NOV Inc. - Quarter Report: 2005 September (Form 10-Q)
Table of Contents
FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark one)
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTER ENDED SEPTEMBER 30, 2005 OR |
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission file number 1-12317
NATIONAL OILWELL VARCO, INC.
(Exact name of registrant as specified in its charter)
Delaware | 76-0475815 | |
(State or other jurisdiction | (I.R.S. Employer | |
of incorporation or organization) | Identification No.) |
10000 Richmond Avenue
Houston, Texas
77042-4200
Houston, Texas
77042-4200
(Address of principal executive offices)
(713) 346-7500
(Registrants telephone number, including area code)
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 þ NOo
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of
the Act).
Yes þ No o
Yes þ No o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act).
Yes o No þ
Yes o No þ
As of October 24, 2005, 174,300,704 common shares were outstanding.
TABLE OF CONTENTS
Table of Contents
ITEM 1. Financial Statements
NATIONAL OILWELL VARCO, INC.
CONSOLIDATED BALANCE SHEETS
(In millions, except share data)
(In millions, except share data)
September 30, | December 31, | |||||||
2005 | 2004 | |||||||
(Unaudited) | ||||||||
ASSETS |
||||||||
Current assets: |
||||||||
Cash and cash equivalents |
$ | 162.2 | $ | 142.7 | ||||
Receivables, net |
989.1 | 480.1 | ||||||
Inventories, net |
1,110.9 | 657.5 | ||||||
Costs in excess of billings |
328.3 | 226.5 | ||||||
Deferred income taxes |
60.1 | 15.6 | ||||||
Prepaid and other current assets |
57.8 | 15.0 | ||||||
Total current assets |
2,708.4 | 1,537.4 | ||||||
Property, plant and equipment, net |
840.1 | 255.1 | ||||||
Deferred income taxes |
59.7 | 55.1 | ||||||
Goodwill |
2,130.2 | 639.0 | ||||||
Intangibles, net |
607.2 | 91.0 | ||||||
Other assets |
22.4 | 21.1 | ||||||
$ | 6,368.0 | $ | 2,598.7 | |||||
LIABILITIES AND STOCKHOLDERS EQUITY |
||||||||
Current liabilities: |
||||||||
Accounts payable |
$ | 483.8 | $ | 407.7 | ||||
Accrued liabilities |
380.3 | 209.5 | ||||||
Current portion of long-term debt and short-term borrowings |
4.6 | 150.0 | ||||||
Accrued income taxes |
32.9 | 33.0 | ||||||
Total current liabilities |
901.6 | 800.2 | ||||||
Long-term debt |
841.0 | 350.0 | ||||||
Deferred income taxes |
388.7 | 102.8 | ||||||
Other liabilities |
87.9 | 31.5 | ||||||
Total liabilities |
2,219.2 | 1,284.5 | ||||||
Commitments and contingencies |
||||||||
Minority interest |
22.1 | 17.8 | ||||||
Stockholders equity: |
||||||||
Common stock par value $.01; 174,202,589 and 85,995,266 shares
issued and outstanding at September 30, 2005 and December 31, 2004 |
1.7 | 0.9 | ||||||
Additional paid-in capital |
3,395.9 | 692.9 | ||||||
Unearned stock-based compensation |
(21.4 | ) | | |||||
Accumulated other comprehensive income (loss) |
(4.0 | ) | 33.4 | |||||
Retained earnings |
754.5 | 569.2 | ||||||
4,126.7 | 1,296.4 | |||||||
$ | 6,368.0 | $ | 2,598.7 | |||||
See notes to unaudited consolidated financial statements.
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NATIONAL OILWELL VARCO, INC.
QUARTERLY CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
(In millions, except per share data)
(In millions, except per share data)
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||
Revenue |
$ | 1,236.5 | $ | 618.9 | $ | 3,267.1 | $ | 1,648.6 | ||||||||
Cost of revenue |
977.8 | 487.0 | 2,591.4 | 1,295.5 | ||||||||||||
Gross profit |
258.7 | 131.9 | 675.7 | 353.1 | ||||||||||||
Selling, general, and administrative |
106.1 | 82.8 | 328.9 | 239.9 | ||||||||||||
Stock-based compensation |
4.8 | | 10.7 | | ||||||||||||
Transaction costs |
2.8 | | 23.1 | | ||||||||||||
Operating profit |
145.0 | 49.1 | 313.0 | 113.2 | ||||||||||||
Interest and financial costs |
(14.6 | ) | (9.8 | ) | (39.4 | ) | (28.7 | ) | ||||||||
Interest income |
1.0 | 1.1 | 3.5 | 2.4 | ||||||||||||
Other income (expense), net |
1.1 | (1.2 | ) | 1.5 | (1.5 | ) | ||||||||||
Income before income taxes and minority interest |
132.5 | 39.2 | 278.6 | 85.4 | ||||||||||||
Provision for income taxes |
42.4 | 10.7 | 90.2 | 24.1 | ||||||||||||
Income before minority interest |
90.1 | 28.5 | 188.4 | 61.3 | ||||||||||||
Minority interest in income of consolidated
subsidiaries |
1.6 | 0.7 | 3.1 | 1.1 | ||||||||||||
Net income |
$ | 88.5 | $ | 27.8 | $ | 185.3 | $ | 60.2 | ||||||||
Net income per share: |
||||||||||||||||
Basic |
$ | 0.51 | $ | 0.32 | $ | 1.23 | $ | 0.70 | ||||||||
Diluted |
$ | 0.50 | $ | 0.32 | $ | 1.22 | $ | 0.70 | ||||||||
Weighted average shares outstanding: |
||||||||||||||||
Basic |
173.7 | 85.9 | 150.5 | 85.7 | ||||||||||||
Diluted |
175.9 | 86.7 | 152.2 | 86.3 | ||||||||||||
See notes to unaudited consolidated financial statements.
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NATIONAL OILWELL VARCO, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(In millions)
(In millions)
Nine Months Ended | ||||||||
September 30, | ||||||||
2005 | 2004 | |||||||
Cash flow from operating activities: |
||||||||
Net income |
$ | 185.3 | $ | 60.2 | ||||
Adjustments to reconcile net income to net cash provided
(used) by operating activities: |
||||||||
Depreciation and amortization |
86.1 | 32.8 | ||||||
Tax benefit from exercise of nonqualified stock options |
29.1 | 3.1 | ||||||
Other |
20.6 | 1.7 | ||||||
Changes in assets and liabilities, net of acquisitions: |
||||||||
Receivables |
(132.3 | ) | (3.3 | ) | ||||
Inventories |
(96.9 | ) | (44.6 | ) | ||||
Costs in excess of billings |
(110.1 | ) | (48.8 | ) | ||||
Prepaid and other current assets |
(16.7 | ) | 21.9 | |||||
Accounts payable |
(23.6 | ) | 16.2 | |||||
Billings in excess of costs |
(10.1 | ) | 1.1 | |||||
Other assets/liabilities, net |
44.7 | 39.4 | ||||||
Net cash provided (used) by operating activities |
(23.9 | ) | 79.7 | |||||
Cash flow from investing activities: |
||||||||
Purchases of property, plant and equipment |
(67.8 | ) | (23.5 | ) | ||||
Cash acquired in Varco merger |
163.5 | | ||||||
Other |
(9.8 | ) | 16.4 | |||||
Net cash provided (used) by investing activities |
85.9 | (7.1 | ) | |||||
Cash flow from financing activities: |
||||||||
Borrowing against lines of credit |
336.7 | 409.3 | ||||||
Payments against lines of credit and other debt |
(483.3 | ) | (494.1 | ) | ||||
Proceeds from stock options exercised |
107.4 | 14.1 | ||||||
Net cash used by financing activities |
(39.2 | ) | (70.7 | ) | ||||
Effect of exchange rate loss on cash |
(3.3 | ) | (2.7 | ) | ||||
Net increase (decrease) in cash and cash equivalents |
19.5 | (0.8 | ) | |||||
Cash and cash equivalents, beginning of period |
142.7 | 74.2 | ||||||
Cash and cash equivalents, end of period |
$ | 162.2 | $ | 73.4 | ||||
Supplemental disclosures of cash flow information: |
||||||||
Cash payments during the period for: |
||||||||
Interest |
$ | 32.2 | $ | 27.7 | ||||
Income taxes |
$ | 77.4 | $ | 16.9 |
See notes to unaudited consolidated financial statements.
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NATIONAL OILWELL VARCO, INC.
Notes to Consolidated Financial Statements (Unaudited)
1. Basis of Presentation
The preparation of financial statements in conformity with accounting principles generally accepted
in the United States requires management to make estimates and assumptions that affect reported and
contingent amounts of assets and liabilities as of the date of the financial statements and
reported amounts of revenues and expenses during the reporting period. Actual results could differ
from those estimates.
The accompanying unaudited consolidated financial statements present information in accordance with
accounting principles generally accepted in the United States for interim financial information and
the instructions to Form 10-Q and applicable rules of Regulation S-X. They do not include all
information or footnotes required by accounting principles generally accepted in the United States
for complete financial statements and should be read in conjunction with our 2004 Annual Report on
Form 10K.
In our opinion, the consolidated financial statements include all adjustments, all of which are of
a normal, recurring nature (except for merger and transaction costs), necessary for a fair
presentation of the results for the interim periods. The results of operations for the three months
and nine months ended September 30, 2005 are not necessarily indicative of the results to be
expected for the full year.
2. Varco Merger
Pursuant to our Amended and Restated Agreement and Plan of Merger with Varco International, Inc.
(Varco), a Delaware corporation, effective as of August 11, 2004 (the Agreement Date), we
issued 0.8363 shares of National Oilwell common stock for each Varco common share on March 11, 2005
(the Merger). We have included the financial results of Varco in our consolidated financial
statements beginning March 11, 2005 (the Merger Date), the date Varco common shares were
exchanged for National Oilwell common shares.
We believe our merger with Varco will better position us to compete more effectively in the global
marketplace and provide greater scale to increase service to our customers, increase our investment
in research and development to accelerate innovation, and increase stockholder value.
The Merger has been accounted for as a purchase business combination. Assets acquired and
liabilities assumed were recorded at their fair values as of March 11, 2005. The total preliminary
purchase price is $2,572.5 million, including the fair value of Varco stock options assumed and
estimated acquisition related transaction costs, and is comprised of (in millions):
Shares issued to acquire the outstanding common stock of Varco (84.0 million
shares
at $29.99 per share) |
$ | 2,518.4 | ||
Fair value of Varco stock options assumed |
48.9 | |||
Unearned compensation related to stock options assumed |
(32.1 | ) | ||
Merger related transaction costs |
37.3 | |||
Total preliminary purchase price |
$ | 2,572.5 | ||
The fair value of shares issued was determined using an average price of $29.99, which represented
the average closing price of our common stock from five trading days before to five trading days
after the Agreement Date. The fair value of options assumed was calculated using the Black-Scholes
valuation model with the following assumptions as of the Merger Date: expected life from vest date
ranging from 0.64 years to 3.6 years, risk-free interest rate of 2.0% 3.1%, expected volatility
of 34% to 47% and no dividend yield. In accordance with our Agreement and Plan of Merger, the
number of Varco options exchanged was determined by multiplying the number of Varco options
outstanding at closing by 0.8363. Approximately 2.2 million of the 4.0 million Varco options
outstanding were fully vested as of the Merger. The portion of the intrinsic value of unvested
Varco options related to future service has been allocated to unearned compensation cost and is
being amortized using the remaining vesting period of 2.3 years. Stock-based compensation expense
of $4.8 million and $10.7 million related to the
amortization of the unvested options was
recognized in the third quarter and first nine months of 2005, respectively.
Merger related transaction costs include severance and other external costs directly related to the
Merger.
Preliminary Purchase Price Allocation
Under the purchase method of accounting, the total preliminary purchase price was allocated to
Varcos net tangible and
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identifiable intangible assets based on their estimated fair values as of
March 11, 2005 as set forth below (in millions). The excess of the purchase price over the net
tangible and identifiable intangible assets was recorded as goodwill. The preliminary allocation of
the purchase price was based upon preliminary valuations and our estimates and assumptions are
subject to change upon the receipt and managements review of the final valuations. The primary
areas of the purchase price allocation which are not yet finalized relate to identifiable
intangible assets; property, plant and equipment; and residual goodwill. In addition, upon the
finalization of the combined companys legal entity structure, additional adjustments to deferred
taxes may be required. The final valuation of net assets is expected to be completed as soon as
possible, but no later than one year from the acquisition date in accordance with GAAP.
Cash and marketable securities |
$ | 163.5 | ||
Trade receivables |
385.3 | |||
Other current assets |
28.5 | |||
Inventory |
378.1 | |||
Property, plant and equipment |
598.6 | |||
Goodwill |
1,493.7 | |||
Intangible assets |
532.1 | |||
Other non-current assets |
11.3 | |||
Accounts payable and accrued liabilities |
(223.9 | ) | ||
Income taxes payable |
(13.7 | ) | ||
Debt |
(492.8 | ) | ||
Deferred tax liabilities, net |
(240.3 | ) | ||
Other non-current liabilities |
(47.9 | ) | ||
Total preliminary purchase price |
$ | 2,572.5 | ||
Pre-Acquisition Contingencies
We have currently not identified any material pre-merger contingencies where a liability is
probable and the amount of the liability can be reasonably estimated. If information becomes
available to us prior to the end of the purchase price allocation period, which would indicate that
it is probable that such events had occurred prior to the Merger Date and the amounts can be
reasonably estimated, such items will be included in the purchase price allocation.
Pro Forma Financial Information
The unaudited financial information in the table below summarizes the combined results of
operations of National-Oilwell and Varco, on a pro forma basis, as though the companies had been
combined as of the beginning of each of the periods presented. The pro forma financial information
is presented for informational purposes only and is not indicative of the results of operations
that would have been achieved if the Merger had taken place at the beginning of each of the periods
presented. The pro forma financial information for the nine months ended September 30, 2005
excludes certain merger-related items such as charges associated with integration expenses,
stock-based compensation charges for unvested options assumed, and severance expenses recorded by
National-Oilwell in its statements of operations related to change in control provisions that were
triggered as part of our Agreement and Plan of Merger in March 2005. The pro forma financial
information for all periods presented includes the business combination accounting effect on
historical Varco revenues, adjustments to depreciation on acquired property, and amortization
charges from acquired intangible assets, and related tax effects.
The unaudited pro forma financial information for the nine months ended September 30, 2005 and 2004
combines the historical results for National-Oilwell for the nine months ended September 30, 2005
and 2004 and the historical results for Varco for the nine months ended September 30, 2005 and 2004
(in millions):
Nine Months Ended September 30, | ||||||||
2005 | 2004 | |||||||
Total revenues |
$ | 3,575.0 | $ | 2,774.2 | ||||
Net income |
$ | 225.9 | $ | 130.7 | ||||
Basic net income per share |
$ | 1.31 | $ | 0.77 | ||||
Diluted net income per share |
$ | 1.30 | $ | 0.77 | ||||
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Other Events
We announced on June 24, 2005 that the merger between National Oilwell and Varco has been
challenged by the Norwegian Competition Authority (NCA). The NCAs objection stipulates that the
Company must divest certain Norwegian subsidiaries owned by National Oilwell prior to the merger,
which conduct business related to the sale and maintenance of drilling equipment. The proposed
remedy as we understand it does not affect businesses in Norway owned by Varco prior to the merger,
nor does it affect National Oilwells business not engaged in the provision of the sale and
maintenance of drilling equipment. We strongly disagree with the NCAs conclusions, and are
actively pursuing an appeal before the Norwegian Ministry of Modernization. We believe that we
will be able to resolve matters with the relevant Norwegian government authorities without any
material impact on the business or operations of the Company. The merger between National Oilwell
and Varco has passed all other applicable anti-trust regulatory agencies around the world, including the
Antitrust Division of the U.S. Department of Justice.
3. Inventories
Inventories consist of (in millions):
September 30, | December 31, | |||||||
2005 | 2004 | |||||||
Raw materials and supplies |
$ | 197.1 | $ | 62.6 | ||||
Work in process |
278.2 | 104.2 | ||||||
Finished goods and purchased products |
635.6 | 490.7 | ||||||
Total |
$ | 1,110.9 | $ | 657.5 | ||||
Inventories at September 30, 2005 includes amounts from the Varco acquisition see Note 2
regarding the Varco Merger.
4. Accrued Liabilities
Accrued liabilities consist of (in millions):
September 30, | December 31, | |||||||
2005 | 2004 | |||||||
Accrued compensation |
$ | 75.1 | $ | 37.0 | ||||
Customer prepayments |
65.4 | 27.9 | ||||||
Billings in excess of costs |
19.8 | 32.0 | ||||||
Other accrued liabilities |
220.0 | 112.6 | ||||||
Total |
$ | 380.3 | $ | 209.5 | ||||
Accrued liabilities at September 30, 2005 includes amounts from the Varco acquisition see Note 2
regarding the Varco Merger.
5. Costs and Estimated Earnings on Uncompleted Contracts
September 30, | December 31, | |||||||
2005 | 2004 | |||||||
Costs incurred on uncompleted contracts |
$ | 1,299.2 | $ | 752.6 | ||||
Estimated earnings |
269.7 | 173.3 | ||||||
1,568.9 | 925.9 | |||||||
Less: Billings to date |
1,260.4 | 731.4 | ||||||
$ | 308.5 | $ | 194.5 | |||||
Costs and estimated earnings in excess of billings on uncompleted contracts |
$ | 328.3 | $ | 226.5 | ||||
Billings in excess of costs and estimated earnings on uncompleted contracts |
(19.8 | ) | (32.0 | ) | ||||
$ | 308.5 | $ | 194.5 | |||||
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6. Comprehensive Income
The components of comprehensive income are as follows (in millions):
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||
Net income |
$ | 88.5 | $ | 27.8 | $ | 185.3 | $ | 60.2 | ||||||||
Currency translation adjustments |
8.8 | 17.5 | (36.9 | ) | 15.4 | |||||||||||
Other |
0.1 | | (0.5 | ) | (0.5 | ) | ||||||||||
Comprehensive income |
$ | 97.4 | $ | 45.3 | $ | 147.9 | $ | 75.1 | ||||||||
7. Business Segments
As a result of the Merger, management has changed its presentation of segment information.
Information for prior periods has been restated on a comparable basis. The following describes our
new business segments:
Rig Technology
Our Rig Technology Group designs, manufactures, sells and services complete rig systems for the
drilling, completion, and remediation of oil and gas wells. The Group offers a comprehensive line
of highly-engineered machinery which automates complex well construction and management operations,
such as offshore and onshore drilling rigs; pipe racking, rotating and assembly systems; coiled
tubing equipment and pressure pumping units; well workover rigs; wireline winches; and cranes.
Demand for the Groups products is primarily dependent upon capital spending plans by drilling
contractors, oilfield service companies, and oil and gas companies, and secondarily on the overall
level of oilfield drilling activity, which drives demand for spare parts for the Groups large
installed base of equipment. We have made strategic acquisitions during the past several years in
an effort to expand our product offering and our global manufacturing capabilities, including new
operations in Norway, the United Kingdom and China.
Petroleum Services & Supplies
Our Petroleum Services & Supplies Group provides a variety of consumable goods and services used to
drill, complete, remediate and workover oil and gas wells, and manage pipelines, flowlines and
other oilfield tubular goods. The Group manufactures, rents and sells a variety of products and
equipment used to perform drilling operations, including solids control systems, drilling motors,
rig instrumentation systems, and drilling mud pump consumables. Demand for these services and
supplies is determined principally by the level of oilfield drilling and workover activity by
drilling contractors, major and independent oil and gas companies, and national oil companies. The
Groups oilfield tubular services include the provision of inspection and internal coating services
and equipment for drillpipe, linepipe, tubing, casing and pipelines, and the design, manufacture
and sale of coiled tubing pipe and advanced composite pipe for application in highly corrosive
environments. The Group sells its tubular goods and services to oil and gas companies; drilling
contractors; pipe distributors; processors and manufacturers; and pipeline operators.
Distribution Services
Our Distribution Services Group provides maintenance, repair and operating supplies and spare parts
to drill site and production locations worldwide. In addition to its comprehensive network of
field locations supporting land drilling operations throughout North America, the Group supports
major offshore drilling contractors through locations in the Middle East, Europe, Southeast Asia
and South America. The Group employs advanced information technologies to provide complete
procurement, inventory management and logistics services to its customers around the globe. Demand
for the Groups services are primarily determined by the level of drilling and remediation
activity, and oil and gas production activities.
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Operating results by segment are as follows (in millions). The 2005 actual results include Varco
operations from the acquisition date of March 11, 2005:
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||
(Restated) | (Restated) | |||||||||||||||
Revenue: |
||||||||||||||||
Rig Technology |
$ | 572.8 | $ | 303.1 | $ | 1,572.4 | $ | 742.6 | ||||||||
Petroleum Services & Supplies |
472.0 | 128.9 | 1,132.6 | 364.9 | ||||||||||||
Distribution Services |
272.4 | 233.3 | 766.3 | 669.8 | ||||||||||||
Eliminations |
(80.7 | ) | (46.4 | ) | (204.2 | ) | (128.7 | ) | ||||||||
Total Revenue |
$ | 1,236.5 | $ | 618.9 | $ | 3,267.1 | $ | 1,648.6 | ||||||||
Operating Profit: |
||||||||||||||||
Rig Technology |
$ | 70.4 | $ | 28.2 | $ | 167.2 | $ | 55.9 | ||||||||
Petroleum Services & Supplies |
87.0 | 16.8 | 198.8 | 47.4 | ||||||||||||
Distribution Services |
14.5 | 8.4 | 31.7 | 20.6 | ||||||||||||
Unallocated expenses and eliminations |
(19.3 | ) | (4.3 | ) | (50.9 | ) | (10.7 | ) | ||||||||
Transaction costs and stock-based
compensation |
(7.6 | ) | | (33.8 | ) | | ||||||||||
Total Operating Profit |
$ | 145.0 | $ | 49.1 | $ | 313.0 | $ | 113.2 | ||||||||
Operating Profit %: |
||||||||||||||||
Rig Technology |
12.3 | % | 9.3 | % | 10.6 | % | 7.5 | % | ||||||||
Petroleum Services & Supplies |
18.4 | % | 13.0 | % | 17.6 | % | 13.0 | % | ||||||||
Distribution Services |
5.3 | % | 3.6 | % | 4.1 | % | 3.1 | % | ||||||||
Total Operating Profit % |
11.7 | % | 7.9 | % | 9.6 | % | 6.9 | % | ||||||||
8. Debt
Debt consists of (in millions):
September 30, | December 31, | |||||||
2005 | 2004 | |||||||
$150.0 million Senior Notes, interest at 6.875% payable semiannually, principal due
on July 1, 2005 |
$ | | $ | 150.0 | ||||
$100.0 million Senior Notes, interest at 7.5% payable semiannually, principal due
on February 15, 2008 |
104.0 | | ||||||
$150.0 million Senior Notes, interest at 6.50% payable semiannually, principal due
on March 15, 2011 |
150.0 | 150.0 | ||||||
$200.0 million Senior Notes, interest at 7.25% payable semiannually, principal due
on May 1, 2011 |
219.6 | | ||||||
$200.0 million Senior Notes, interest at 5.65% payable semiannually, principal due
on November 15, 2012 |
200.0 | 200.0 | ||||||
$150.0 million Senior Notes, interest at 5.5% payable semiannually, principal due
on November 19, 2012 |
151.9 | | ||||||
Other |
20.1 | | ||||||
Total debt |
845.6 | 500.0 | ||||||
Less current portion |
4.6 | 150.0 | ||||||
Long-term debt |
$ | 841.0 | $ | 350.0 | ||||
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Senior Notes
Our $150 million of 6.875% unsecured senior notes were repaid on July 1, 2005 using available cash
balances. The Senior Notes contain reporting covenants and the credit facility contains financial
covenants regarding maximum debt to capitalization and minimum interest coverage. We were in
compliance with all covenants at September 30, 2005.
Revolver Facilities
On June 21, 2005, we amended and restated our existing $150 million revolving credit facility
with a syndicate of lenders to provide the Company a $500 million unsecured revolving credit
facility. This facility will expire in July 2010, and replaces the Companys $175 million North
American revolving credit facility and our Norwegian facility. The Company has the right to
increase the facility to $750 million and to extend the term of the facility for an additional
year. At September 30, 2005, there was $5.0 million in borrowings against this facility and there
were $74 million in outstanding letters of credit. Interest under this multicurrency facility is
based upon LIBOR, NIBOR or EURIBOR plus 0.30% subject to ratings-based grid, or the prime rate.
Other
Other debt includes approximately $12.3 million in promissory notes due to former owners of
businesses acquired who remain employed by the Company.
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9. Stock-Based Compensation
We apply Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to
Employees, and related interpretations in accounting for our stock option plans. Compensation
expense is generally not recognized for stock option grants as all options granted have an exercise
price equal to the market value of the underlying common stock on the date of grant. However, for
the unvested Varco options exchanged in the Merger (see Note 2), we expense the intrinsic value of
those options over the remaining vesting period. Compensation expense of $4.8 million and $10.7
million related to the vesting of the exchanged options was recognized in the third quarter and
first nine months of 2005, respectively. Had compensation expense for all of our stock option
grants been determined on the fair value at the grant dates consistent with the method of Statement
of Financial Accounting Standards Board (SFAS) No. 123, Accounting for Stock-Based Compensation,
our net income and income per share would have been adjusted to the pro forma amounts indicated
below (amounts in millions, except per share amounts):
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||
Net income, as reported |
$ | 88.5 | $ | 27.8 | $ | 185.3 | $ | 60.2 | ||||||||
Add: |
||||||||||||||||
Total stock-based employee
compensation expense
included in net income,
net of related tax effects |
3.2 | | 7.0 | | ||||||||||||
Deduct: |
||||||||||||||||
Total stock-based employee
compensation expense
determined under fair
value based method for all
awards, net of related tax
effects |
(8.5 | ) | (1.8 | ) | (20.3 | ) | (5.4 | ) | ||||||||
Pro forma net income |
$ | 83.2 | $ | 26.0 | $ | 172.0 | $ | 54.8 | ||||||||
Net income per common
share: |
||||||||||||||||
Basic, as reported |
$ | 0.51 | $ | 0.32 | $ | 1.23 | $ | 0.70 | ||||||||
Basic, pro forma |
$ | 0.48 | $ | 0.30 | $ | 1.14 | $ | 0.64 | ||||||||
Diluted, as reported |
$ | 0.50 | $ | 0.32 | $ | 1.22 | $ | 0.70 | ||||||||
Diluted, pro forma |
$ | 0.47 | $ | 0.30 | $ | 1.13 | $ | 0.63 | ||||||||
For purposes of determining compensation expense using the provisions of SFAS No. 123, the fair
value of option grants was determined using the Black-Scholes option-valuation model. The weighted
average fair value per share of stock options granted in the 2005 and 2004 was $13.19 and $9.20,
respectively. The key input variables used in valuing the options granted in 2005 and 2004 were:
risk-free interest rate of 2.7% in 2005 and 2.6% in 2004; dividend yield of zero in each year;
stock price volatility of 51% in 2005 and 48% in 2004, and expected option lives of five years for
each year presented.
10. Recently Issued Accounting Standards
The Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting
Standards No. 123R, Share-Based Payment (SFAS 123R), which originally required implementation for
interim or annual reporting periods beginning after June 15, 2005. However, in April 2005, the
Securities and Exchange Commission adopted a new rule to amend the compliance date to the beginning
of the Companys next fiscal year (January 1, 2006, for the Company). SFAS 123R requires us to
recognize the cost of employee services received in exchange for the companys equity instruments.
Currently, in accordance with APB Opinion 25, we record the intrinsic value of stock based
compensation as expense. Accordingly, no compensation expense is currently recognized for fixed
stock option plans, except as described in Notes 2 and 9 related to the Varco Merger, as the
exercise price equals the stock price on the date of grant. Under SFAS 123R, we will be required to
measure compensation expense over the options vesting period based on the stock options fair
value at the date the options are granted and classify the tax
benefit from the exercise of non-qualified stock options as a
financing activity in the statement of cash flow. SFAS 123R allows for the use of the Black-Scholes or a
lattice option-pricing model to value such options. We will use the Black-Scholes option-pricing
model to calculate the fair value of the options. We have elected to adopt SFAS 123R on a modified
prospective basis. Note 9 illustrates the effects on net income and earnings per share if we had
adopted SFAS 123R using the Black-Scholes option-pricing model.
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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
Introduction
On March 11, 2005, National-Oilwell, Inc., a Delaware corporation (National Oilwell), and Varco
International, Inc., a Delaware corporation (Varco), jointly announced that the merger of the two
companies was approved by stockholders of each company by substantial margins. Pursuant to the
Amended and Restated Agreement and Plan of Merger, effective as of August 11, 2004 (the Merger
Agreement), between National Oilwell and Varco, on closing of the merger, Varco was merged with
and into National Oilwell (the Merger) and National Oilwells name was changed to National
Oilwell Varco, Inc. In addition, as a result of the merger, each share of Varco common stock
outstanding at the effective time was converted into the right to receive 0.8363 shares of NOV
common stock. Effective Monday, March 14, 2005, National Oilwell Varcos common stock began to
trade under the symbol NOV on the New York Stock Exchange.
National Oilwell Varco is a worldwide leader in the design, manufacture and sale of equipment and
components used in oil and gas drilling and production, the provision of oilfield services, and
supply chain integration services to the upstream oil and gas industry.
As a result of the Merger, management has changed its presentation of segment information.
Information for prior periods has been made to conform on a comparable basis. The following
describes our new business segments:
Rig Technology
Our Rig Technology group designs, manufactures, sells and services complete rig systems for the
drilling, completion, and remediation of oil and gas wells. The group offers a comprehensive line
of highly-engineered machinery which automates complex well construction and management operations,
such as offshore and onshore drilling rigs; pipe racking, rotating and assembly systems; coiled
tubing equipment and pressure pumping units; well workover rigs; wireline winches; and cranes.
Demand for the groups products is primarily dependent upon capital spending plans by drilling
contractors, oilfield service companies, and oil and gas companies, and secondarily on the overall
level of oilfield drilling activity, which drives demand for spare parts for the groups large
installed base of equipment. We have made strategic acquisitions during the past several years in
an effort to expand our product offering and our global manufacturing capabilities, including new
operations in Norway, the United Kingdom and China.
Petroleum Services & Supplies
Our Petroleum Services & Supplies group provides a variety of consumable goods and services used to
drill, complete, remediate and workover oil and gas wells, and manage pipelines, flowlines and
other oilfield tubular goods. The group manufactures, rents and sells a variety of products and
equipment used to perform drilling operations, including solids control systems, drilling motors,
rig instrumentation systems, and drilling mud pump consumables. Demand for these services and
supplies is determined principally by the level of oilfield drilling and workover activity by
drilling contractors, major and independent oil and gas companies, and national oil companies. The
groups oilfield tubular services include the provision of inspection and internal coating services
and equipment for drillpipe, linepipe, tubing, casing and pipelines, and the design, manufacture
and sale of coiled tubing pipe and advanced composite pipe for application in highly corrosive
environments. The Group sells its tubular goods and services to oil and gas companies; drilling
contractors; pipe distributors, processors and manufacturers; and pipeline operators.
Distribution Services
Our Distribution Services group provides maintenance, repair and operating supplies and spare parts
to drill site and production locations worldwide. In addition to its comprehensive network of
field locations supporting land drilling operations throughout North America, the group supports
major offshore drilling contractors through locations in the Middle East, Europe, Southeast Asia
and South America. The group employs advanced information technologies to provide complete
procurement, inventory management and logistics services to its customers around the globe. Demand
for the groups services are primarily determined by the level of drilling and remediation
activity, and oil and gas production activities.
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Executive Summary
Activity levels in most of our markets were high during the third quarter. Recovering economies of
developed nations, and the desire for improved standards of living among many in developing
nations, have fueled rising demand for energy. As a result, oil and gas prices have increased
significantly over the past few years, which has in turn led to rising levels of exploration and
development drilling in many oil and gas basins around the globe. Oil and gas companies, facing
declining reserves and the need to grow production to satisfy the rising energy needs of the world,
have increased levels of investment in new oil and gas wells. This has led to a level of drilling
activity not seen since the early 1980s, which has, in turn, resulted in steadily rising demand
for oilfield services over the last several quarters. Much of the new incremental drilling
activity is occurring in harsh environments, and employs increasingly sophisticated technology to
find and produce reserves.
The rise in demand for drilling rigs has tested the capability of the worlds fleet, much of which
is old and of limited capability. Drilling contractors have realized higher rig dayrates over the
past few quarters, which has increased cash flows and available financing. Many drilling
contractors are reinvesting in their rig fleets by upgrading and refurbishing older rigs, or by
constructing new rigs. Many new offshore rig construction projects were announced through the
first nine months of 2005. There are over 40 new jackup rigs and several new floating rigs being
constructed worldwide. The available supply of offshore rigs declined during the third quarter due
to the impact of Gulf Coast Hurricanes Katrina and Rita, which seriously damaged or sunk as many as
11 offshore rigs in the Gulf of Mexico. Several other offshore rigs sustained some level of damage
as well. Demand for land rigs and components also continued to strengthen through the third
quarter.
This increasing level of investment in rig capability is benefiting the Companys Rig Technology
group, which is a leading supplier of drilling equipment and technology. The company has the
capability to supply up to approximately $41.0 million of equipment for a typical jackup, and more
than $100.0 million of equipment for a floating rig. Placement of orders for drilling equipment
for many of these rig construction projects, together with continued strong demand for land rigs
and components, drove a 47% increase in backlog for the group through the third quarter.
Additionally, the group has benefited from the sale of coiled tubing and nitrogen injection
equipment used to execute sophisticated new well-stimulation techniques. Overall the group posted
revenue of $572.8 million, down $2.4 million from the second quarter. Hurricanes in the Gulf of
Mexico during the third quarter interrupted shipment of approximately $9.2 million of equipment.
Operating profit was $70.4 million, or 12.3% of sales, up from $51.9 million, or 9.0% of sales in
the second quarter and excluding transaction and merger charges from both periods. The sequential
improvement in operating profit was mostly due to the second quarter charge taken on a large
drilling rig fabrication project. Those two rigs were shipped to Kazakhstan during the third
quarter, as expected, and will be commissioned there over the next few months. The estimated
operating profit impact of the hurricanes on group results was $4.4 million primarily as a result
of shipment delays.
The Companys Petroleum Services & Supplies group is benefiting from higher activity levels in the
oilfield, which fuels demand for the goods and services it supplies. Sales of composite fiberglass
pipe, solids control products and services, drilling motors and jars, mud pump expendables, coiled
tubing pipe, rig instrumentation equipment and services, and tubular coating and inspection have
all benefited from the higher levels of exploration and production investment in drilling and
stimulating wells. The third quarter results for the group were favorably impacted by the
resumption of activity following the end of the second quarter seasonal breakup in Canada, when
road bans enacted during the thawing season limit movement of rigs and thus reduce drilling
activity. The Groups operating profit in Canada increased $7.6 million in the third quarter
compared to the second quarter as a result. Third quarter results benefited from sequential
improvement in the groups pipeline inspection operations, but these remain below historical levels
due to lower pricing and volumes in the U.S. Overall the group posted 5% higher revenues in the
third quarter as compared to the second, at 51% incremental margins, due to the high level of
oilfield activity in most areas, and the effect of price increases implemented across many products
and services over the last few quarters. Revenues were $472.0 million and operating profit was
$87.0 million, or 18.4% of sales. The estimated adverse impact of the Gulf of Mexico hurricanes on
third quarter group results was $11.0 million in revenue and $5.1 million in operating profit,
primarily as a result of shipment delays and a reduction in Gulf of Mexico rig activity.
The Companys Distribution Services group has also benefited from higher levels of oilfield
activity, which has spurred rising demand for the maintenance, repair and operating supplies it
furnishes to the petroleum industry. Many oil companies and drilling contractors are outsourcing
their purchasing of routine consumable items to the group, which offers greater purchasing power
and sophisticated information management techniques. Revenues were $272.4 million and operating
profit was $14.5 million for the third quarter, and the financial impact of the Gulf of Mexico
hurricanes during the quarter on Distribution Services are estimated to be negligible. The groups
revenues increased 6% from the second quarter to the third, at 34% incremental margins. The group
benefited from strong demand across the U.S. Midcontinent region, Canada, and many international
locations; improving mix of products; and net supplier rebate credits during the third quarter
(which may not repeat in future
quarters). As a result, margins improved from 3.7% in the second
quarter to 5.3% in the third
quarter. Margins are expected to be in the range of 4% in the fourth quarter.
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The outlook for the Company through fourth quarter of 2005 is good, as overall activity is expected
to remain strong, and as the Companys backlog for capital equipment sales has risen 124% since the
beginning of the year. Overall very high levels of drilling across the North America land market
and the Middle East, in particular, are expected to continue to drive improved results. Over the
long run, and excluding swings in mix and other factors, we expect operating leverage, or
incremental operating profit divided by incremental revenue, for the Rig Technology group to be in
the range of about 22%; for the Petroleum Services & Supply group to be in the range of 30%; and
for the Distribution Services group to be in the range of 10%.
Gulf Coast Hurricanes Katrina and Rita discussed above resulted in several days of downtime for
drilling and support operations along the Gulf, as well as the delay in shipment of equipment. All
of our employees have been accounted for. Overall, we estimate that the total financial impact of
these storms on the Companys third quarter results was approximately $20.3 million in revenue and
$9.5 million in operating profit, or $0.04 per share. We expect to see the hurricane disruptions
continue into the fourth quarter, and expect a $2.0 million to $4.0 million operating profit
reduction in our Petroleum Services & Supplies segment as a result. However, our Rig Technology
segment is expected to benefit from new equipment orders to replace or repair rigs damaged by the
storm. Rig operators continue to survey their equipment and assess damages.
Upon the completion of the merger with Varco on March 11, 2005 the Company commenced its
integration activities to achieve merger synergies. The synergies are expected to result from,
among other things, the reduction of redundant overheads between the companies; lower insurance,
interest, IT and corporate governance costs; and the combining of manufacturing, sales and
engineering functions in product lines where the two organizations overlap. Additionally, we
expect to achieve benefits from bringing the manufacture of components in-house, that were
previously purchased from third party vendors. Operating profit improvements in the range of $60
million pre-tax on an annualized run rate basis are expected to be achieved by the end of the first
quarter of 2006. We estimate consolidation savings arising from the merger during the third
quarter of 2005 were in the range of $6.0 million. While there can be no guarantee that this level
will be achieved, we believe this goal is realistic, and continue to develop and execute our plans.
We recognized $2.8 million in transaction and restructuring costs during the third quarter,
including severance expenses.
We announced in late-June that the merger between National Oilwell and Varco has been challenged by
the Norwegian Competition Authority (NCA). The NCAs objection stipulates that the Company must
divest certain Norwegian subsidiaries owned by National Oilwell prior to the merger, which conduct
business related to the sale and maintenance of drilling equipment. The proposed remedy as we
understand it does not affect businesses in Norway owned by Varco prior to the merger, nor does it
affect National Oilwells business not engaged in the provision of the sale and maintenance of
drilling equipment. We strongly disagree with the NCAs conclusions, and are actively pursuing an
appeal before the Norwegian Ministry of Modernization. We believe that we will be able to resolve
matters with the relevant Norwegian government authorities without any material impact on the
business or operations of the Company. The merger between National Oilwell and Varco has passed
all other applicable anti-trust regulatory agencies around the world, including the Antitrust Division of the
U.S Department of Justice.
14
Table of Contents
Operating Environment Overview
The Companys results are dependent on, among other things, the level of worldwide oil and gas
drilling, well remediation activity, the prices of crude oil and natural gas, capital spending by
other oilfield service companies and drilling contractors, pipeline maintenance activity, and
worldwide oil and gas inventory levels. Key industry indicators for the third quarters of 2005 and
2004, and the second quarter of 2005 include the following:
% | % | |||||||||||||||||||
3Q05V | 3Q05V | |||||||||||||||||||
3Q05* | 3Q04* | 2Q05* | 3Q04 | 2Q05 | ||||||||||||||||
Active Drilling Rigs: |
||||||||||||||||||||
U.S. |
1,428 | 1,229 | 1,336 | 16.2 | % | 6.9 | % | |||||||||||||
Canada |
497 | 326 | 241 | 52.5 | % | 106.2 | % | |||||||||||||
International |
911 | 846 | 916 | 7.7 | % | (0.5 | %) | |||||||||||||
Worldwide |
2,836 | 2,401 | 2,493 | 18.1 | % | 13.8 | % | |||||||||||||
Active Workover Rigs: |
||||||||||||||||||||
U.S. |
1,384 | 1,255 | 1,314 | 10.3 | % | 5.3 | % | |||||||||||||
Canada |
628 | 634 | 441 | (0.9 | %) | 42.4 | % | |||||||||||||
North America |
2,012 | 1,889 | 1,755 | 6.5 | % | 14.6 | % | |||||||||||||
West Texas Intermediate Crude Prices (per
barrel) |
$ | 63.20 | $ | 43.79 | $ | 53.09 | 44.3 | % | 19.0 | % | ||||||||||
Natural Gas Prices ($/mmbtu) |
$ | 9.70 | $ | 5.48 | $ | 6.94 | 77.0 | % | 39.8 | % |
* | Averages for the quarters indicated. See sources below. |
The following table details the U.S., Canadian, and international rig activity and West Texas
Intermediate Oil prices for the past nine quarters ended September 30, 2005 on a quarterly basis:
![(PERFORMANCE GRAPH)](https://www.sec.gov/Archives/edgar/data/0001021860/000095012905010324/h29750h2975001.gif)
Source: Rig count: Baker Hughes, Inc. (www.bakerhughes.com); West Texas Intermediate Crude Price:
Department of Energy, Energy Information Administration (www.eia.doe.gov).
15
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The worldwide and U.S. quarterly average rig count increased 18.1% (from 2,401 to 2,836) and 16.2%
(from 1,229 to 1,428), respectively, in the third quarter of 2005 compared to the third quarter of
2004. The average per barrel price of West Texas Intermediate Crude increased 44.3% (from $43.79
per barrel to $63.20 per barrel) while natural gas prices increased 77.0% (from $5.48 per mmbtu to
$9.70 per mmbtu) in the third quarter of 2005 compared to the third quarter of 2004.
U.S. rig activity at October 21, 2005 was 1,474 rigs compared to the third quarter average of 1,428
rigs. The Company believes that current industry projections are forecasting commodity prices to
remain strong. However, numerous events could significantly alter these projections including
political tensions in the Middle East or elsewhere, the acceleration or deceleration of the
recovery of the U.S. and world economies, a build up in world oil inventory levels, or numerous
other events or circumstances.
16
Table of Contents
Results of Operations
Operating results by segment are as follows. The actual results include results from Varco
operations from the acquisition date of March 11, 2005 (in millions):
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||
(Restated) | (Restated) | |||||||||||||||
Revenue: |
||||||||||||||||
Rig Technology |
$ | 572.8 | $ | 303.1 | $ | 1,572.4 | $ | 742.6 | ||||||||
Petroleum Services & Supplies |
472.0 | 128.9 | 1,132.6 | 364.9 | ||||||||||||
Distribution Services |
272.4 | 233.3 | 766.3 | 669.8 | ||||||||||||
Eliminations |
(80.7 | ) | (46.4 | ) | (204.2 | ) | (128.7 | ) | ||||||||
Total Revenue |
$ | 1,236.5 | $ | 618.9 | $ | 3,267.1 | $ | 1,648.6 | ||||||||
Operating Profit: |
||||||||||||||||
Rig Technology |
$ | 70.4 | $ | 28.2 | $ | 167.2 | $ | 55.9 | ||||||||
Petroleum Services & Supplies |
87.0 | 16.8 | 198.8 | 47.4 | ||||||||||||
Distribution Services |
14.5 | 8.4 | 31.7 | 20.6 | ||||||||||||
Unallocated expenses and
eliminations |
(19.3 | ) | (4.3 | ) | (50.9 | ) | (10.7 | ) | ||||||||
Transaction costs and stock-based
compensation |
(7.6 | ) | | (33.8 | ) | | ||||||||||
Total Operating Profit |
$ | 145.0 | $ | 49.1 | $ | 313.0 | $ | 113.2 | ||||||||
Operating Profit %: |
||||||||||||||||
Rig Technology |
12.3 | % | 9.3 | % | 10.6 | % | 7.5 | % | ||||||||
Petroleum Services & Supplies |
18.4 | % | 13.0 | % | 17.6 | % | 13.0 | % | ||||||||
Distribution Services |
5.3 | % | 3.6 | % | 4.1 | % | 3.1 | % | ||||||||
Total Operating Profit % |
11.7 | % | 7.9 | % | 9.6 | % | 6.9 | % | ||||||||
Rig Technology
Three Months Ended September 30, 2005 and 2004. Rig Technology revenue in the third quarter of
2005 was $572.8 million, an increase of $269.7 million (89%) compared to the same period of 2004.
Third quarter revenue included approximately $228.0 million of revenue related to the acquisition
of Varco. The remainder of the increase can be attributed to the growing market for capital
equipment, as evidenced by backlog growth over the past several quarters, as well as increases in
spare parts and service revenue. The increase was partially offset by delayed equipment shipments
of approximately $9.2 million as a result of Gulf Coast Hurricanes Katrina and Rita. Operating
profit from Rig Technology was $70.4 million for the third quarter ended September 30, 2005, an
increase of $42.2 million (150%) over the same period of 2004. The acquisition of Varco contributed
approximately $53.0 million of the increase in operating profit in the third quarter of 2005.
Gulf Coast Hurricanes Katrina and Rita reduced operating profit for the segment by approximately
$4.4 million as a result of delayed shipments and fixed costs related to facility closures.
Nine Months Ended September 30, 2005 and 2004. Revenue for the first nine months of 2005 was
$1,572.4 million, an increase of $829.8 million (112%) compared to the same period of 2004. The
first nine months of 2005 revenue includes $519.9 million of revenue related to the acquisition of
Varco, with the remainder of the increase due to the factors discussed above. Operating profit for
the first nine months of 2005 was $167.2 million, an increase of $111.3 million (199%) compared to
2004. The Varco acquisition accounted for $122.9 million of the increase. The increase in operating
profit from the higher revenue volume was largely offset by the charges taken on a large Kazakhstan
rig fabrication project as a result of additional costs attributed to higher rig-up costs and more
material than originally planned.
Petroleum Services & Supplies
Three Months Ended September 30, 2005 and 2004. Revenue from Petroleum Services & Supplies was
$472.0 million for the third quarter of 2005 compared to $128.9 million for the third quarter of
2004, an increase of $343.1 million (266%). The
17
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majority of the increase is attributable to the
addition of product lines acquired from Varco effective March 11, 2005, which totaled $300.2
million for the quarter. The remaining increase is attributable to high demand for downhole tools
and pumping products, which had revenue increases of 37% and 25%, respectively. These increases
were the result of strong U.S. and worldwide drilling markets, as reflected by rig count increases
of 16% and 18%, respectively, in the third quarter of 2005 compared to the same period 2004.
Petroleum Services & Supplies also benefited from price increases implemented during 2004.
Revenues increased 27% compared to the third quarter of 2004, excluding Varco revenues. Revenues
in the third quarter of 2005 were negatively impacted by Gulf Coast Hurricanes Katrina and Rita by
an estimated $11.0 million.
Operating profit from Petroleum Services & Supplies was $87.0 million for the third quarter of 2005
compared to $16.8 million for the third quarter of 2004, an increase of $70.2 million (418%). The
majority of the increase was attributable to the addition of product lines acquired from Varco
effective March 11, 2005. Operating profit from these product lines was $64.6 million for the
period. The remaining increase was attributable to higher profitability from downhole tool sales
and rentals, and sales of pumping products which had operating profit increases of 77% and 31%,
respectively. Operating profits in the third quarter of 2005 were negatively impacted by Gulf
Coast Hurricanes Katrina and Rita by an estimated $5.1 million.
Nine Months Ended September 30, 2005 and 2004. Revenue from Petroleum Services & Supplies was
$1,132.6 million for the first nine months of 2005 compared to $364.9 million for the first nine
months of 2004, an increase of $767.7 million (210%). The majority of the increase is attributable
to the addition of product lines acquired from Varco effective March 11, 2005, which totaled $645.1
million for the period. The remaining increase is attributable to high demand for downhole tools
and pumping products, which had revenue increases of 40% and 29%, respectively. These increases
were the result of strong U.S. and worldwide drilling markets, as reflected by rig count increases
of 15% and 14%, respectively, in the first nine months of 2005 compared to the same period 2004.
Petroleum Services & Supplies also benefited from price increases implemented during 2004.
Revenues increased 33% compared to the first nine months of 2004, excluding Varco revenues.
Revenues in the third quarter of 2005 were negatively impacted by Gulf Coast Hurricanes Katrina and
Rita by an estimated $11.0 million.
Operating profit from Petroleum Services & Supplies was $198.8 million for the first nine months of
2005 compared to $47.4 million for the first nine months of 2004, an increase of $151.4 million
(319%). The majority of the increase was attributable to the addition of product lines acquired
from Varco effective March 11, 2005. Operating profit from these product lines was $131.6 million
for the period. The remaining increase was attributable to higher profitability from downhole tool
sales and rentals, and sales of pumping products which had operating profit increases of 82% and
43%, respectively. Operating profits in the third quarter of 2005 were negatively impacted by Gulf
Coast Hurricanes Katrina and Rita by an estimated $5.1 million.
Distribution Services
Three Months Ended September 30, 2005 and 2004. Revenue from Distribution Services was $272.4 million,
an increase of $39.1 million (17%) during the third quarter of 2005 over the comparable 2004
period. North American and International revenues were up 16% and 18%, respectively, enjoying
continued growth in the number of active rigs running in 2005. From a product perspective,
maintenance, repair and operating supplies (MRO), spare parts, and tubular sales all posted
increases.
Operating income of $14.5 million in the third quarter of 2005 increased $6.1 million over the
prior year results due to gross margin improvement on higher revenue volumes; with strong expense
management in the US; and higher rebates from suppliers.
Nine
Months Ended September 30, 2005 and 2004. Revenue from Distribution Services increased $96.5
million (14%) in the first nine months of 2005 when compared to the prior year. Revenue in the
international market was up 9%, Canada increased 21% and the U.S. increased 13%, all influenced by
the year over year improvement in rig count activity.
Operating income in the first nine months of 2005 of $31.7 million increased by $11.1 million (54%)
from the comparable period in 2004. This increase in operating income was largely achieved by
absorbing the revenue increase across an already established distribution infrastructure and
expense base.
Unallocated expenses and eliminations
Unallocated expenses and eliminations were $19.3 million and $50.9 million for the three and nine
months ended September 30, 2005 compared to $4.3 million and $10.7 million for the same periods of
2004. The increase in operations costs was primarily due to costs associated with Varco operations
since the acquisition date and greater inter-segment profit eliminations.
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Stock-based
compensation
Stock-based
compensation expense was $4.8 million and $10.7 million for
the third quarter and first nine months of 2005, respectively,
related to the amortization of unvested options assumed as a result
of the merger.
Transaction costs
Transaction costs were $2.8 million and $23.1 million for the third quarter and first nine months
of 2005. Transaction costs for the third quarter and first nine months of 2005 consisted primarily
of inventory to be discontinued as a result of the merger and severance costs related to former
executive officers and employees of National Oilwell.
Interest and financial costs
Interest
and financial costs were $14.6 million and $39.4 million
for the third quarter and first nine
months of 2005 compared to $9.8 million and $28.7 million for the same periods of 2004. The
increase was primarily due to interest costs associated with debt assumed in the Varco transaction.
See summary of outstanding debt at September 30, 2005 under Liquidity and Capital Resources.
Provision for income taxes
The effective tax rate for the three and nine months ended September 30, 2005 was 32.0% and 32.4%
respectively (32.4% and 32.3% excluding transaction costs and stock-based compensation associated
with the Varco merger) compared to 27.3% and 28.2% for the same periods in 2004, reflecting a lower
percentage of earnings in foreign jurisdictions with lower tax rates and reduced benefits in the US
associated with export sales. The US laws granting this tax benefit were modified as part of the
American Jobs Creation Act of 2004 and this benefit will be phased out during the next two years.
A new tax benefit associated with US manufacturing operations passed into law under the same Act
will be phased in over the next five years. Whereas the timing of the phase out of the export tax
benefit and the phase in of the manufacturing tax benefit may differ, we expect the tax reduction
associated with the new manufacturing deduction, when fully implemented, to be similar in amount to
the export benefit. We anticipate our tax rate for 2005 to be approximately 32% for continuing
operations.
Liquidity and Capital Resources
At September 30, 2005, the Company had cash and cash equivalents of $162.2 million, and total debt
of $845.6 million. At December 31, 2004, cash and cash equivalents were $142.7 million and total
debt was $500.0 million. The increase in cash holdings and outstanding debt was primarily a result
of cash acquired of $163.5 million, offset by increases in working capital and debt assumed of
$492.8 million related to the Varco acquisition. The Companys outstanding debt at September 30,
2005 consisted of $200.0 million of 5.65% senior notes due 2012, $200.0 million of 7.25% senior
notes due 2011, $150.0 million of 6.5% senior notes due 2011, $150.0 million of 5.5% senior notes
due 2012, $100.0 million of 7.5% senior notes due 2008, and other debt $45.6 million. Included in
other debt is the fair market value adjustment of the Varco debt assumed in the acquisition which
resulted in additional debt recognition of $30.6 million. The difference will be amortized to
interest expense over the remaining life of the debt.
For the first nine months of 2005, cash used by operating activities was $23.9 million compared to
cash provided by operating activities of $79.7 million in the same period of 2004. Cash was used
by operations primarily through increases in receivables of $132.3 million, inventories of $96.9
million, and costs in excess of billings of $110.1 million. These negative cash flows were offset
by net income of $185.3 million plus non-cash charges of $86.1 million and $29.1 million of tax
benefit from the exercise of nonqualified stock options. Receivables and costs in excess of
billings increased due to greater revenue and activity in the third quarter of 2005 compared to the
fourth quarter of 2004, while inventory increased due to growing backlog orders.
For the first nine months of 2005, cash provided from investing activities was $85.9 million
compared to $7.1 million used for the same period of 2004. Cash acquired in the Varco acquisition
in the first quarter of 2005 was $163.5 million.
For the first nine months of 2005, cash used by financing activities was $39.2 million compared to
cash used of $70.7 million in 2004. Cash was used by financing activities through the repayment of
the Companys $150 million 6.875% senior notes offset partly by proceeds from exercised stock
options of $107.4 million.
The Companys $150 million 6.875% senior notes were repaid on July 1, 2005 using available cash
balances. On June 21, 2005, we amended and restated our existing $150 million revolving credit
facility with a syndicate of lenders to provide the Company a $500 million unsecured revolving
credit facility. The facility will expire in July 2010, and replaces the Companys $175 million
North American revolving credit facility and our Norwegian facility. The Company has the right to
increase the facility to $750 million and to extend the term of the facility for an additional
year. At September 30, 2005, there were $5.0 million of borrowings against this facility and there
were $74 million in outstanding letters of credit. Interest under this multicurrency facility is
based upon LIBOR, NIBOR or EURIBOR plus 0.30% subject to a ratings-based grid, or the prime rate.
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We believe cash generated from operations and amounts available under the credit facilities and
from other sources of debt will be sufficient to fund operations, working capital needs, capital
expenditure requirements and financing obligations. We also believe increases in capital
expenditures caused by any need to increase manufacturing capacity can be funded from operations or
through debt financing.
We intend to pursue additional acquisition candidates, but the timing, size or success of any
acquisition effort and the related potential capital commitments cannot be predicted. We expect to
fund future cash acquisitions primarily with cash flow from operations and borrowings, including
the unborrowed portion of the credit facility or new debt issuances, but may also issue additional
equity either directly or in connection with acquisitions. There can be no assurance that
additional financing for acquisitions will be available at terms acceptable to us.
Inflation has had an impact on certain of our operations in recent years. We believe that the
higher costs for energy, steel and other commodities experienced in 2004 have largely been
mitigated by increased prices and component surcharges for the products we sell. However, higher
steel, labor, energy or other commodity prices may adversely impact future periods.
Critical Accounting Policies and Estimates
In preparing the financial statements, we make assumptions, estimates and judgments that affect the
amounts reported. We periodically evaluate our estimates and judgments related to allowance for
doubtful accounts; inventory reserves; warranty accruals; impairments of long-lived assets
(including goodwill); income taxes and pensions and other postretirement benefits. Our estimates
are based on historical experience and on our future expectations that we believe are reasonable;
the combination of these factors forms the basis for making judgments about the carrying values of
assets and liabilities that are not readily apparent from other sources. Actual results are likely
to differ from our current estimates and those differences may be material.
Revenue Recognition
The Companys products and services are sold based upon purchase orders or contracts with the
customer that include fixed or determinable prices and that do not include right of return or other
similar provisions or other significant post delivery obligations. Except for certain construction
contracts described below, the Company records revenue at the time its manufacturing process is
complete, the customer has been provided with all proper inspection and other required
documentation, title and risk of loss has passed to the customer, collectibility is reasonably
assured and the product has been delivered. Customer advances or deposits are deferred and
recognized as revenue when the Company has completed all of its performance obligations related to
the sale. The Company also recognizes revenue as services are performed. The amounts billed for
shipping and handling cost are included in revenue and related costs are included in costs of
sales.
Revenue Recognition under Long-term Construction Contracts
The Company uses the percentage-of-completion method to account for certain long-term construction
contracts that are built or constructed to the customers specifications, and are manufactured
outside the Companys normal manufacturing process and marketed outside of the Companys normal
marketing channels. Projects recognized under the percentage-of-completion method include the
following characteristics: 1) the contracts include custom designs for customer specific
applications; 2) components are often modified with change orders throughout the project; 3) the
structural design is unique and requires significant engineering efforts; and 4) construction
projects often have progress payments. This method requires us to make estimates regarding the
total costs of the project, our progress against the project schedule and the estimated completion
date, all of which impact the amount of revenue and gross margin we recognize in each reporting
period. Changes in job performance, job conditions, and estimated profitability, including those
arising from contract penalty provisions, and final contract settlements may result in revisions to
costs and income and are recognized in the period in which the revisions are determined. Profit
incentives are included in revenues when their realization is reasonably assured. Provisions for
anticipated losses on uncompleted contracts are recorded in full when such losses become evident.
The Company measures the extent of progress towards completion on these projects using either input
or output based methods that are appropriate to the contract circumstances. The output methods are
based upon engineering estimates and the input measures are based upon the ratio of costs incurred
to the total projected costs. By the end of 2005, the Company believes that most of its progress
to completion estimates will be based on actual costs incurred.
Allowance for Doubtful Accounts
Allowance for doubtful accounts are determined on a specific identification basis when we believe
that the required payment of specific amounts owed to us is not probable. A substantial portion of
the Companys revenues come from international oil companies, international oilfield service
companies, and government-owned or government-controlled oil companies. Therefore, the Company has
significant receivables in many foreign jurisdictions. If worldwide oil and gas drilling activity
or
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changes in economic conditions in foreign jurisdictions deteriorate, our customers may be unable
to repay these receivables, and additional allowances could be required.
Inventory Reserves
Reserves for inventory are determined based on our historical usage of inventory on-hand as well as
our future expectations related to requirements to provide spare parts for our substantial
installed base and new products. Changes in worldwide oil and gas drilling activity and the
development of new technologies associated with the drilling industry could require the Company to
record additional allowances to reduce the value of inventory to the lower of its cost or net
realizable value.
Warranty Accruals
Accruals for warranty claims are provided based on historical experience at the time of sale. Most
product warranties cover periods from one to three years. Our accruals for warranty claims are
affected by the size of our installed base of products currently under warranty, as well as new
products delivered to the market. If actual experience proves different from historical estimates,
changes to the Companys provision rates may be required.
Impairment of Long-Lived Assets (Including Goodwill)
Long-lived assets, which include property and equipment, goodwill, and identified intangible
assets, comprise a significant amount of the Companys total assets. The Company makes judgments
and estimates in conjunction with the carrying value of these assets, including amounts to be
capitalized, depreciation and amortization methods and useful lives. Additionally, the carrying
values of these assets are reviewed for impairment periodically or whenever events or changes in
circumstances indicate that the carrying amounts may not be recoverable. An impairment loss is
recorded in the period in which it is determined that the carrying amount is not recoverable. This
requires the Company to make long-term forecasts of its future revenues and costs related to the
assets subject to review. These forecasts require assumptions about demand for the Companys
products and services, future market conditions and technological developments. Significant and
unanticipated changes to these assumptions or the intended use of these assets could require a
provision for impairment in a future period.
In accordance with SFAS 142, the Company performs a review of goodwill for impairment annually or
earlier if indicators of potential impairment exist. The annual impairment tests are performed
during the fourth quarter of each year. If it is determined that goodwill is impaired, that
impairment is measured based on the amount by which the book value of goodwill exceeds its implied
fair value. The implied fair value of goodwill is determined by deducting the fair value of a
reporting units identifiable assets and liabilities from the fair value of that reporting unit as
a whole. Additional impairment assessments may be performed on an interim basis if the Company
encounters events or changes in circumstances that would indicate that, more likely than not, the
carrying amount of goodwill has been impaired. Fair value of the reporting units is determined
based on internal management estimates, using a combination of three methods: discounted cash flow,
comparable companies, and representative transactions.
Income Taxes
In accordance with the provisions of SFAS No. 109, Accounting for Income Taxes, we account for
income taxes using the asset and liability method. In determining income (loss) for financial
statement purposes, we must make certain estimates and judgments. These estimates and judgments
affect the calculation of certain tax liabilities and the determination of the recoverability of
certain of the deferred tax assets, which arise from temporary differences between the tax and
financial statement recognition of revenue and expense. Deferred tax assets are also reduced by a
valuation allowance if, based on the weight of available evidence, it is more likely than not that
some portion or all of the recorded deferred tax assets will not be realized in future periods. In
evaluating our ability to recover our deferred tax assets we consider all available positive and
negative evidence including our past operating results, the existence of cumulative losses in the
most recent years and our forecast of future taxable income. In estimating future taxable income,
we develop assumptions including the amount of future state, federal and international pretax
operating income, reversal of temporary differences and the implementation of feasible and prudent
tax planning strategies. These assumptions require significant judgment about the forecasts of
future taxable income and are consistent with the plans and estimates we are using to manage the
underlying businesses.
We currently have recorded significant valuation allowances that we intend to maintain until it is
more likely than not the deferred tax assets will be realized. Other than valuation allowances
associated with tax attributes acquired through acquisitions, our income tax expense recorded in
the future will be reduced to the extent of decreases in our valuation allowances. The realization
of our remaining deferred tax assets is primarily dependent on future taxable income. Any reduction
in future taxable income including but not limited to any future restructuring activities may
require that we record an additional valuation allowance against our deferred tax assets. An
increase in the valuation allowance would result in additional income tax expense
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in such period and could have a significant impact on our future earnings. If a change in a valuation allowance
occurs, which was established in connection with an acquisition, such adjustment may impact
goodwill rather than the income tax provision. In addition, the calculation of our tax liabilities
involves dealing with uncertainties in the application of complex tax regulations in a multitude of
jurisdictions across our global operations. We recognize potential liabilities and record tax
reserves for anticipated tax audit issues in the U.S. and other tax jurisdictions based on our
estimate of whether, and the extent to which, additional taxes will be due. These tax liabilities
are reflected net of related tax loss carry forwards. We adjust these reserves in light of changing
facts and circumstances; however, due to the complexity of some of these uncertainties, the
ultimate resolution may result in a payment that is materially different from our current estimate
of the tax liabilities. If our estimate of tax liabilities proves to be less than the ultimate
assessment, an additional charge to expense would result. If payment of these amounts ultimately
proves to be less than the recorded amounts, the reversal of the liabilities would result in tax
benefits being recognized in the period when we determine the reserves are no longer necessary. If
the tax liabilities relate to tax uncertainties existing at the date of the acquisition of a
business, the adjustment of such tax liabilities will result in an adjustment to the goodwill
recorded at the date of acquisition.
Pensions and Other Postretirement Benefits
The Company accounts for our defined benefit pension plans in accordance with Statement of
Financial Accounting Standards No. 87, Employers Accounting for Pensions (FAS 87), which requires
that amounts recognized in the financial statements be determined on an actuarial basis.
Significant elements in determining our pension income or expense in accordance with FAS 87 are the
discount rate assumption and the expected return on plan assets. The discount rate used
approximates the weighted average rate of return on high-quality fixed income investments whose
maturities match the expected payouts. The expected return on plan assets is based upon the
geometric mean of historical returns of a number of different equities, including stocks, bonds and
U.S. treasury bills. The assumed long-term rate of return on assets is applied to a calculated
value of plan assets which results in an estimated return on plan assets that is included in
current year pension income or expense. The difference between this expected return and the actual
return on plan assets is deferred and amortized against future
pension income or expense. The total net expense associated with the
Companys defined benefit pension and postretirement benefit plans
was approximately $1.9 million and $5.6 million for the
three months and nine months ended September 30, 2005,
respectively, compared to $1.2 million and $3.6 million for
the same periods of 2004. The acquisition of Varco resulted in the
addition of approximately $42.4 million of pension and
post-retirement benefit plan obligations.
Recently Issued Accounting Standards
The Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting
Standards No. 123R, Share-Based Payment (SFAS 123R), which originally required implementation for
interim or annual reporting periods beginning after June 15, 2005. However, in April 2005, the
Securities and Exchange Commission adopted a new rule to amend the compliance date to the beginning
of the Companys next fiscal year (January 1, 2006, for the Company). SFAS 123R requires us to
recognize the cost of employee services received in exchange for the companys equity instruments.
Currently, in accordance with APB Opinion 25, we record the intrinsic value of stock based
compensation as expense. Accordingly, no compensation expense is currently recognized for fixed
stock option plans, except as described in Notes 2 and 9 related to the Varco Merger, as the
exercise price equals the stock price on the date of grant. Under SFAS 123R, we will be required to
measure compensation expense over the options vesting period based on the stock options fair
value at the date the options are granted and classify the tax
benefit from the exercise of non-qualified stock options as a
financing activity in the statement for cash flow. SFAS 123R allows for the use of the Black-Scholes or a
lattice option-pricing model to value such options. We will use the Black-Scholes option-pricing
model to calculate the fair value of its options. We have elected to adopt SFAS 123R on a modified
prospective basis. Note 9 illustrates the effects on net income and earnings per share if we had
adopted SFAS 123R using the Black-Scholes option-pricing model.
Forward-Looking Statements
Some of the information in this document contains, or has incorporated by reference,
forward-looking statements. Statements that are not historical facts, including statements about
our beliefs and expectations, are forward-looking statements. Forward-looking statements typically
are identified by use of terms such as may, will, expect, anticipate, estimate, and
similar words, although some forward-looking statements are expressed differently. All statements
herein regarding expected Merger synergies, the expected completion of the Kazakhstan rig
fabrication project or the expected segment growth, margins, or
incremental operating leverage are forward-looking statements. You should be aware that our actual results
could differ materially from results anticipated in the forward-looking statements due to a number
of factors, including but not limited to changes in oil and gas prices, customer demand for our
products, difficulties encountered in
integrating mergers and acquisitions, and worldwide economic activity. You should also consider
carefully the statements under Risk Factors, as disclosed in our Form 10-K for the year ending
December 31, 2004, which address additional factors that could cause our actual results to differ
from those set forth in the forward-looking statements. Given these uncertainties, current or
prospective investors are cautioned not to place undue reliance on any such forward-looking
statements. We undertake no obligation to update any such factors or forward-looking statements to
reflect future events or developments.
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Supplemental Pro Forma Comparison
The pro forma information reflects results as if the Varco acquisition occurred at the beginning of
the first quarter of 2005 and 2004. The results prior to the merger date include the estimated
effect of purchase accounting adjustments, but do not include any effect from cost savings that may
result from the merger and do not include restructuring charges, amortization of unvested
compensation expense associated with options issued as part of the Merger, litigation gains and
transaction-related costs in prior periods. The unaudited pro forma financial statements are
presented for informational purposes only and are not necessarily indicative of actual results of
operations or financial position that would have occurred had the transaction been consummated at
the beginning of the period presented, nor are they necessarily indicative of future results.
Pro forma combined operating results by segment are as follows (in millions):
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||
Revenue: |
||||||||||||||||
Rig Technology |
$ | 572.8 | $ | 475.8 | $ | 1,691.3 | $ | 1,201.2 | ||||||||
Petroleum Services & Supplies |
472.0 | 370.4 | 1,325.5 | 1,031.9 | ||||||||||||
Distribution Services |
272.4 | 233.3 | 766.3 | 669.8 | ||||||||||||
Eliminations |
(80.7 | ) | (46.4 | ) | (208.1 | ) | (128.7 | ) | ||||||||
Total Revenue |
$ | 1,236.5 | $ | 1,033.1 | $ | 3,575.0 | $ | 2,774.2 | ||||||||
Operating Profit: |
||||||||||||||||
Rig Technology |
$ | 70.4 | $ | 53.3 | $ | 183.6 | $ | 107.6 | ||||||||
Petroleum Services & Supplies |
87.0 | 58.3 | 227.2 | 152.1 | ||||||||||||
Distribution Services |
14.5 | 8.4 | 31.7 | 20.6 | ||||||||||||
Unallocated expenses and
eliminations |
(19.3 | ) | (14.6 | ) | (62.0 | ) | (38.8 | ) | ||||||||
Total Operating Profit |
$ | 152.6 | $ | 105.4 | $ | 380.5 | $ | 241.5 | ||||||||
Operating Profit %: |
||||||||||||||||
Rig Technology |
12.3 | % | 11.2 | % | 10.9 | % | 9.0 | % | ||||||||
Petroleum Services & Supplies |
18.4 | % | 15.7 | % | 17.1 | % | 14.7 | % | ||||||||
Distribution Services |
5.3 | % | 3.6 | % | 4.1 | % | 3.1 | % | ||||||||
Total Operating Profit % |
12.3 | % | 10.2 | % | 10.6 | % | 8.7 | % | ||||||||
Rig Technology
Three
Months Ended September 30, 2005 and 2004. Rig Technology
revenue on a pro forma basis in the third quarter of
2005 was $572.8 million, an increase of $97.0 million (20%) compared to the same period of 2004.
The increase can be attributed to the growing market for capital equipment, as evidenced by backlog
growth over the past several quarters, as well as increases in spare parts and service revenue,
partially offset by delayed equipment shipments of approximately $9.2 million as a result of Gulf
Coast Hurricanes Katrina and Rita. Operating profit on a pro forma
basis from Rig Technology was $70.4 million for the
third quarter ended September 30, 2005, an increase of $17.1 million (32%) over the same period of
2004, primarily as result of the increase in business activity discussed above. Gulf Coast
Hurricanes Katrina and Rita reduced operating profit for the segment by approximately $4.4 million
as a result of delayed shipments and fixed costs related to facility closures.
Nine
Months Ended September 30, 2005 and 2004. Revenue on a pro
forma basis for the first nine months of 2005 was
$1,691.3 million, an increase of $490.1 million (41%) compared to the same period of 2004. The
increase is primarily due to the factors discussed above. Operating
profit on a pro forma basis for the first nine
months of 2005 was $183.6 million, an increase of
$76 million (71%) compared to 2004. The
increase in operating profit from the higher revenue volume was partly offset by charges taken on
a large Kazakhstan rig fabrication project as a result of additional costs attributed to higher
rig-up costs and more material than originally planned.
Petroleum Services & Supplies
Three Months Ended September 30, 2005 and 2004. Revenue on a pro forma basis from Petroleum
Services & Supplies was $472.0 million for the third quarter of 2005 compared to $370.4 million for
third quarter of 2004, an increase of $101.6 million (27%). The increase is attributable to a
significant increase in U.S. and worldwide drilling activity, price increases implemented
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during 2004, strong spare part and consumable sales to support increased drilling and acquisitions made in
2004. The revenue increase attributable to acquisitions is approximately $2.9 million. Operating
profit on a pro forma basis for Petroleum Services & Supplies was $87.0 million for the third
quarter of 2005 compared to $58.3 million for the third quarter of 2004, an increase of $28.7 million
(49%). Improved quarter-over-quarter results were posted across all product lines with the
exception of pipeline inspection. Operating profits in the third quarter of 2005 were negatively
impacted by Gulf Coast Hurricanes Katrina and Rita by an estimated $5.1 million.
Nine Months Ended September 30, 2005 and 2004. Revenue on a pro forma basis from Petroleum
Services & Supplies was $1,325.5 million for the first nine months of 2005 compared to $1,031.9
million for first nine months of 2004, an increase of $293.6 million (28%). The increase is
attributable to a significant increase in U.S. and worldwide drilling activity, price increases
implemented during 2004, strong spare parts and consumable sales to support increased drilling and
acquisitions made in 2004. The revenue increase attributable to acquisitions is approximately
$14.7 million. Operating profit on a pro forma basis for Petroleum Services & Supplies was $227.2
million for the first nine months of 2005 compared to $152.1 million for the first nine months of
2004, an increase of $75.1 million (49%). Improved quarter-over-quarter results were posted across
all product lines with the exception of pipeline inspection. Revenues in the third quarter of 2005
were negatively impacted by Gulf Coast Hurricanes Katrina and Rita by an estimated $11.0 million.
Distribution Services
Results for Distribution Services on a pro forma basis are the same as they are for actual. See
discussion above regarding Distribution Services.
Unallocated expenses and eliminations
Unallocated expenses and eliminations on a pro forma basis were $19.3 million and $62.0 million for
the three and nine months ended September 30, 2005, increases of $4.7 million and $23.2 million
compared to the three and nine months ended September 30, 2004. The increase in unallocated
operating costs was due to greater inter-segment profit eliminations, cost increases associated
with complying with Sarbanes-Oxley legislation, and greater legal costs, offset by corporate
overhead consolidation savings.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to changes in foreign currency exchange rates and interest rates. Additional
information concerning each of these matters follows:
Foreign Currency Exchange Rates
We have operations in foreign countries, including Canada, Norway and the United Kingdom, as well
as operations in Latin America, China and other European countries. The net assets and liabilities
of these operations are exposed to changes in foreign currency exchange rates, although such
fluctuations generally do not affect income since their functional currency is the local currency.
These operations also have net assets and liabilities not denominated in the functional currency,
which exposes us to changes in foreign currency exchange rates that do impact income. We recorded
foreign exchange gains in our income statement of approximately $3.1 million in the first nine
months of 2005, compared to $1.7 million in foreign exchange losses in the same period of the prior
year. We do not believe that a hypothetical 10% movement in these foreign currencies would have a
material impact on our earnings.
Some of our revenues in foreign countries are denominated in U.S. dollars, and therefore, changes
in foreign currency exchange rates impact our earnings to the extent that costs associated with
those U.S. dollar revenues are denominated in the local currency. In order to mitigate that risk,
we may utilize foreign currency forward contracts to better match the currency of our revenues and
associated costs. We do not use foreign currency forward contracts for trading or speculative
purposes.
At September 30, 2005, we had also entered into several foreign currency forward contracts with
notional amounts aggregating $465.8 million to hedge exposure to currency fluctuations in various
foreign currencies, including the British Pound Sterling, the Euro, Norwegian Kroner and the
Singapore Dollar. These exposures arise when local currency operating expenses are not in balance
with local currency revenue collections. These foreign currency forward contracts are designated
as cash flow hedging instruments and are fully effective. Based on quoted market prices as of
September 30, 2005 for contracts with similar terms and maturity dates, we have recorded a loss for
the first nine months of $5.1 million, net of tax of $1.8 million, to adjust these foreign currency
forward contracts to their fair market value. This loss is included in other comprehensive income
in the consolidated balance sheet. We do not believe that a hypothetical 10% movement in these
foreign currencies would have a material impact on our earnings related to these forward contracts.
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The company also had several foreign currency forward contracts with notional amounts aggregating
$31.7 million designated and qualifying as fair value hedges to hedge exposure to the Euro. Based
on quoted market prices as of September 30, 2005 for contracts with similar terms and maturity
dates, we recorded a loss of $0.1 million to adjust these foreign currency forward contracts to
their fair market value. This loss offsets designated gains on firm commitments. We do not
believe that a hypothetical 10% movement in these foreign currencies would have a material impact
on our earnings related to these forward contracts.
The Company has other financial market risk sensitive instruments denominated in foreign currencies
totaling $4.1 million as of September 30, 2005 excluding trade receivables and payables, which
approximate fair value. These market risk sensitive instruments consisted of cash balances and
overdraft facilities. The Company estimates that a hypothetical 10% movement of all applicable
foreign currency exchange rates on these financial market risk sensitive instruments would affect
net income by $0.3 million.
The counterparties to forward contracts are major financial institutions. The credit ratings and
concentration of risk of these financial institutions are monitored on a continuing basis. In the
unlikely event that the counterparties fail to meet the terms of a foreign currency contract, our
exposure is limited to the foreign currency rate differential.
Interest Rate Risk
At September 30, 2005 our long term borrowings consisted of $100 million in 7.5% senior notes,
$150 million in 6.5% senior notes, $200 million in 7.25% senior notes, $200 million in 5.65% senior
notes and $150 million in 5.5% senior notes. We had
$5 million of borrowings under our other credit facilities
at September 30, 2005. We occasionally have borrowings under our other credit facilities, and a
portion of these borrowings could be denominated in multiple currencies which could expose us to
market risk with exchange rate movements. These instruments carry interest at a pre-agreed upon
percentage point spread from either LIBOR, NIBOR or EURIBOR, or at the prime interest rate. Under
our credit facilities, we may, at our option, fix the interest rate for certain borrowings based on
a spread over LIBOR, NIBOR or EURIBOR for 30 days to 6 months. Our objective is to maintain a
portion of our debt in variable rate borrowings for the flexibility obtained regarding early
repayment without penalties and lower overall cost as compared with fixed-rate borrowings.
As of September 30, 2005, we had three interest rate swap agreements with an aggregate notional
amount of $100 million associated with our 2008 senior notes. Under this agreement, we receive
interest at a fixed rate of 7.5% and pay interest at a floating rate of six-month LIBOR plus a
weighted average spread of approximately 4.675%. The swap agreements will settle semi-annually and
will terminate in February 2008. The swap agreements originally entered into by Varco were
recorded at their fair market value at the date of the Merger and no longer qualify as effective
hedges under FAS 133. The swaps will be marked-to-market for periods subsequent to the Merger and
any change in their value will be reported as an adjustment to interest expense. The change in the
fair market value of the interest swap agreements resulted in a $1.3 million increase in interest
expense for the quarter ended September 30, 2005.
Item 4. Controls and Procedures
As of the end of the period covered by this report, we carried out an evaluation, under the
supervision and with the participation of the Companys management, including the Companys
Chairman, President and Chief Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of the Companys disclosure controls and procedures. Based upon that
evaluation, the Companys Chairman, President and Chief Executive Officer along with the Companys Chief
Financial Officer concluded that the Companys disclosure controls and procedures are effective as
of the end of the period covered by this report to timely alert them to material information
relating to the Company (including its consolidated subsidiaries) required to be included in the
Companys periodic Securities and Exchange Commission filings.
We are required to disclose certain changes in our internal control over financial reporting (as
defined in Rule 13a-15(f) under the Exchange Act) that occurred during our most recent fiscal
quarter that have materially affected or are reasonably likely to materially affect our internal
control over financial reporting. There are none. However, in the process of documenting and
testing our internal control in connection with compliance with Rule 13a-15(c) under the Exchange
Act of 1934, as amended (required by Section 404 of the Sarbanes-Oxley Act of 2002) we have made
changes, and will continue to make changes, to refine and improve our internal control.
Additionally, the Company appointed a new Chief Financial Officer and a new Corporate Controller
following its merger with Varco during the first quarter.
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Table of Contents
PART II OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
The annual meeting of stockholders was held on July 22, 2005. Stockholders elected three directors
nominated by the board of directors for terms expiring in 2008 by the following votes: Robert E.
Beauchamp 153,863,534 votes for and 1,334,268 votes withheld, Jeffery A. Smisek 153,861,460
votes for and 1,336,342 votes withheld, and James D. Woods 153,573,148 votes for and 1,624,654
withheld. There were no nominees to office other than the directors elected.
A proposal to ratify the appointment of Ernst & Young LLP as the Companys independent auditors for
the fiscal year ending December 31, 2005 was voted on by the stockholders as follows: 153,397,840
votes for, 938,224 votes against and 861,737 votes abstaining.
Item 6. Exhibits
Reference is hereby made to the Exhibit Index commencing on Page 27.
SIGNATURE
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.
Date: October 31, 2005 | /s/ Clay C. Williams | |||
Clay C. Williams | ||||
Senior Vice President and Chief Financial Officer (Duly Authorized Officer, Principal Financial and Accounting Officer) |
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Table of Contents
INDEX TO EXHIBITS
(a) Exhibits
10.1
|
Form of Nonqualified Stock Option Agreement (incorporated by reference to our Current Report on Form 8-K filed on October 14, 2005) | |
10.2
|
Form of Restricted Stock Award Agreement (incorporated by reference to our Current Report on Form 8-K filed on October 14, 2005) | |
31.1
|
Certification pursuant to Rule 13a-14a and Rule 15d-14(a) of the Securities and Exchange Act, as amended | |
31.2
|
Certification pursuant to Rule 13a-14a and Rule 15d-14(a) of the Securities and Exchange Act, as amended | |
32.1
|
Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
32.2
|
Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
27