NOV Inc. - Quarter Report: 2005 June (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 JUNE 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 NO o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of
the Act). Yes þ No o
As of July 29, 2005, 173,396,555 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)
June 30, | December 31, | |||||||
2005 | 2004 | |||||||
(Unaudited) | ||||||||
ASSETS |
||||||||
Current assets: |
||||||||
Cash and cash equivalents |
$ | 322.4 | $ | 142.7 | ||||
Receivables, net |
892.5 | 480.1 | ||||||
Inventories, net |
1,070.2 | 657.5 | ||||||
Costs in excess of billings |
349.0 | 226.5 | ||||||
Deferred income taxes |
54.6 | 15.6 | ||||||
Prepaid and other current assets |
51.7 | 15.0 | ||||||
Total current assets |
2,740.4 | 1,537.4 | ||||||
Property, plant and equipment, net |
931.9 | 255.1 | ||||||
Deferred income taxes |
60.6 | 55.1 | ||||||
Goodwill |
2,109.3 | 639.0 | ||||||
Intangibles, net |
520.3 | 91.0 | ||||||
Other assets |
20.6 | 21.1 | ||||||
$ | 6,383.1 | $ | 2,598.7 | |||||
LIABILITIES AND STOCKHOLDERS EQUITY |
||||||||
Current liabilities: |
||||||||
Accounts payable |
$ | 525.9 | $ | 407.7 | ||||
Accrued liabilities |
379.5 | 209.5 | ||||||
Current portion of long-term debt and short-term borrowings |
154.3 | 150.0 | ||||||
Accrued income taxes |
46.6 | 33.0 | ||||||
Total current liabilities |
1,106.3 | 800.2 | ||||||
Long-term debt |
835.4 | 350.0 | ||||||
Deferred income taxes |
371.2 | 102.8 | ||||||
Other liabilities |
73.4 | 31.5 | ||||||
Total liabilities |
2,386.3 | 1,284.5 | ||||||
Commitments and contingencies |
||||||||
Minority interest |
18.4 | 17.8 | ||||||
Stockholders equity: |
||||||||
Common stock par value $.01; 173,106,566 and 85,995,266 shares
issued and outstanding at June 30, 2005 and December 31, 2004 |
1.7 | 0.9 | ||||||
Additional paid-in capital |
3,349.8 | 692.9 | ||||||
Unearned stock-based compensation |
(26.2 | ) | | |||||
Accumulated other comprehensive income (loss) |
(12.9 | ) | 33.4 | |||||
Retained earnings |
666.0 | 569.2 | ||||||
3,978.4 | 1,296.4 | |||||||
$ | 6,383.1 | $ | 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 June 30, | Six Months Ended June 30, | |||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||
Revenue |
$ | 1,215.7 | $ | 533.5 | $ | 2,030.6 | $ | 1,029.7 | ||||||||
Cost of revenue |
960.5 | 415.9 | 1,613.6 | 808.5 | ||||||||||||
Gross profit |
255.2 | 117.6 | 417.0 | 221.2 | ||||||||||||
Selling, general, and administrative |
137.8 | 79.3 | 222.8 | 157.1 | ||||||||||||
Transaction costs |
15.3 | | 26.2 | | ||||||||||||
Operating profit |
102.1 | 38.3 | 168.0 | 64.1 | ||||||||||||
Interest and financial costs |
(14.1 | ) | (9.6 | ) | (24.8 | ) | (18.9 | ) | ||||||||
Interest income |
1.5 | 0.7 | 2.5 | 1.3 | ||||||||||||
Other income (expense), net |
1.1 | 1.0 | 0.4 | (0.3 | ) | |||||||||||
Income before income taxes and minority interest |
90.6 | 30.4 | 146.1 | 46.2 | ||||||||||||
Provision for income taxes |
28.3 | 8.8 | 47.8 | 13.4 | ||||||||||||
Income before minority interest |
62.3 | 21.6 | 98.3 | 32.8 | ||||||||||||
Minority interest in income of consolidated
subsidiaries |
1.1 | 0.2 | 1.5 | 0.4 | ||||||||||||
Net income |
$ | 61.2 | $ | 21.4 | $ | 96.8 | $ | 32.4 | ||||||||
Net income per share: |
||||||||||||||||
Basic |
$ | 0.35 | $ | 0.25 | $ | 0.70 | $ | 0.38 | ||||||||
Diluted |
$ | 0.35 | $ | 0.25 | $ | 0.69 | $ | 0.38 | ||||||||
Weighted average shares outstanding: |
||||||||||||||||
Basic |
172.3 | 85.8 | 138.8 | 85.6 | ||||||||||||
Diluted |
174.2 | 86.4 | 140.4 | 86.2 | ||||||||||||
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)
Six Months Ended | ||||||||
June 30, | ||||||||
2005 | 2004 | |||||||
Cash flow from operating activities: |
||||||||
Net income |
$ | 96.8 | $ | 32.4 | ||||
Adjustments to reconcile net income to net cash provided
(used) by operating activities: |
||||||||
Depreciation and amortization |
51.3 | 20.7 | ||||||
Tax benefit from exercise of nonqualified stock options |
13.9 | 2.7 | ||||||
Other |
(3.4 | ) | 5.7 | |||||
Changes in assets and liabilities, net of acquisitions: |
||||||||
Receivables |
(9.6 | ) | 14.8 | |||||
Inventories |
(56.9 | ) | (75.0 | ) | ||||
Costs in excess of billing |
(135.9 | ) | 3.2 | |||||
Prepaid and other current assets |
(10.8 | ) | 22.0 | |||||
Accounts payable |
29.5 | (17.5 | ) | |||||
Billings in excess of cost |
(13.9 | ) | (3.1 | ) | ||||
Other assets/liabilities, net |
18.3 | 12.9 | ||||||
Net cash provided (used) by operating activities |
(20.7 | ) | 18.8 | |||||
Cash flow from investing activities: |
||||||||
Purchases of property, plant and equipment |
(38.5 | ) | (14.1 | ) | ||||
Cash acquired in Varco merger |
163.5 | | ||||||
Other |
2.8 | 4.7 | ||||||
Net cash provided (used) by investing activities |
127.8 | (9.4 | ) | |||||
Cash flow from financing activities: |
||||||||
Borrowing against lines of credit |
170.2 | 278.8 | ||||||
Payments against lines of credit and other debt |
(171.1 | ) | (308.4 | ) | ||||
Proceeds from stock options exercised |
76.5 | 11.6 | ||||||
Net cash provided (used) by financing activities |
75.6 | (18.0 | ) | |||||
Effect of exchange rate loss on cash |
(3.0 | ) | (2.9 | ) | ||||
Increase (decrease) in cash equivalents |
179.7 | (11.5 | ) | |||||
Cash and cash equivalents, beginning of period |
142.7 | 74.2 | ||||||
Cash and cash equivalents, end of period |
$ | 322.4 | $ | 62.7 | ||||
Supplemental disclosures of cash flow information: |
||||||||
Cash payments during the period for: |
||||||||
Interest |
$ | 17.8 | $ | 17.2 | ||||
Income taxes |
$ | 43.5 | $ | 14.2 |
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 transaction costs), necessary for a fair presentation of the
results for the interim periods. The results of operations for the three months and six months
ended June 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 $2,563.5 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 |
28.3 | |||
Total preliminary purchase price |
$ | 2,563.5 | ||
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.
Compensation expense of $4.8 million and $5.9 million
related to the vesting of the exchanged options was recognized
in the second quarter and first half of 2005, respectively, and is
included in transaction costs on the income statement.
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 identifiable intangible assets based on their estimated fair values as of
March 11, 2005 as set forth below (in millions). The
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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 |
688.6 | |||
Goodwill |
1,484.7 | |||
Intangible assets |
442.1 | |||
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 |
$ | 2,563.5 | ||
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 six months ended June 30, 2005 excludes
certain merger-related items such as one-time expense associated with integration expenses and
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 six months ended June 30, 2005 and 2004
combines the historical results for National-Oilwell for the six months ended June 30, 2005 and
2004 and the historical results for Varco for the six months ended June 30, 2005 and 2004 (in
millions):
Six Months Ended June 30, | ||||||||
2005 | 2004 | |||||||
Total revenues |
$ | 2,338.5 | $ | 1,741.1 | ||||
Net income |
$ | 132.8 | $ | 73.6 | ||||
Basic net income per share |
$ | 0.77 | $ | 0.43 | ||||
Diluted net income per share |
$ | 0.77 | $ | 0.43 | ||||
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Recent 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 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):
June 30, | December 31, | |||||||
2005 | 2004 | |||||||
Raw materials and supplies |
$ | 180.0 | $ | 62.6 | ||||
Work in process |
243.4 | 104.2 | ||||||
Finished goods and purchased products |
646.8 | 490.7 | ||||||
Total |
$ | 1,070.2 | $ | 657.5 | ||||
Inventories at June 30, 2005 includes amounts from the Varco acquisition see Note 2 regarding the
Varco Merger.
4. Accrued Liabilities
Accrued liabilities consist of (in millions):
June 30, | December 31, | |||||||
2005 | 2004 | |||||||
Accrued compensation |
$ | 72.6 | $ | 37.0 | ||||
Customer prepayments |
60.9 | 27.9 | ||||||
Billings in excess of costs |
16.6 | 32.0 | ||||||
Other accrued liabilities |
229.4 | 112.6 | ||||||
Total |
$ | 379.5 | $ | 209.5 | ||||
Accrued liabilities at June 30, 2005 includes amounts from the Varco acquisition see Note 2
regarding the Varco Merger.
5. Comprehensive Income
The components of comprehensive income are as follows (in millions):
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||
Net income |
$ | 61.2 | $ | 21.4 | $ | 96.8 | $ | 32.4 | ||||||||
Currency translation adjustments |
(27.5 | ) | | (45.7 | ) | (2.1 | ) | |||||||||
Other |
(3.7 | ) | | (0.6 | ) | (0.5 | ) | |||||||||
Comprehensive income |
$ | 30.0 | $ | 21.4 | $ | 50.5 | $ | 29.8 | ||||||||
6. 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:
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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 June 30, | Six Months Ended June 30, | |||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||
(Restated) | (Restated) | |||||||||||||||
Revenue: |
||||||||||||||||
Rig Technology |
$ | 575.2 | $ | 234.9 | $ | 999.6 | $ | 439.5 | ||||||||
Petroleum Services & Supplies |
451.5 | 120.3 | 660.6 | 236.0 | ||||||||||||
Distribution Services |
258.0 | 218.4 | 493.9 | 436.5 | ||||||||||||
Eliminations |
(69.0 | ) | (40.1 | ) | (123.5 | ) | (82.3 | ) | ||||||||
Total Revenue |
$ | 1,215.7 | $ | 533.5 | $ | 2,030.6 | $ | 1,029.7 | ||||||||
Operating Profit: |
||||||||||||||||
Rig Technology |
$ | 51.9 | $ | 17.4 | $ | 96.8 | $ | 25.0 | ||||||||
Petroleum Services & Supplies |
76.6 | 17.4 | 111.8 | 33.3 | ||||||||||||
Distribution Services |
9.6 | 6.7 | 17.2 | 12.2 | ||||||||||||
Unallocated expenses and
eliminations |
(20.7 | ) | (3.2 | ) | (31.6 | ) | (6.4 | ) | ||||||||
Transaction costs |
(15.3 | ) | | (26.2 | ) | | ||||||||||
Total Operating Profit |
$ | 102.1 | $ | 38.3 | $ | 168.0 | $ | 64.1 | ||||||||
Operating Profit %: |
||||||||||||||||
Rig Technology |
9.0 | % | 7.4 | % | 9.7 | % | 5.7 | % | ||||||||
Petroleum Services & Supplies |
17.0 | % | 14.5 | % | 16.9 | % | 14.1 | % | ||||||||
Distribution Services |
3.7 | % | 3.1 | % | 3.5 | % | 2.8 | % | ||||||||
Total Operating Profit % |
8.4 | % | 7.2 | % | 8.3 | % | 6.2 | % | ||||||||
7. Debt
Debt consists of (in millions):
June 30, | December 31, | |||||||
2005 | 2004 | |||||||
$150.0 million Senior Notes, interest at 6.875% payable semiannually, principal due
on July 1, 2005 |
$ | 150.0 | $ | 150.0 | ||||
$100.0 million Senior Notes, interest at 7.5% payable semiannually, principal due
on February 15, 2008 |
103.9 | | ||||||
$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 |
220.5 | | ||||||
$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 |
152.0 | | ||||||
Other |
13.3 | | ||||||
Total debt |
989.7 | 500.0 | ||||||
Less current portion |
154.3 | 150.0 | ||||||
Long-term debt |
$ | 835.4 | $ | 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 June 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 June 30, 2005, there were no borrowings against this facility and there were $86 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 $11 million in promissory notes due to former owners of
businesses acquired who remain employed by the Company.
8. Employee Benefit Plans
Total net benefit expense associated with the Companys defined benefit pension and postretirement
benefit plans consisted of the following (in millions):
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||
Pension Benefits |
||||||||||||||||
Service cost |
$ | 0.9 | $ | 0.7 | $ | 1.6 | $ | 1.5 | ||||||||
Interest cost |
2.4 | 1.9 | 4.5 | 3.8 | ||||||||||||
Expected return on plan assets |
(2.2 | ) | (2.0 | ) | (4.4 | ) | (4.0 | ) | ||||||||
Net amortization and deferral |
0.3 | 0.4 | 0.7 | 0.7 | ||||||||||||
Total net benefit expense |
$ | 1.4 | $ | 1.0 | $ | 2.4 | $ | 2.0 | ||||||||
Postretirement Benefits |
||||||||||||||||
Service cost |
$ | 0.1 | $ | | $ | 0.1 | $ | | ||||||||
Interest cost |
0.5 | 0.2 | 0.6 | 0.3 | ||||||||||||
Net amortization and deferral |
0.1 | | 0.2 | 0.1 | ||||||||||||
Total net benefit expense |
$ | 0.7 | $ | 0.2 | $ | 0.9 | $ | 0.4 | ||||||||
The acquisition of Varco resulted in the addition of $42.4 million of pension and post-retirement
benefit plan obligations. See Note 2 regarding the Varco Merger.
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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 $5.9 million
related to the vesting of the exchanged options was recognized in the second quarter and
first half of 2005, respectively, and is included in transaction costs on the income statement.
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 | Six Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||
Net income, as reported |
$ | 61.2 | $ | 21.4 | $ | 96.8 | $ | 32.4 | ||||||||
Add: |
||||||||||||||||
Total stock-based employee
compensation expense
included in net income,
net of related tax effects |
3.1 | | 3.8 | | ||||||||||||
Deduct: |
||||||||||||||||
Total stock-based employee
compensation expense
determined under fair
value based method for all
awards, net of related tax
effects |
(8.5 | ) | (2.1 | ) | (11.8 | ) | (3.6 | ) | ||||||||
Pro forma net income |
$ | 55.8 | $ | 19.3 | $ | 88.8 | $ | 28.8 | ||||||||
Net income per common
share: |
||||||||||||||||
Basic, as reported |
$ | 0.35 | $ | 0.25 | $ | 0.70 | $ | 0.38 | ||||||||
Basic, pro forma |
$ | 0.32 | $ | 0.23 | $ | 0.64 | $ | 0.34 | ||||||||
Diluted, as reported |
$ | 0.35 | $ | 0.25 | $ | 0.69 | $ | 0.38 | ||||||||
Diluted, pro forma |
$ | 0.32 | $ | 0.22 | $ | 0.63 | $ | 0.33 | ||||||||
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 first six months of 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
In March 2005, the Financial Accounting Standards Board (FASB) issued Interpretation No. 47,
Accounting for Conditional Asset Retirement Obligations, (FIN 47) which clarifies when an
entity is required to recognize a liability for the fair value of a conditional asset retirement
obligation. FIN 47 will be effective for fiscal years ending after December 15, 2005, with earlier
adoption encouraged. We are currently evaluating the impact this interpretation may have on our
financial position, results of operations or cash flows.
In May 2005, the FASB issued Statement of Financial Accounting Standards No. 154, Accounting
Changes and Error Corrections (SFAS 154), which replaces APB Opinion No. 20, Accounting
Changes, and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements. SFAS 154
requires a voluntary change in accounting principle to be applied retrospectively to all prior
period financial statements so that those financial statements are presented as if the current
accounting principle had always been applied. SFAS 154 is effective for accounting changes and
correction of errors made after January 1, 2006, with early adoption permitted. We do not expect
the adoption of SFAS 154 to have a material impact on our financial position, results of operations
or cash flows.
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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 very strong during the second quarter of 2005.
Historically high oil and gas prices over the past few years have 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 benefited from higher rig dayrates
over the past few quarters, and dayrates moved significantly higher during the second quarter of
2005. This has increased cash flows to drilling contractors, who are reinvesting in their fleets
of equipment by upgrading and refurbishing older rigs, or by constructing new rigs. Many new
offshore jackup rig construction projects were announced through the first half of 2005, and the
second quarter saw the announcement of a number of more expensive offshore floating rig new
construction projects. There are approximately 37 jackup rigs and 10 floating rigs being
constructed worldwide. Additionally, demand for land rigs and components continued to strengthen.
This increasing 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 million of equipment for a typical jackup rig, up to
approximately $100 million of equipment for a floating rig, and an entire land rig (except for
certain components such as engines, which the Company buys in). Placement of orders for drilling
equipment for many of these offshore projects, together with continued strong demand for land rigs
and components, drove a 40% increase in backlog for the Rig Technology group through the second
quarter. Additionally, the group has benefited from the sale of coiled tubing and nitrogen
injection equipment used to execute sophisticated new well-stimulation techniques.
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 second quarter results for the group were adversely impacted by the
seasonal breakup in Canada, when road bans enacted during the spring thaw season limit movement of
rigs and thus reduce drilling activity in Canada. The groups operating profit from Canada
declined approximately $10.2 million due to breakup, compared to the pro forma combined results for
the group in the first quarter. Group results are expected to improve in Canada in the third
quarter, as oilfield activity typically resumes following the second quarter seasonal decline in
activity. Second quarter results were also adversely impacted by weak results from the groups
pipeline inspection operations, which had low volumes due to delays in several projects, and lower
pricing in North America. Excluding Canadian oilfield services and worldwide pipeline inspection
operations, the group posted higher revenues, up 13% on a proforma basis, at excellent 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.
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. The groups Canadian revenues declined
slightly due to breakup, but the decline was more than offset by gains in the U.S. and in other
international locations.
The Rig Technology group results were adversely impacted by developments with a large rig
fabrication project for a customer in Kazakhstan, which resulted in a $21.7 million pre-tax charge, or $0.08 per
share after tax, during the second quarter. Our customer awarded us this $150 million design and
fabrication project last summer, on a very fast one-year timetable. The project includes two large
3000 horsepower land rigs that are coupled with a joint support module designed to hold enough
pipe, mud and cement to continue drilling throughout the harsh Caspian winters. The entire
structure utilizes a unique skidding system to walk across the ground to move from well to well.
The rigs were scheduled to ship in the third quarter of 2005, in order to be able to deliver the
rigs to Kazakhstan before cold winter weather prevented their arrival. Due to the short timetable,
components for the rigs were fabricated at many of our facilities around the world, and were
brought to our Galena Park facility in Houston during the second quarter for final rig up. As
components arrived it became evident that additional engineering and assembly would be required in
order to integrate the components. As a result of the required modifications the overall weight of
the project was increased from approximately 9,000 tons to 11,000 tons, and substantially more
rig-up labor was required to complete the rigs. We currently expect to ship the rigs in the third
quarter of 2005, very close to our original deadline. We believe our latest cost estimates to
complete the project are realistic, but cannot offer absolute assurance that we will not encounter
additional setbacks. Excluding the revenue and operating profit impact of this project, Rig
Technology revenues were $563.2 million and operating profit was $73.6 million, or 13.1% of revenue
for the second quarter of 2005.
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The outlook for the Company through the second half of 2005 is good, because, overall activity is
expected to remain strong, and because, the Companys backlog for capital equipment sales has risen
52% through the first half 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. Nevertheless, a few important markets have not recovered to the levels of activity seen
in prior cyclical peaks, namely the Gulf of Mexico, the North Sea, and Venezuela, but these all
appear to be showing modest improvement.
High demand for equipment are expected to result in improved results for our Rig Technology
segment in the second half. 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%. Emergence from the seasonal breakup in
Canada, and improving pricing for many products and services are expected to result in improved
results in the Petroleum Services & Supplies segment. Over the long run, and excluding swings in
mix and other factors, we expect operating leverage in the Petroleum Services & Supplies group to
be in the range of 30%. The Distribution segment is expected to benefit from the resumption of
higher activity levels in Canada, as well as continued high levels of drilling and workover
activity elsewhere in the world. Over the long run, and excluding swings in mix and other factors,
we expect operating leverage in this group to be approximately 10%.
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 flow into the financial results of
the Company throughout 2005 and into the first quarter of 2006, higher than earlier estimates.
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 $15.3MM in transaction and
restructuring costs during the second quarter, including severance expenses, inventory
rationalization costs, and the amortization of options issued by the company as consideration for
the Varco merger.
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 anti-trust regulatory agencies around the world, including the
Antitrust Division of the U.S Department of Justice.
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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 second quarters of 2005 and
2004, and the first quarter of 2005 include the following:
% | % | |||||||||||||||||||
2Q05V | 2Q05V | |||||||||||||||||||
2Q05* | 2Q04* | 1Q05* | 2Q04 | 1Q05 | ||||||||||||||||
Active Drilling Rigs: |
||||||||||||||||||||
U.S. |
1,336 | 1,163 | 1,279 | 14.9 | % | 4.5 | % | |||||||||||||
Canada |
241 | 202 | 521 | 19.3 | % | (53.7 | %) | |||||||||||||
International |
916 | 838 | 876 | 9.3 | % | 4.6 | % | |||||||||||||
Worldwide |
2,493 | 2,203 | 2,676 | 13.2 | % | (6.8 | %) | |||||||||||||
Active Workover Rigs: |
||||||||||||||||||||
U.S. |
1,314 | 1,201 | 1,261 | 9.4 | % | 4.2 | % | |||||||||||||
Canada |
441 | 420 | 769 | 5.0 | % | (42.7 | %) | |||||||||||||
North America |
1,755 | 1,621 | 2,030 | 8.3 | % | (13.5 | %) | |||||||||||||
West Texas Intermediate Crude Prices (per
barrel) |
$ | 53.09 | $ | 38.36 | $ | 49.88 | 38.4 | % | 6.4 | % | ||||||||||
Natural Gas Prices ($/mbtu) |
$ | 6.94 | $ | 6.10 | $ | 6.42 | 13.8 | % | 8.1 | % |
* | 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 June 30, 2005 on a quarterly basis:
![(BAR GRAPH)](https://www.sec.gov/Archives/edgar/data/0001021860/000095012905007758/h27622h2762200.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 13.2% (from 2,203 to 2,493) and 14.9%
(from 1,163 to 1,336), respectively, in the second quarter of 2005 compared to the second quarter
of 2004. The average per barrel price of West Texas Intermediate Crude increased 38.4% (from
$38.36 per barrel to $53.09 per barrel) while natural gas prices increased 13.8% (from $6.10 per
mmbtu to $6.94 per mmbtu) in the second quarter of 2005 compared to the second quarter of 2004.
U.S. rig activity at July 29, 2005 was 1,412 rigs compared to the second quarter average of 1,336
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, 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 June 30, | Six Months Ended June 30, | |||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||
(Restated) | (Restated) | |||||||||||||||
Revenue: |
||||||||||||||||
Rig Technology |
$ | 575.2 | $ | 234.9 | $ | 999.6 | $ | 439.5 | ||||||||
Petroleum Services & Supplies |
451.5 | 120.3 | 660.6 | 236.0 | ||||||||||||
Distribution Services |
258.0 | 218.4 | 493.9 | 436.5 | ||||||||||||
Eliminations |
(69.0 | ) | (40.1 | ) | (123.5 | ) | (82.3 | ) | ||||||||
Total Revenue |
$ | 1,215.7 | $ | 533.5 | $ | 2,030.6 | $ | 1,029.7 | ||||||||
Operating Profit: |
||||||||||||||||
Rig Technology |
$ | 51.9 | $ | 17.4 | $ | 96.8 | $ | 25.0 | ||||||||
Petroleum Services & Supplies |
76.6 | 17.4 | 111.8 | 33.3 | ||||||||||||
Distribution Services |
9.6 | 6.7 | 17.2 | 12.2 | ||||||||||||
Unallocated expenses and
eliminations |
(20.7 | ) | (3.2 | ) | (31.6 | ) | (6.4 | ) | ||||||||
Transaction costs |
(15.3 | ) | | (26.2 | ) | | ||||||||||
Total Operating Profit |
$ | 102.1 | $ | 38.3 | $ | 168.0 | $ | 64.1 | ||||||||
Operating Profit %: |
||||||||||||||||
Rig Technology |
9.0 | % | 7.4 | % | 9.7 | % | 5.7 | % | ||||||||
Petroleum Services & Supplies |
17.0 | % | 14.5 | % | 16.9 | % | 14.1 | % | ||||||||
Distribution Services |
3.7 | % | 3.1 | % | 3.5 | % | 2.8 | % | ||||||||
Total Operating Profit % |
8.4 | % | 7.2 | % | 8.3 | % | 6.2 | % | ||||||||
Rig Technology
Three Months Ended June 30, 2005 and 2004. Rig Technology
revenue in the second quarter of
2005 was $575.2 million, an increase of $340.3 million (145%) compared to the same period of 2004.
Second quarter revenue included approximately $218.3 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. Operating profit from Rig Technology was $51.9 million for the
second quarter ended June 30, 2005, an increase of $34.5 million (198%) over the same period of
2004. The acquisition of Varco contributed approximately $48.7 million of the increase in
operating profit in the second quarter of 2005. This was offset by the impact of a $21.7 million
charge taken on a large Kazakhstan rig fabrication project in the second quarter. The charge was
the result of additional costs primarily due to higher rig-up costs and more material than
originally planned.
Six Months Ended June 30, 2005 and 2004. Revenue for the first half of 2005 was $999.6 million, an
increase of $560.1 million (127%) compared to the same period of 2004. The first half of 2005
revenue includes $295.9 million of revenue related to the acquisition of Varco, with the remainder
of the increase due to the increased business activity as discussed above. Operating profit for
the first six months of 2005 was $96.8 million, an increase of $71.8 million (287%) compared to
2004. The Varco acquisition accounted for $67.8 million of the increase. In addition, higher
revenue volumes on several large capital equipment orders in the first quarter also contributed to
the year to date increase. The increase in operating profit from the higher revenue volume was
largely offset by the second quarter charge related to the Kazakhstan rigs discussed above.
Petroleum Services & Supplies
Three Months Ended June 30, 2005 and 2004. Revenue from Petroleum Services & Supplies was $451.5
million for the second quarter of 2005 compared to $120.3 million for the second quarter of 2004,
an increase of $331.2 million (275%). The majority of the increase is attributable to the addition
of product lines acquired from Varco effective March 11, 2005, which totaled $278.8 million for the
quarter. The remaining increase is attributable to high demand for downhole tools and pumping
products,
17
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which had revenue increases of 42% and 30%, respectively. These increases were the
result of strong U.S. and worldwide drilling markets, as reflected by rig count increases of 15%
and 13%, respectively, in the second quarter of 2005 compared to the same period 2004. Petroleum
Services & Supplies also benefited from price increases implemented during 2004. Revenues
increased 35% compared to the second quarter of 2004, excluding Varco revenues.
Operating profit from Petroleum Services & Supplies was $76.6 million for the second quarter of
2005 compared to $17.4 million for the second quarter of 2004, an increase of $59.2 million (340%).
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 $51.7 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 113% and 45%,
respectively.
Six Months Ended June 30, 2005 and 2004. Revenue from Petroleum Services & Supplies was $660.6
million for the first six months of 2005 compared to $236.0 million for the first six months of
2004, an increase of $424.6 million (180%). The majority of the increase is attributable to the
addition of product lines acquired from Varco effective March 11, 2005, which totaled $339.2
million for the period. The remaining increase is attributable to high demand for downhole tools
and pumping products, which had revenue increases of 34% and 31%, respectively. These increases
were the result of strong U.S. and worldwide drilling markets, as reflected by rig count increases
of 15% and 13%, respectively, in the first six months of 2005 compared to the same period 2004.
Petroleum Services & Supplies also benefited from price increases implemented during 2004.
Revenues increased 32% compared to the first six months of 2004, excluding Varco revenues.
Operating profit from Petroleum Services & Supplies was $111.8 million for the first six months of
2005 compared to $33.3 million for the first six months of 2004, an increase of $78.5 million
(236%). 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 $64.2 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 86% and
50%, respectively.
Distribution Services
Three Months Ended June 30, 2005 and 2004. Revenue from Distribution Services was $258.0 million,
an increase of $39.6 million (18%) during the second quarter of 2005 over the comparable 2004
period as all geographic regions showed improvement. North American revenues were especially strong
due to the continued growth in the number of active rigs running in 2005 as well as benefits from
additional line pipe projects in Canada. From a product perspective, maintenance, repair and
operating supplies, spare parts, and tubular sales all posted increases. Operating income of $9.6
million in the second quarter of 2005 increased $2.9 million over the prior year results due to
gross margin improvement on higher revenue volumes, partially offset by an increased portion of
lower margin project business.
Six Months Ended June 30, 2005 and 2004. Revenue from Distribution Services increased $57.4
million (13%) in the first half of 2005 when compared to the prior year. Revenue in the
international market was up 4%, Canada increased 23% and the U.S Operations increased 12%, all
influenced by the year over year improvement in rig count activity. Operating income in the first
half of 2005 of $17.2 million increased by $5.0 million (41%) 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 $20.7 million and $31.6 million for the three and six
months ended June 30, 2005 compared to $3.2 million and $6.4 million for the same periods of 2004.
The increase in operations costs was due to costs associated with Varco operations since the
acquisition date, greater inter-segment profit eliminations, and cost increases associated with
complying with the Sarbanes-Oxley Act of 2002.
Transaction costs
Transaction costs were $15.3 million and $26.2 million for the second quarter and first half of
2005. Transaction costs for the second quarter and first half of 2005 consisted primarily of $9.0
million of inventory rationalization to be discontinued as a result of the merger, severance costs
related to former executive officers and employees of National Oilwell, and the amortization of
unvested stock options assumed in the merger.
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Interest and financial costs
Interest
and financial costs were $14.1 million and $24.8 million for the second quarter and first
half of 2005 compared to $9.6 and $18.9 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 June 30, 2005 under Liquidity and Capital Resources.
Provision for income taxes
The
effective tax rate for the three and six months ended June 30, 2005 was 31.2% and 32.7%
respectively (32.0% and 32.3% excluding transaction costs associated with the Varco merger)
compared to 28.9% and 29.0% 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 repealed 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 June 30, 2005, the Company had cash and cash equivalents of $322.4 million, and total debt of
$989.7 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 and debt assumed of $492.8 million related to the Varco
acquisition. The Companys outstanding debt at June 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 6.875%
senior notes due July 2005, $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 $39.7 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 $33.6 million. The difference will be
amortized to interest expense over the remaining life of the debt.
For the first six months of 2005, cash used by operating activities was $20.7 million compared to
cash provided by operating activities of $18.8 million in the same period of 2004. Cash was used
by operations primarily through increases in receivables of $9.6 million, inventories of $56.9
million, costs in excess of billings of $135.9 million, and decreases in billings in excess of
costs of $13.9 million. These negative cash flows were offset by net income of $96.8 million plus
non-cash charges of $51.3 million and $13.9 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 first six months of 2005 compared to the fourth quarter of 2004, while
inventory increased due to growing backlog orders.
For the first six months of 2005, cash provided from investing activities was $127.8 million
compared to $9.4 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 half of 2005, cash provided by financing activities was $75.6 million compared to
cash used of $18.0 million in 2004. Cash was provided by proceeds from exercised stock options of
$76.5 million offset by net debt retirements of $0.9 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 June 30, 2005, there were no borrowings against this facility and there were $86 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.
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
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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 not had a material impact on our operating results or financial condition 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, 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 recognizes revenue on certain long-term construction contracts using the
percentage-of-completion method, an output based measure focused on engineering estimates and
manufacturing progress. For certain projects where output measures are not clearly identified, the
Company uses the cost-to-cost method. 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.
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 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.
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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 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
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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.
Recently Issued Accounting Standards
In March 2005, the Financial Accounting Standards Board (FASB) issued Interpretation No. 47,
Accounting for Conditional Asset Retirement Obligations, (FIN 47) which clarifies when an
entity is required to recognize a liability for the fair value of a conditional asset retirement
obligation. FIN 47 will be effective for fiscal years ending after December 15, 2005, with earlier
adoption encouraged. We are currently evaluating the impact this interpretation may have on our
financial position, results of operations or cash flows.
In May 2005, the FASB issued Statement of Financial Accounting Standards No. 154, Accounting
Changes and Error Corrections (SFAS 154), which replaces APB Opinion No. 20, Accounting
Changes, and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements. SFAS 154
requires a voluntary change in accounting principle to be applied retrospectively to all prior
period financial statements so that those financial statements are presented as if the current
accounting principle had always been applied. SFAS 154 is effective for accounting changes and
correction of errors made after January 1, 2006, with early adoption permitted. We do not expect
the adoption of SFAS 154 to have a material impact on our financial position, results of operations
or cash flows.
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 or the expected completion of the Kazakhstan rig
fabrication project 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.
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 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.
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Pro forma combined operating results by segment are as follows (in millions):
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||
Revenue: |
||||||||||||||||
Rig Technology |
$ | 575.2 | $ | 382.2 | $ | 1,118.5 | $ | 725.4 | ||||||||
Petroleum Services & Supplies |
451.5 | 342.0 | 853.5 | 661.5 | ||||||||||||
Distribution Services |
258.0 | 218.4 | 493.9 | 436.5 | ||||||||||||
Eliminations |
(69.0 | ) | (40.1 | ) | (127.4 | ) | (82.3 | ) | ||||||||
Total Revenue |
$ | 1,215.7 | $ | 902.5 | $ | 2,338.5 | $ | 1,741.1 | ||||||||
Operating Profit: |
||||||||||||||||
Rig Technology |
$ | 51.9 | 36.2 | $ | 113.2 | $ | 54.3 | |||||||||
Petroleum Services & Supplies |
76.6 | 47.9 | 140.2 | 93.8 | ||||||||||||
Distribution Services |
9.6 | 6.7 | 17.2 | 12.2 | ||||||||||||
Unallocated expenses and
eliminations |
(20.7 | ) | (12.7 | ) | (42.7 | ) | (24.2 | ) | ||||||||
Total Operating Profit |
$ | 117.4 | $ | 78.1 | $ | 227.9 | $ | 136.1 | ||||||||
Operating Profit %: |
||||||||||||||||
Rig Technology |
9.0 | % | 9.5 | % | 10.1 | % | 7.5 | % | ||||||||
Petroleum Services & Supplies |
17.0 | % | 14.0 | % | 16.4 | % | 14.2 | % | ||||||||
Distribution Services |
3.7 | % | 3.1 | % | 3.5 | % | 2.8 | % | ||||||||
Total Operating Profit % |
9.7 | % | 8.7 | % | 9.7 | % | 7.8 | % | ||||||||
Rig Technology
Three and Six Months Ended June 30, 2005 and 2004. Rig Technology revenue on a pro forma basis in
the second quarter and first half of 2005 was $575.2 million and $1,118.5 million, an increase of
$193.0 million or 50% and $393.1 million or 54% compared to the same periods of 2004, principally
due to the growing capital equipment market for drilling, workover and coiled tubing products
discussed above. Rig Technology operating profit was $51.9 million and $113.2 million for the
second quarter and first half of 2005, increases of $15.7 million and $58.9 million over the same
periods of 2004 on a pro forma basis. The increase was due to higher sales volumes and reduced
costs on capital equipment orders as compared to the second quarter and first six months of 2004,
as well as overhead cost reductions, offset by the $21.7 million charge on the Kazahkstan rig
fabrication project in the second quarter of 2005. Backlog of the Rig Technology capital products
was $1,191 million at June 30, 2005, an increase of 339.4 million (40%) over backlog of $851.6
million at March 31, 2005, and an increase of 52% over pro forma combined backlog of $782.9 million
at December 31, 2004. New orders for the second quarter were $735.5 million, reflective of the
growing demand for the Companys drilling and well servicing products.
Petroleum Services & Supplies
Three Months Ended June 30, 2005 and 2004. Revenue on a pro forma basis from Petroleum Services &
Supplies was $451.5 million for the second quarter of 2005 compared to $342.0 million for second
quarter of 2004, an increase of $109.5 million (32%). The increase is attributable to a
significant increase in U.S. and worldwide drilling activity, price increases implemented 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 $4.4 million. Operating
profit on a pro forma basis for Petroleum Services & Supplies was $76.6 million for the second
quarter of 2005 compared to $47.9 for the second quarter of 2004, an increase of $28.7 million
(60%). Improved quarter-over-quarter results were posted across all product lines with the
exception of pipeline inspection.
Six Months Ended June 30, 2005 and 2004. Revenue on a pro forma basis from Petroleum Services &
Supplies was $853.5 million for the first six months of 2005 compared to $661.5 million for first
six months of 2004, an increase of $192.0 million (29%). 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
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increase attributable to acquisitions is approximately $11.8 million.
Operating profit on a pro forma basis for Petroleum Services & Supplies was $140.2 million for the
first six months of 2005 compared to $93.8 million for the first six months of 2004, an increase of
$46.4 million (49%). Improved year-over-year results were posted across most product lines with
the exception of pipeline inspection and fiberglass pipe sales which experienced lower margins due
to significantly higher raw material costs.
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 $20.7 million and $42.7 million for
the three and six months ended June 30, 2005, increases of $8.0 million and $18.5 million compared
to the three and six months ended June 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.
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 six
months of 2005, compared to $1.0 million in foreign exchange gains 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 June 30, 2005, we had also entered into several foreign currency forward contracts with notional
amounts aggregating $301.9 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 June 30, 2005 for
contracts with similar terms and maturity dates, we have recorded a loss for the first six months
of $2.8 million, net of tax of $0.9 million, to adjust these foreign currency forward contracts to
their fair market value. This loss is included in other comprehensive income in the consolidated
condensed balance sheet. We do not believe that a hypothetical 10% movement in these foreign
currencies would have a material impact on our earnings.
The company also had several foreign currency forward contracts with notional amounts aggregating
$33.7 million designated and qualifying as fair value hedges to hedge exposure to the Euro. Based
on quoted market prices as of June 30, 2005 for contracts with similar terms and maturity dates, we
recorded a gain of $0.4 million to adjust these foreign currency forward contracts to their fair
market value. This gain offsets designated losses on firm commitments. We do not believe that a
hypothetical 10% movement in these foreign currencies would have a material impact on our earnings.
The Company has other financial market risk sensitive instruments denominated in foreign currencies
totaling $5.4 million as of June 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 $0.4 million.
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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 June 30, 2005 our long term borrowings consisted of $150 million in 6.875% senior notes, (which
matured and were repaid on July 1, 2005), $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 no borrowings under our other credit facilities at June 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 June 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 $1.7 million reduction in interest expense for the
quarter ended June 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
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 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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PART II OTHER INFORMATION
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: August 5, 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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INDEX TO EXHIBITS
(a) Exhibits
Exhibit No. | Description | Note No. | ||
4.1
|
Indenture, dated as of February 25, 1998, between Varco, the Guarantors named therein and The Bank of New York as trustee, relating to $100,000,000 aggregate principal amount of 7.5% Senior Notes due 2008; Specimen Certificate of 7.5% Senior Notes due 2008 (private notes); and Specimen Certificate at 7.5% Senior Notes due 2008 (public notes). | (Note 2) | ||
4.1.1
|
Fifth Supplemental Indenture dated September 30, 2004 to Indenture dated February 25, 1998 by and among Varco, the Guarantors named therein and the Bank of New York Trust Company, N.A. as trustee. | (Note 18) | ||
4.2
|
Indenture, dated as of May 1, 2001, among Varco, the Guarantors named therein and The Bank of New York as trustee, relating to $200,000,000 aggregate principal amount of 7.25% Senior Notes due 2011; Specimen Certificate of 7.25% Senior Notes due 2011 (private notes); and Specimen Certificate of 7.25% Senior Notes due 2011 (public notes). | (Note 3) | ||
4.2.1
|
Third Supplemental Indenture dated September 30, 2004 to Indenture dated May 1, 2001 by and among Varco, the Guarantors named therein and the Bank of New York Trust Company, N.A. as trustee. | (Note 18) | ||
4.3
|
Indenture, dated as of November 19, 2002, between Varco, the guarantors named therein and The Bank of New York Trust Company of Florida as trustee, relating to $150,000,000 aggregate principal amount of 5.5% Senior Notes due 2012 (private notes) Specimen Certificate of 5.5% Senior Notes due 2012 (private notes); and Specimen Certificate of 5.5% Senior Notes due 2012 (public notes). | (Note 4) | ||
4.3.1
|
First Supplemental Indenture dated September 30, 2004 to Indenture dated November 19, 2002 by and among Varco, the Guarantors named therein and the Bank of New York Trust Company, N.A. as trustee. | (Note 18) | ||
4.4
|
Registration Rights Agreement dated as of November 19, 2002, among Varco and Salomon Smith Barney Inc. | (Note 4) | ||
10.1.1*
|
Form of Stock Option Agreement (Exhibit 10.1) | (Note 1) | ||
10.2
|
Amended and Restated Credit Agreement, dated as of June 21, 2005, among National Oilwell Varco, Inc., the financial institutions signatory thereto, including Wells Fargo Bank, National Association, in their capacities as lenders thereunder, as US administrative agent for the lenders, as Lead Arranger and Sole Book Runner, DnB NOR Bank ASA, as Norwegian Administrative Agent, DnB NOR Bank ASA and the Bank of Nova Scotia as Co-Documentation Agents, and Comerica Bank and JPMorgan Case Bank, N.A. as Co-Syndication Agents. | (Note 17) | ||
10.3*
|
Varco International, Inc. Deferred Compensation Plan (effective January 1, 2003) | (Note 14) | ||
10.4*
|
2003 Equity Participation Plan of Varco International, Inc. | (Note 15) | ||
10.4.1*
|
Form of Non-qualified Stock Option Agreement for Employees and Consultants; Form of Non-qualified Stock Option Agreement for Independent Directors. | (Note 13) | ||
10.4.2*
|
Form of Signature Page for Executive Officer Stock Option Agreement | (Note 16) | ||
10.5*
|
Amended and Restated Stock Option Plan for Key Employees of Tuboscope Vetco International Corporation; Form of Revised Incentive Stock Option Agreement; and Form of Revised Non-Qualified Stock Option Agreement. | (Note 5) |
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Table of Contents
Exhibit No. | Description | Note No. | ||
10.6*
|
Stock Option Plan for Non-Employee Directors; Amendment to Stock Option Plan for Non-Employee Directors; and Form of Stock Option Agreement. | (Note 6) | ||
10.7*
|
Amendment and Restatement of the Varco International, Inc. Supplemental Executive Retirement Plan (effective as of November 15, 2001) | (Note 14) | ||
10.8.5
|
Amendment dated as of January 11, 1996, with respect to Lease included as Exhibit 10.8 | (Note 7) | ||
10.9
|
Standard Industrial Lease-Net dated September 29, 1988 for the premises at 743 N. Eckhoff, Orange, California | (Note 8) | ||
10.9.1
|
First amendment dated as of January 11, 1996 to Lease included as Exhibit 10 B | (Note 7) | ||
10.10*
|
The Varco International, Inc. 1990 Stock Option Plan, as amended | (Note 9) | ||
10.10.1*
|
Amendments to the Varco International, Inc. 1990 Stock Option Plan | (Note 10) | ||
10.11*
|
Varco International, Inc. 1994 Directors Stock Option Plan | (Note 7) | ||
10.11.1*
|
Amendment to Varco International, Inc. 1994 Directors Stock Option Plan | (Note 11) | ||
10.12*
|
Amendment and Restatement of the Varco International, Inc. Executive Retiree Medical Plan (effective as of November 15, 2001) | (Note 14) | ||
10.12.1*
|
First Amendment to the Amendment and Restatement of the Varco International, Inc. Executive Retiree Medical Plan | (Note 16) | ||
10.13*
|
Form of Amendment and Restated Executive Agreement of certain members of senior management | (Note 16) | ||
10.14*
|
Form of Executive Agreement of certain members of senior management | (Note 12) | ||
10.14.1*
|
Form of First Amendment to Executive Agreements | (Note 12) | ||
10.15*
|
Executive Agreement of John F. Lauletta | (Note 12) | ||
10.16*
|
Executive Agreement of Joseph C. Winkler | (Note 12) | ||
10.17*
|
Agreement with George Boyadjieff dated November 29, 2002 | (Note 14) | ||
10.17.1*
|
First Amendment to Agreement with George Boyadjieff dated December 19, 2003 | (Note 16) | ||
10.18*
|
Form of Indemnity Agreement | (Note 12) | ||
10.19*
|
Form of Amended and Restated Indemnification Agreement | (Note 18) | ||
10.20*
|
Form of Deferred Stock Unit Award | (Note 16) | ||
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 amend | |||
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. |
28
Table of Contents
* | Compensatory plan or arrangement for management or others | |
Note 1 | Filed as an Exhibit to our Current Report on Form 8-K filed on February 10, 2005. | |
Note 2 | Incorporated by reference to Varcos Registration Statement on Form S-4 (No. 333-51115), filed on April 27, 1998. | |
Note 3 | Incorporated by reference to Varcos Registration Statement on Form S-4 (No. 333-64226), filed on June 29, 2001. | |
Note 4 | Incorporated by reference to Varcos Registration Statement on Form S-4 (No. 333-102162), filed on December 23, 2002. | |
Note 5 | Incorporated by reference to Varcos Registration Statement on Form S-8 (No. 33-72150), filed on November 24, 1993. | |
Note 6 | Incorporated by reference to Varcos Registration Statement on Form S-8 (No. 33-72072), filed on November 23, 1993. | |
Note 7 | Incorporated by reference to Varcos Annual Report on Form 10-K for the fiscal year ended December 31, 1995, filed on March 29, 1996. | |
Note 8 | Incorporated by reference to Varcos Annual Report on Form 10-K for the fiscal year ended December 31, 1988, filed on March 30, 1989. | |
Note 9 | Incorporated by reference to Varcos Registration Statement on Form S-8, Registration No. 333-21681, filed on February 12, 1997. | |
Note 10 | Incorporated by reference to Varcos Annual Report on Form 10-K for the year ended December 31, 1999, filed on March 24, 2000. | |
Note 11 | Incorporated by reference to Varcos Annual Report on Form 10-K for the fiscal year ended December 31, 1997, filed on March 26, 1998. | |
Note 12 | Incorporated by reference to Varcos Registration Statement of Form S-4 (333-34582), filed on April 12, 2000. | |
Note 13 | Incorporated by reference to Varcos Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2002, filed on November 8, 2002. | |
Note 14 | Incorporated by reference to Varcos Annual Report on Form 10-K for the fiscal year ended December 31, 2002, filed on March 28, 2003. | |
Note 15 | Incorporated by reference to Varcos Quarterly Report on Form 10Q for the fiscal quarter ended March 31, 2003, filed on May 20, 2003. | |
Note 16 | Incorporated by reference to Varcos Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2004, filed on May 6, 2004. | |
Note 17 | Incorporated by reference to Current Report on Form 8-K, filed on June 23, 2005. | |
Note 18 | Incorporated by reference to Varcos Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2004, filed on November 9, 2004. |
29