, 1999 and December 31, 1998................................... 2
Consolidated Statements of Cash Flows -
For the Nine Months Ended September 30, 1999 and 1998............................ 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................................................................................. 16
SIGNATURES.................................................................................... 17
</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,
---------------------------- ----------------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
REVENUES ......................................... $ 481,541 $ 520,209 $ 1,268,258 $ 1,656,891
COSTS AND EXPENSES:
Costs of Revenues .............................. 362,705 365,644 939,398 1,147,604
Selling Expenses ............................... 81,213 84,283 221,911 257,313
General and Administrative Expenses ............ 23,284 18,313 65,706 60,914
Gain on Sale and Other Non-Recurring Items ..... (81,378) -- (83,999) 55,000
----------- ----------- ----------- -----------
Total Costs and Expenses .................. 385,824 468,240 1,143,016 1,520,831
----------- ----------- ----------- -----------
INCOME BEFORE INTEREST AND TAXES ................. 95,717 51,969 125,242 136,060
INTEREST EXPENSE, NET ............................ 7,816 11,388 31,188 30,314
----------- ----------- ----------- -----------
INCOME BEFORE INCOME TAXES AND
MINORITY INTERESTS ............................. 87,901 40,581 94,054 105,746
INCOME TAX PROVISION ............................. 38,549 12,515 42,044 34,151
----------- ----------- ----------- -----------
INCOME BEFORE MINORITY INTERESTS ................. 49,352 28,066 52,010 71,595
MINORITY INTERESTS ............................... 2,492 4,013 1,565 21,457
----------- ----------- ----------- -----------
NET INCOME ....................................... $ 46,860 $ 24,053 $ 50,445 $ 50,138
=========== =========== =========== ===========
EARNINGS PER SHARE:
Basic .......................................... $ 0.96 $ 0.50 $ 1.04 $ 1.05
=========== =========== =========== ===========
Diluted ........................................ $ 0.95 $ 0.50 $ 1.03 $ 1.04
=========== =========== =========== ===========
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic .......................................... 48,835 48,129 48,474 47,833
Diluted ........................................ 49,471 48,411 49,082 48,258
</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,
1999 1998
-------------- ------------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents .................................................... $ 28,289 $ 22,717
Receivables, net ............................................................. 433,564 424,054
Inventories, net ............................................................. 479,287 465,705
Deferred tax assets, net ..................................................... 43,869 48,509
Prepaid expenses and other ................................................... 24,023 36,170
----------- -----------
Total current assets ....................................................... 1,009,032 997,155
----------- -----------
PROPERTY, PLANT AND EQUIPMENT, NET ............................................. 385,164 375,236
GOODWILL, NET .................................................................. 345,806 289,242
OTHER ASSETS ................................................................... 108,238 97,355
----------- -----------
TOTAL ASSETS ................................................................... $ 1,848,240 $ 1,758,988
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Short-term borrowings and current portion of long-term debt .................. $ 52,665 $ 345,253
Accounts payable ............................................................. 182,344 145,338
Accrued payroll costs ........................................................ 67,196 46,296
Income taxes payable ......................................................... 18,446 32,402
Accrued merger and restructuring costs ....................................... -- 36,299
Other ........................................................................ 105,908 87,712
----------- -----------
Total current liabilities ................................................ 426,559 693,300
----------- -----------
LONG-TERM DEBT ................................................................. 331,212 368,823
DEFERRED TAX LIABILITIES ....................................................... 38,532 29,421
OTHER LONG-TERM LIABILITIES .................................................... 23,584 23,903
MINORITY INTERESTS ............................................................. 314,561 9,507
SHAREHOLDERS' EQUITY:
Preferred Stock, $1 par value; 5,000 shares authorized; no shares
issued or outstanding in 1999 or 1998 ...................................... -- --
Common Stock, $1 par value; 60,000 shares authorized; 49,570 shares
issued and outstanding in 1999 (48,793 in 1998) ............................ 49,570 48,793
Additional paid-in capital ................................................... 350,943 323,056
Retained earnings ............................................................ 331,230 280,785
Cumulative translation adjustments ........................................... (10,249) (10,898)
Less - treasury securities, at cost; 656 common shares in 1999 and 1998 ..... (7,702) (7,702)
----------- -----------
Total shareholders' equity ............................................... 713,792 634,034
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY ..................................... $ 1,848,240 $ 1,758,988
=========== ===========
</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,
------------------------
1999 1998
--------- ---------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ........................................................... $ 50,445 $ 50,138
Adjustments to reconcile net income to net cash provided by operating
activities, excluding the net effects of acquisitions:
Depreciation and amortization ..................................... 56,610 51,696
Minority interests ................................................ 1,565 21,457
Provision for losses on receivables ............................... 1,216 1,788
Gain on disposal of property, plant and equipment ................. (5,383) (7,001)
Foreign currency translation losses ............................... 662 757
Gain on sale and other non-recurring items, net of tax ............ (45,810) 37,217
Changes in operating assets and liabilities:
Receivables ....................................................... 27,274 43,099
Inventories, net .................................................. 69,154 (32,970)
Accounts payable .................................................. (18,190) (55,419)
Accrued merger and restructuring costs ............................ (33,285) --
Other current assets and liabilities .............................. (33,772) (35,024)
Other non-current assets and liabilities .......................... (6,497) (28,790)
--------- ---------
Net cash provided by operating activities ............................. 63,989 46,948
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from M-I Transaction ......................................... 321,000 --
Proceeds from disposal of operations .................................. 44,218 --
Acquisition of businesses, net of cash acquired ....................... (300,593) (22,732)
Purchases of property, plant and equipment ............................ (42,060) (93,033)
Proceeds from disposal of property, plant and equipment ............... 13,431 12,747
--------- ---------
Net cash provided by (used in) investing activities ................... 35,996 (103,018)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt .............................. 49,855 62,532
Principal payments of long-term debt .................................. (87,231) (20,008)
Net increase (decrease) in short-term borrowings ...................... (58,606) 854
Proceeds from exercise of stock options ............................... 2,685 378
Contributions from (distributions to) minority interest partners ..... (1,440) 2,712
--------- ---------
Net cash provided by (used in) financing activities ................... (94,737) 46,468
--------- ---------
Effect of exchange rate changes on cash ............................... 324 30
--------- ---------
Increase (decrease) in cash and cash equivalents ...................... 5,572 (9,572)
Cash and cash equivalents at beginning of period ...................... 22,717 37,109
--------- ---------
Cash and cash equivalents at end of period ............................ $ 28,289 $ 27,537
========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for interest ................................................ $ 29,276 $ 31,915
Cash paid for income taxes ............................................ $ 27,946 $ 36,604
</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 audited financial statements
and accompanying notes included in the Company's 1998 Annual Report on Form 10-K
and other current filings with the Commission.
The unaudited consolidated financial statements reflect all adjustments
(consisting of normal recurring adjustments) which the Company considers
necessary for a fair presentation of the interim periods. All significant
intercompany balances and transactions have been eliminated in the accompanying
financial statements. Results for the interim periods are not necessarily
indicative of results for the year.
2) BUSINESS COMBINATIONS
On July 25, 1999, the Company completed a transaction with Schlumberger
Limited ("Schlumberger") related to the combination of certain M-I L.L.C ("M-I")
and Dowell drilling fluids operations under a joint venture arrangement.
Schlumberger contributed their non-U.S. Dowell drilling fluid operations,
including an asset equalization payment of $41 million, and paid cash
consideration of $280 million to the Company in exchange for a 40 percent
minority ownership interest in the combined operations (collectively, the "M-I
Transaction"). Proceeds from the transaction were used to reduce outstanding
borrowings of the Company. See Note 3 for a discussion of the gain recognized in
connection with the M-I Transaction.
The operations acquired in the M-I Transaction have been accounted for under
the purchase method of accounting and, accordingly, have been included in the
results of operations since July 25, 1999. The purchase price was allocated to
the net assets acquired based upon their estimated fair market values at the
date of acquisition. The excess of purchase price over the estimated fair value
of the net assets acquired was $41.4 million, which has been recorded as
goodwill.
On May 28, 1999, the Company acquired certain operations of ConEmsco, Inc.
("CE") and CE's majority ownership interest in CE Franklin, Ltd., businesses
primarily engaged in oilfield supply and distribution in the United States and
Canada. In connection with the acquisition, the Company issued 548,527 shares of
common stock and a $30.0 million note payable to the seller. The acquisition has
been recorded using the purchase method of accounting and, accordingly, the
acquired operations have been included in the results of operations since the
acquisition date. The purchase price was allocated to the net assets acquired
based upon their estimated fair market values at the date of acquisition. The
excess of the purchase price over the estimated fair value of the net assets
acquired was $21.4 million, which has been recorded as goodwill.
The balances included in the September 30, 1999 Consolidated Balance Sheet
related to these acquisitions are based upon preliminary information and are
subject to change when additional information concerning final asset and
liability valuations are obtained. Material changes in the preliminary
allocations are not anticipated by management.
4
<PAGE> 7
The unaudited pro forma supplemental information for the nine months ended
September 30, 1999 and 1998 is presented below (in thousands, except per share
amounts):
<TABLE>
<CAPTION>
For the Nine Months
Ended September 30,
------------------------------
1999 1998
------------- -------------
<S> <C> <C>
Revenues ..................... $ 1,499,028 $ 2,187,409
Net income (loss) ............ $ (1,848) $ 54,654
Earnings (loss) per share:
Basic ...................... $ (0.04) $ 1.12
Diluted .................... $ (0.04) $ 1.11
</TABLE>
As discussed below, the Company recognized an after-tax, non-recurring gain
of $45.0 million, or $0.91 per share, in connection with the M-I Transaction,
which is excluded from the unaudited pro forma supplemental information. 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 combination been in effect at
the date indicated or of future results for the combined entities.
The following schedule summarizes investing activities related to the
business acquisition amount included in the Consolidated Statements of Cash
Flows for the nine months ended September 30, 1999 (in thousands):
<TABLE>
<S> <C>
Fair value of assets, net of cash acquired ................ $229,434
Goodwill recorded ......................................... 62,795
Note payments related to acquisitions ..................... 280,500
Less: Total liabilities and minority interest assumed .... 248,412
Less: Common stock issued for consideration .............. 23,724
--------
Acquisition of businesses, net of cash acquired ........... $300,593
========
</TABLE>
3) GAIN ON SALE AND OTHER NON-RECURRING ITEMS
During the third quarter of 1999, the Company recognized a non-recurring
gain of $81.4 million ($45.0 million, or $0.91 per share, after-tax) associated
with the M-I Transaction in accordance with the provisions of Staff Accounting
Bulletin No. 51. The non-recurring gain is presented net of transaction-related
charges of $25.4 million, including profit sharing and incentive requirements,
professional fees and other related costs. Additionally, in the first quarter of
1999, the Company recorded a non-recurring net gain of $2.6 million ($0.2
million after-tax) related to a combination of a gain on disposal of an
industrial bentonite mining operation offset by unrelated charges to write-off
certain assets and settle a customer receivable.
During 1998, the Company recorded a charge of $55.0 million ($37.2 million,
or $0.77 per share, after-tax) related to the acquisition and integration of the
Wilson Industries, Inc. operations and various restructuring efforts.
5
<PAGE> 8
4) EARNINGS PER SHARE
Basic earnings per share ("EPS") is computed using the weighted average
number of common shares outstanding during the period. Diluted EPS gives effect
to the potential dilution of earnings which could have occurred if additional
shares were issued for stock option exercises under the treasury stock method.
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,
------------------------- -------------------------
1999 1998 1999 1998
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
BASIC EPS
Net income ......................... $ 46,860 $ 24,053 $ 50,445 $ 50,138
========== ========== ========== ==========
Weighted average number of common
shares outstanding ............... 48,835 48,129 48,474 47,833
---------- ---------- ---------- ----------
Basic earnings per share ........... $ 0.96 $ 0.50 $ 1.04 $ 1.05
========== ========== ========== ==========
DILUTED EPS
Net income ......................... $ 46,860 $ 24,053 $ 50,445 $ 50,138
========== ========== ========== ==========
Weighted average number of common
shares outstanding ............... 48,835 48,129 48,474 47,833
Dilutive effect of stock options ... 636 282 608 425
---------- ---------- ---------- ----------
49,471 48,411 49,082 48,258
---------- ---------- ---------- ----------
Diluted earnings per share ......... $ 0.95 $ 0.50 $ 1.03 $ 1.04
========== ========== ========== ==========
</TABLE>
5) COMPREHENSIVE INCOME
The Company's comprehensive income, which encompasses net operating results
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,
----------------------- -----------------------
1999 1998 1999 1998
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Net income ........................ $ 46,860 $ 24,053 $ 50,445 $ 50,138
Currency translation adjustments .. 2,380 1,257 649 620
--------- --------- --------- ---------
Comprehensive income .............. $ 49,240 $ 25,310 $ 51,094 $ 50,758
========= ========= ========= =========
</TABLE>
6
<PAGE> 9
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,
1999 1998
------------- ------------
<S> <C> <C>
Raw materials ................................... $ 41,081 $ 43,612
Work-in-process ................................. 44,649 57,913
Products purchased for resale ................... 100,265 72,444
Finished goods .................................. 316,822 313,597
---------- ----------
502,817 487,566
Reserves to state certain domestic inventories
($232,149 and $221,653 in 1999 and 1998,
respectively) on a LIFO basis ............... (25,530) (21,861)
---------- ----------
Inventories, net ................................ $ 479,287 $ 465,705
========== ==========
</TABLE>
7) DEBT
The following summarizes the Company's outstanding debt (in thousands):
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
------------- ------------
<S> <C> <C>
Current:
Short-term notes payable ................. $ -- $ 259,922
Short-term bank borrowings ............... 30,135 63,036
Current portion of long-term debt ........ 22,530 22,295
---------- ----------
$ 52,665 $ 345,253
---------- ----------
Long-term:
Notes, net of unamortized discount ....... $ 274,733 $ 279,750
Bank revolvers payable ................... 49,631 75,600
Term loans ............................... 29,378 35,768
---------- ----------
353,742 391,118
Less current portion of long-term debt ... (22,530) (22,295)
---------- ----------
Long-term debt ........................... $ 331,212 $ 368,823
========== ==========
</TABLE>
At December 31, 1998, the Company's short-term borrowings included the
discounted value of a note payable to Halliburton Company ("Halliburton") issued
in connection with the acquisition of the remaining 36 percent interest in M-I.
The note matured and was repaid in 1999.
8) LITIGATION
On October 29, 1996, the Company was served with a complaint in the United
States District Court entitled Rock Bit International, Inc. v. Smith
International, Inc. This lawsuit is a patent infringement dispute alleging that
drill bits made by the Company infringe a U.S. patent owned by Rock Bit
International, Inc. ("RBI") which was issued on September 8, 1992. RBI alleges
that the Company infringes its patent by making and selling certain three-cone
rock bits having cutting structures covered by the claims of RBI's patent. On
September 30, 1999, the United States District Court granted the Company's
motion for summary judgement and entered a Final Judgement holding the asserted
claims of the RBI patent invalid. RBI has filed a Notice of Appeal.
7
<PAGE> 10
On July 27, 1999, the United States Department of Justice filed petitions
with the United States District Court in Washington, D.C. alleging civil and
criminal contempt in connection with the formation of the Company's drilling
fluids joint venture. The petitions allege that the Company and Schlumberger
violated a Consent Decree and Final Order issued in 1994 in United States v.
Baroid Corporation. The Company agreed to be bound by the Consent Decree in
connection with the purchase of the majority ownership interest in M-I which was
acquired in April 1994. The Justice Department's petitions request that the
Court rescind the transaction, fine the Company $100,000 per day for violations
under the Consent Decree and levy an appropriate fine against the Company under
the criminal pleading. The Company has been advised that it has a strongly
defensible position as the transaction did not involve any of Schlumberger's
U.S. drilling fluids assets or businesses, had no significant impact on U.S.
business and, therefore, was not subject to the terms of the Consent Decree. The
Company does not anticipate that the outcome of a hearing on this matter, which
is currently scheduled for the later portion of November 1999, will have a
material adverse impact on the Company's consolidated financial position or
results of operations.
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. 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 manufacture and sale of premium
products and services to the oil and gas industry's exploration and production
sectors. 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, packers and liner hangers. The Company also operates an
extensive network of supply branches through which it markets pipe, 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 energy prices but may also be affected by expectations
related to the worldwide supply of and demand for crude oil and natural gas,
finding and development costs, decline and depletion rates, political actions
and uncertainties, environmental concerns, capital expenditure plans of
exploration and production companies and the overall level of global economic
growth and activity.
The Company's reported results continue to be impacted by the decline in
worldwide drilling activity which reached historically low levels in the second
quarter of 1999. While land-based drilling activity in North America increased
during the third quarter in response primarily to natural gas pricing,
exploration and production activity outside North America continues to remain
depressed and may not improve in the near-term. The continuation and strength
of the recovery in exploration and production activity in North America will
depend upon the long-term outlook for energy prices and customer spending
levels. The timing and extent of improvement in demand for the various products
and services offered by the Company may vary based on the nature and extent of
future exploration and production activities.
RECENT DEVELOPMENTS
On July 25, 1999, the Company completed a transaction with Schlumberger
Limited ("Schlumberger") related to the combination of certain M-I L.L.C.
("M-I") and Dowell drilling fluids operations under a joint venture arrangement.
Schlumberger contributed their non-U.S. Dowell drilling fluid operations,
including an asset equalization payment of $41 million, and paid cash
consideration of $280 million to the Company in exchange for a 40 percent
minority ownership interest in the combined operations (collectively, the "M-I
Transaction"). Proceeds from the transaction were used to reduce outstanding
borrowings of the Company.
The operations acquired in the M-I Transaction has been accounted for under
the purchase method of accounting and, accordingly, have been included in the
results of operations since July 25, 1999. In connection with the M-I
Transaction, the Company recognized a non-recurring gain of $81.4 million ($45.0
million, or $0.91 per share, after-tax) which is presented net of
transaction-related charges.
On May 28, 1999, the Company acquired certain operations of ConEmsco, Inc.
("CE") and CE's majority ownership interest in CE Franklin, Ltd. (collectively,
the "ConEmsco Transaction"), businesses primarily engaged in oilfield supply and
distribution in the United States and Canada. In connection with the
acquisition, the Company issued 548,527 shares of common stock and a $30.0
million note payable to the seller which was repaid prior to September 30, 1999.
In the second quarter of 1999, the Company also divested of Wilson's Oil Country
Tubular Goods ("OCTG") operations and received cash proceeds of $14.6 million.
9
<PAGE> 12
RESULTS OF OPERATIONS
REVENUES
Although the Company provides products to the petrochemical industry and
certain industrial markets, the majority of the Company's revenues are derived
from sales to the oil and gas exploration and production industry. The Company
operates through five business units which market the Company's products and
services throughout the world. The following table presents revenue and average
rig count information for the periods shown (in thousands, except rig count and
percentage information).
<TABLE>
<CAPTION>
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
---------------------------------------- ----------------------------------------
1999 1998 1999 1998
-------------------- ------------------- ------------------ ---------------------
Amount % Amount % Amount % Amount %
-------------------- ------------------- ------------------ ---------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues by Business Unit:
M-I - Fluids ............... $ 188,567 39 $ 209,436 40 $ 528,119 42 $ 664,905 40
M-I - SWACO ................ 23,077 5 39,185 8 73,318 6 112,374 7
Wilson Supply .............. 155,269 32 117,057 22 325,905 26 381,280 23
Smith Bits ................. 59,720 12 71,769 14 174,439 14 242,948 15
Smith Services ............. 54,908 12 82,762 16 166,477 12 255,384 15
---------- --- ---------- --- ---------- --- ---------- ---
Total .............. $ 481,541 100 $ 520,209 100 $1,268,258 100 $1,656,891 100
========== === ========== === ========== === ========== ===
Revenues by Area:
U.S ........................ $ 226,071 47 $ 242,126 47 $ 594,124 47 $ 807,340 49
Export ..................... 21,585 4 42,703 8 70,030 6 134,127 8
Non-U.S .................... 233,885 49 235,380 45 604,104 47 715,424 43
---------- --- ---------- --- ---------- --- ---------- ---
Total .............. $ 481,541 100 $ 520,209 100 $1,268,258 100 $1,656,891 100
========== === ========== === ========== === ========== ===
Average Active Rig Count:
U.S ........................ 641 794 570 875
Canada ..................... 253 205 216 280
Non-North America .......... 565 728 593 779
---------- ----------- ---------- ----------
Total .............. 1,459 1,727 1,379 1,934
========== ========== ========== ==========
</TABLE>
M-I-FLUIDS
M-I-Fluids, a division of M-I, provides drilling fluid and completion fluid
systems, engineering and technical services to the oil and gas industry.
M-I-Fluids revenues decreased $20.9 million, or 10 percent, from the third
quarter of 1998 and $136.8 million, or 21 percent, from the first nine months of
1998. The majority of the revenue decline from the prior year periods related to
reduced customer spending outside of North America, primarily Latin America and
Europe/Africa, which was associated with the significant decline in drilling
activity. Completion of the M-I Transaction discussed above, resulted in an
increase in revenues outside the United States, and partially offset the impact
of the decline in activity from 1998 levels.
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. Due to the further integration of solids control and waste
management services in the INTEGRATED FLUIDS ENGINEERING(SM) program, the two
M-I business units will be combined for reporting purposes in future periods.
M-I-SWACO revenues decreased $16.1 million, or 41 percent, and $39.1 million, or
35 percent, from the third quarter and first nine months of 1998, respectively.
The revenue decline from the comparable periods of 1998 primarily related to
lower demand for fluid processing equipment and services. On a geographic basis,
the largest portion of the decline was reported in the United States,
Europe/Africa and Latin America which related to a combination of decreased
activity levels and reduced capital spending by its customers.
10
<PAGE> 13
WILSON SUPPLY
Wilson Supply markets pipe, valves and other capital and expendable
maintenance products to the petroleum and petrochemical industries primarily
through an extensive network of North American supply branches. Wilson Supply's
revenues increased $38.2 million, or 33 percent, from the third quarter of 1998
and decreased $55.4 million, or 15 percent, from the first nine months of 1998.
The increase in revenues from the third quarter of 1998 reflects the CE
Transaction which was partially offset by the impact of the sale of Wilson's
OCTG operations in June 1999 and lower product sales to the upstream sector. For
the nine month period, the decline in revenues reflects lower branch sales due
to the lower activity levels and the OCTG divestiture, partially offset by
incremental revenues from the operations acquired in the second quarter of 1999.
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
operations manufacture polycrystalline diamond and cubic boron nitride materials
which are used in drill bits and in other specialized cutting tools. Smith Bits
revenues decreased $12.0 million, or 17 percent, from the third quarter of 1998
and $68.5 million, or 28 percent, from the first nine months of 1998. The
majority of the decline from the prior year periods related to lower sales of
petroleum three-cone bits associated with the decrease in activity levels in
Europe/Africa and the United States.
SMITH SERVICES
Smith Services manufactures and markets products and services used in the
oil and gas industry for drilling, workover, well completion and well re-entry.
Smith Services' revenues decreased $27.9 million, or 34 percent, from the third
quarter of 1998 and $88.9 million, or 35 percent, from the first nine months of
1998. The revenue decline from the prior year periods primarily related to lower
tubular sales and decreased demand for remedial products and services in the
United States and Europe/Africa.
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 (in
thousands, except percentage data):
<TABLE>
<CAPTION>
For the Three Months Ended For the Nine Months Ended
September 30, September 30,
-------------------------------------- -----------------------------------------
1999 1998 1999 1998
----------------- ------------------ ------------------ -------------------
Amount % Amount % Amount % Amount %
----------------- ------------------ ------------------ -------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues .......................... $ 481,541 100 $ 520,209 100 $ 1,268,258 100 $ 1,656,891 100
---------- --------- ----------- -----------
Gross profit ...................... 118,836 25 154,565 30 328,860 26 509,287 31
Operating expenses ................ 104,497 22 102,596 20 287,617 23 318,227 20
Gain on sale and other
non-recurring items ............. (81,378) (17) -- -- (83,999) (7) 55,000 3
---------- --- --------- --- ----------- --- ----------- --
---
Income before interest and taxes .. 95,717 20 51,969 10 125,242 10 136,060 8
Interest expense, net ............. 7,816 2 11,388 2 31,188 3 30,314 2
---------- --- --------- --- ----------- --- ----------- ---
Income before income taxes and
minority interests .............. 87,901 18 40,581 8 94,054 7 105,746 6
Income tax provision .............. 38,549 8 12,515 2 42,044 3 34,151 2
---------- --- --------- --- ----------- --- ----------- ---
Income before minority interests .. 49,352 10 28,066 6 52,010 4 71,595 4
Minority interests ................ 2,492 -- 4,013 1 1,565 -- 21,457 1
---------- --- --------- --- ----------- --- ----------- ---
Net income ........................ $ 46,860 10 $ 24,053 5 $ 50,445 4 $ 50,138 3
========== === ========= === =========== === =========== ===
</TABLE>
Total revenues decreased $38.7 million, or 7 percent, from the prior year
quarter and $388.6 million, or 23 percent, from the first nine months of 1998.
Lower oil prices experienced in the last half of 1998 continue to impact
activity levels, contributing to reduced demand for the Company's products and
services. Although crude oil prices have posted a significant recovery during
1999, activity levels have been slow to respond as operators continue to delay
oil-related drilling programs. The majority of the revenue decline from the
third quarter of 1998 related to decreased volumes in Europe/Africa associated
with the continuing decline in drilling activity in that region. For the
nine-month period, over half of the revenue decrease was reported in the U.S.
and was attributable to reduced customer spending for land-based drilling
projects. The revenue decline in both periods was partially offset by
incremental revenues from the ConEmsco Transaction and, to a lesser extent,
increased sales associated with the drilling fluids joint venture. On a
geographic basis, acquisitions and base business growth in the oilfield
distribution operations, which are primarily concentrated in North America, have
resulted in the Company's North American revenues increasing to 60 percent of
total revenues in the third quarter of 1999.
Gross profit as a percentage of revenues decreased from 30 percent and 31
percent in the third quarter and first nine months of the prior year,
respectively, to 25 percent and 26 percent in the third quarter and first nine
months of 1999, respectively. The variance in gross profit margins reflects the
impact of the lower revenues on fixed cost coverage, with decreased
manufacturing volumes and rental equipment utilization contributing to the
majority of the overall margin decline. To a lesser extent, competitive pricing
pressures in certain markets in which the Company participates and an increased
proportion of oilfield supply and distribution revenues, which traditionally
generate lower gross profit margins, have contributed to the decline in gross
profit margins.
Operating expenses, consisting of selling, general and administrative
expenses, increased $1.9 million from the third quarter of 1998 reflecting the
incremental costs associated with the acquired operations, partially offset by a
reduction in variable costs associated with the decline in activity. Operating
expenses decreased $30.6 million from the first nine months of 1998, reflecting
a reduction in variable costs associated with the lower volumes, including
reduced headcount levels and other cost control measures implemented in response
to the activity level declines experienced in the last half of 1998.
Non-recurring items increased income before interest and taxes by $81.4
million over the three-month period and $139.0 million when compared to the
first nine months of 1998. During the third quarter of 1999, the Company
recognized a non-recurring gain of $81.4 million ($45.0 million after-tax)
associated with the M-I Transaction. The non-recurring gain is presented net of
transaction-related charges of $25.4 million, including profit sharing and
incentive requirements, professional fees and other related costs. Additionally,
in the first quarter of 1999, the Company recorded a non-recurring net gain of
$2.6 million ($0.2 million
12
<PAGE> 15
after-tax) related to a combination of a gain on disposal of an industrial
bentonite mining operation offset by unrelated charges to write-off certain
assets and settle a customer receivable. During 1998, the Company recorded a
charge of $55.0 million ($37.2 million after-tax) related to the acquisition and
integration of the Wilson Industries, Inc. operations and various restructuring
efforts.
Net interest expense, which represents interest expense less interest
income, decreased $3.6 from the third quarter of 1998 and increased $0.9 million
from the first nine months of 1998. The interest expense decline for the
three-month period relates primarily to the impact of the M-I Transaction as
proceeds were utilized to repay outstanding borrowings. Higher interest expense
amounts associated with the purchase of Halliburton's minority ownership
interest in M-I accounted for the increase over the first nine months of 1998.
The interest amounts associated with the minority interest purchase were
partially offset by increased repayments of borrowings under revolving credit
facilities.
The effective tax rate for the first nine months of 1999 approximated 45
percent, which was an increase from the 32 percent rate reported in the
comparable period of the prior year and higher than the U.S. statutory rate. The
rate exceeded both the prior year effective rate and the statutory rate due
primarily to the inclusion of non-deductible costs associated with the M-I
Transaction and the sale of one of the Company's mining operations.
Minority interests reflect the portion of the results of majority-owned
operations which are applicable to the minority interest partners. For the prior
year periods, minority interests amounts primarily represent the share of M-I
profits associated with the former minority partner's interest in those
operations. The variance from the third quarter of 1998 primarily relates to the
lower profitability of the M-I operations. The decrease for the nine-month
period relates to the impact of purchasing Halliburton's ownership interest in
M-I, which was acquired in August 1998, and lower profitability of the M-I
operations.
LIQUIDITY AND CAPITAL RESOURCES
General
Cash and cash equivalents increased $5.6 million during the nine-month
period to $28.3 million at September 30, 1999. The Company's operations
generated $64.0 million of cash flows in the first nine months of 1999, a $17.0
million increase over the amounts reported in the prior year period. The effect
of the decline in drilling activity on the Company's operations has favorably
impacted working capital levels, with decreased base-business inventory and
receivable levels contributing to the increase in operating cash flow from the
first nine months of 1998. Cash proceeds received by the Company during the
third quarter of 1999 in connection with the M-I Transaction were used to reduce
outstanding borrowings.
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 $211.6 million at September 30, 1999. The Company believes funds generated
from operations and amounts available under existing credit facilities will be
sufficient to finance capital expenditures and working capital needs of the
existing operations for the foreseeable future. Management continues to evaluate
opportunities to acquire products or businesses 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.
On October 29, 1996, the Company was served with a complaint in the U.S.
District Court entitled Rock Bit International, Inc. v. Smith International,
Inc. This lawsuit is a patent infringement dispute alleging that drill bits made
by the Company infringe a U.S. patent owned by Rock Bit International, Inc.
("RBI") which was issued on September 8, 1992. RBI alleges that the Company
infringes its patent by making and selling certain three-cone rock bits having
cutting structures covered by the claims of RBI's patent. On September 30,1999,
the United States District Court granted the Company's motion for summary
judgement and entered a Final Judgement holding the asserted claims of the RBI
patent invalid. RBI has filed a Notice of Appeal.
13
<PAGE> 16
On July 27, 1999, the United States Department of Justice filed petitions
with the United States District Court in Washington, D.C. alleging civil and
criminal contempt in connection with the formation of the Company's drilling
fluids joint venture. The petitions allege that the Company and Schlumberger
violated a Consent Decree and Final Order issued in 1994 in United States v.
Baroid Corporation. The Company agreed to be bound by the Consent Decree in
connection with the purchase of the majority ownership interest in M-I which was
acquired in April 1994. The Justice Department's petitions request that the
Court rescind the transaction, fine the Company $100,000 per day for violations
under the Consent Decree and levy an appropriate fine against the Company under
the criminal pleading. The Company has been advised that it has a strongly
defensible position as the transaction did not involve any of Schlumberger's
U.S. drilling fluids assets or businesses, had no significant impact on U.S.
business and, therefore, was not subject to the terms of the Consent Decree. The
Company does not anticipate that the outcome of a hearing on this matter, which
is currently scheduled for the later portion of November 1999, will have a
material adverse impact on the Company's consolidated financial position or
results of operations.
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, 2000. 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 position or results of
operations.
In the first quarter of 1999, the Company adopted Statement of Position 98-5
("SOP 98-5"), "Reporting on the Costs of Start-Up Activities". The statement
requires costs of start-up activities and organization costs to be expensed as
incurred. The adoption did not have a material adverse impact on the Company's
financial position or results of operations.
YEAR 2000
The Company believes it has achieved its objective of Year 2000 compliance
for critical business systems and continues to test and certify system readiness
and implement modifications to its non-critical business systems in order to
achieve Year 2000 date conversion compliance without an effect on customers or
business operations.
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 have and 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 1998 and subsequent product
upgrades. As of September 30, 1999, all of the Company's critical systems were
Year 2000 compliant and the substantially all of the Company's non-critical
systems were Year 2000 compliant. Although the Company continues to install new
applications and upgrade existing ones in order to bring non-critical
applications for international locations into compliance, migration or
replacement plans are currently in place for these systems. Additionally, if
certain of these non-critical systems are not addressed until early 2000,
non-compliance would not have a material impact on the Company's operations. As
of September 30, 1999, the Company estimates that the implementation and testing
process for both Information Technology ("IT") and non-IT systems was over 95
percent complete. Although the Company continues to address non-critical
systems, the remainder of the year will be primarily focused on ensuring
critical business continuity plans are adequate and ready to implement if
necessary.
The Company has communicated with major suppliers, financial institutions
and others with whom it does business to address their compliance efforts and
the Company's exposure in the event of the failure of these efforts. The Company
has validated the responses received, and is in the final stage of collecting
additional vendor information as warranted. The Company has determined that its
key suppliers and financial institutions are Year 2000 compliant. However, in
the event of non-compliance of any of these suppliers or financial institutions,
a written contingency program has been developed. Management continues to
believe that non-compliance by the Company's suppliers is
14
<PAGE> 17
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 related to achieving Year 2000 compliance are not
expected to have a material impact on the Company's financial condition or
results of operations. All expenditures related to the Year 2000 initiative will
be funded with cash flows from operations.
ITEM 3. QUALITATIVE AND QUANTITATIVE MARKET RISK DISCLOSURES
The Company is exposed to certain market risks arising from transactions
that are entered into in the normal course of business. These risks, which are
primarily related to interest rate changes and fluctuations in foreign exchange
rates, are not considered to be material to the Company. During the reporting
period, no events or transactions have occurred which would materially change
the information disclosed in the Company's Annual Report on Form 10-K.
15
<PAGE> 18
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On July 27, 1999, the United States Department of Justice filed petitions
with the United States District Court in Washington, D.C. alleging civil and
criminal contempt in connection with the formation of the Company's drilling
fluids joint venture. The petitions allege that the Company and Schlumberger
violated a Consent Decree and Final Order issued in 1994 in United States v.
Baroid Corporation. The Company agreed to be bound by the Consent Decree in
connection with the purchase of the majority ownership interest in M-I which was
acquired in April 1994. The Justice Department's petitions request that the
Court rescind the transaction, fine the Company $100,000 per day for violations
under the Consent Decree and levy an appropriate fine against the Company under
the criminal pleading. The Company has been advised that it has a strongly
defensible position as the transaction did not involve any of Schlumberger's
U.S. drilling fluids assets or businesses, had no significant impact on U.S.
business and, therefore, was not subject to the terms of the Consent Decree. The
Company does not anticipate that the outcome of a hearing on this matter, which
is currently scheduled for the later portion of November 1999, will have a
material adverse impact on the Company's consolidated financial position or
results of operations.
On October 29, 1996, the Company was served with a complaint in the United
States District Court entitled Rock Bit International, Inc. v. Smith
International, Inc. This lawsuit is a patent infringement dispute alleging that
drill bits made by the Company infringe a U.S. patent owned by Rock Bit
International, Inc. ("RBI") which was issued on September 8, 1992. RBI alleges
that the Company infringes its patent by making and selling certain three-cone
rock bits having cutting structures covered by the claims of RBI's patent. On
September 30, 1999, the United States District Court granted the Company's
motion for summary judgement and entered a Final Judgement holding the asserted
claims of the RBI patent invalid. RBI has filed a Notice of Appeal.
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
(27) Financial Data Schedules.
27.1 Financial Data Schedule for the nine month period ended
September 30, 1999.
(b) Reports on Form 8-K
The Registrant filed a Form 8-K dated July 14, 1999, and, as
amended September 27, 1999, reporting under "Item 5. Other
Events", related to a press release announcing the completion of
a transaction with Schlumberger Limited related to the
combination of certain M-I and non-U.S. Dowell drilling fluid
operations.
The Registrant filed a Form 8-K dated July 28, 1999,
reporting under "Item 5. Other Events" related to a press release
announcing petitions filed against the Company by the United
States Justice Department.
16
<PAGE> 19
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 12, 1999 By: /s/ Douglas L. Rock
----------------------- ----------------------------------------
Douglas L. Rock
Chairman of the Board, Chief Executive
Officer, President and Chief Operating
Officer
Date: November 12, 1999 By: /s/ Margaret K. Dorman
----------------------- ----------------------------------------
Margaret K. Dorman
Senior Vice President and
Chief Financial Officer
(Principal Accounting Officer)
<PAGE> 20
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- ------------
<S> <C>
27.1 Financial Data Schedule for the nine month period ended
September 30, 1999.
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 28,289
<SECURITIES> 0
<RECEIVABLES> 445,217
<ALLOWANCES> 11,653
<INVENTORY> 479,287
<CURRENT-ASSETS> 1,009,032
<PP&E> 692,024
<DEPRECIATION> 306,860
<TOTAL-ASSETS> 1,848,240
<CURRENT-LIABILITIES> 426,559
<BONDS> 331,212
0
0
<COMMON> 49,570
<OTHER-SE> 664,222
<TOTAL-LIABILITY-AND-EQUITY> 1,848,240
<SALES> 1,268,258
<TOTAL-REVENUES> 1,268,258
<CGS> 939,398
<TOTAL-COSTS> 939,398
<OTHER-EXPENSES> 203,967
<LOSS-PROVISION> 1,216
<INTEREST-EXPENSE> 31,188
<INCOME-PRETAX> 92,489
<INCOME-TAX> 42,044
<INCOME-CONTINUING> 50,445
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 50,445
<EPS-BASIC> 1.04
<EPS-DILUTED> 1.03
</TABLE>
