NOV Inc. - Quarter Report: 2006 March (Form 10-Q)
Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark one)
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTER ENDED MARCH 31, 2006 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 of incorporation or organization) |
(I.R.S. Employer 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 a large accelerated filer, an accelerated filer,
or a non-accelerated filer. See definition accelerated filer and large accelerated filer in Rule
12b-2 of the Exchange Act. (Check one):
Large Accelerated Filer þ Accelerated Filer o Non-Accelerated Filer o
Large Accelerated Filer þ Accelerated Filer o Non-Accelerated Filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act). Yes o No þ
As of May 2, 2006, 174,968,830 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)
CONSOLIDATED BALANCE SHEETS
(In millions, except share data)
March 31, | December 31, | |||||||
2006 | 2005 | |||||||
(Unaudited) | ||||||||
ASSETS |
||||||||
Current assets: |
||||||||
Cash and cash equivalents |
$ | 263.0 | $ | 209.4 | ||||
Receivables, net |
1,204.5 | 1,139.2 | ||||||
Inventories, net |
1,353.5 | 1,198.3 | ||||||
Costs in excess of billings |
348.7 | 341.9 | ||||||
Deferred income taxes |
58.6 | 58.6 | ||||||
Prepaid and other current assets |
90.2 | 50.8 | ||||||
Total current assets |
3,318.5 | 2,998.2 | ||||||
Property, plant and equipment, net |
878.4 | 877.6 | ||||||
Deferred income taxes |
52.4 | 52.2 | ||||||
Goodwill |
2,136.6 | 2,117.7 | ||||||
Intangibles, net |
603.8 | 611.5 | ||||||
Other assets |
19.8 | 21.3 | ||||||
Total assets |
$ | 7,009.5 | $ | 6,678.5 | ||||
LIABILITIES AND STOCKHOLDERS EQUITY |
||||||||
Current liabilities: |
||||||||
Accounts payable |
$ | 605.6 | $ | 568.2 | ||||
Accrued liabilities |
641.5 | 530.1 | ||||||
Current portion of long-term debt and short-term borrowings |
4.2 | 5.7 | ||||||
Accrued income taxes |
115.3 | 83.2 | ||||||
Total current liabilities |
1,366.6 | 1,187.2 | ||||||
Long-term debt |
834.8 | 835.6 | ||||||
Deferred income taxes |
357.2 | 373.3 | ||||||
Other liabilities |
70.3 | 63.7 | ||||||
Total liabilities |
2,628.9 | 2,459.8 | ||||||
Commitments and contingencies
|
||||||||
Minority interest |
24.9 | 24.5 | ||||||
Stockholders equity: |
||||||||
Common stock
par value $.01; 174,853,276 and 174,362,488 shares
issued and outstanding at March 31, 2006 and December 31, 2005 |
1.7 | 1.7 | ||||||
Additional paid-in capital |
3,409.5 | 3,400.9 | ||||||
Unearned stock-based compensation |
| (16.5 | ) | |||||
Accumulated other comprehensive loss |
(5.7 | ) | (21.8 | ) | ||||
Retained earnings |
950.2 | 829.9 | ||||||
Total stockholders equity |
4,355.7 | 4,194.2 | ||||||
Total liabilities and stockholders equity |
$ | 7,009.5 | $ | 6,678.5 | ||||
See notes to unaudited consolidated financial statements.
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Table of Contents
NATIONAL OILWELL VARCO, INC.
QUARTERLY CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(In millions, except per share data)
QUARTERLY CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(In millions, except per share data)
Three Months Ended | ||||||||
March 31, | ||||||||
2006 | 2005 | |||||||
Revenue |
$ | 1,511.8 | $ | 814.9 | ||||
Cost of revenue |
1,162.0 | 653.1 | ||||||
Gross profit |
349.8 | 161.8 | ||||||
Selling, general, and administrative (*) |
144.1 | 86.1 | ||||||
Integration costs |
7.9 | 9.8 | ||||||
Operating profit |
197.8 | 65.9 | ||||||
Interest and financial costs |
(13.6 | ) | (10.7 | ) | ||||
Interest income |
1.7 | 1.0 | ||||||
Other expense, net |
(3.0 | ) | (0.7 | ) | ||||
Income before income taxes and minority interest |
182.9 | 55.5 | ||||||
Provision for income taxes |
61.3 | 19.5 | ||||||
Income before minority interest |
121.6 | 36.0 | ||||||
Minority interest in income of consolidated
subsidiaries |
1.3 | 0.4 | ||||||
Net income |
$ | 120.3 | $ | 35.6 | ||||
Net income per share: |
||||||||
Basic |
$ | 0.69 | $ | 0.34 | ||||
Diluted |
$ | 0.68 | $ | 0.33 | ||||
Weighted average shares outstanding: |
||||||||
Basic |
174.6 | 105.3 | ||||||
Diluted |
176.6 | 106.6 | ||||||
(*) Stock-based compensation expense included in
selling, general, and administrative expense |
$ | 6.8 | $ | 1.1 | ||||
See notes to unaudited consolidated financial statements.
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NATIONAL OILWELL VARCO, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In millions)
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In millions)
Three Months Ended | ||||||||
March 31, | ||||||||
2006 | 2005 | |||||||
Cash flow from operating activities: |
||||||||
Net income |
$ | 120.3 | $ | 35.6 | ||||
Adjustments to reconcile net income to net cash provided
(used) by operating activities: |
||||||||
Depreciation and amortization |
38.4 | 16.3 | ||||||
Tax benefit from exercise of nonqualified stock options |
| 13.5 | ||||||
Excess tax benefit from exercise of nonqualified stock options |
(5.2 | ) | | |||||
Other |
1.1 | 1.8 | ||||||
Changes in assets and liabilities, net of acquisitions: |
||||||||
Receivables |
(65.3 | ) | (19.9 | ) | ||||
Inventories |
(155.2 | ) | (22.1 | ) | ||||
Costs in excess of billing |
(6.8 | ) | (27.8 | ) | ||||
Prepaid and other current assets |
(39.4 | ) | (0.6 | ) | ||||
Accounts payable |
37.4 | 9.6 | ||||||
Billings in excess of cost |
96.3 | (28.8 | ) | |||||
Other assets/liabilities, net |
65.0 | (20.1 | ) | |||||
Net cash provided (used) by operating activities |
86.6 | (42.5 | ) | |||||
Cash flow from investing activities: |
||||||||
Purchases of property, plant and equipment |
(30.2 | ) | (10.0 | ) | ||||
Cash acquired in Varco merger, net |
| 158.8 | ||||||
Businesses acquisitions, net of cash acquired |
(21.0 | ) | | |||||
Other |
| 3.3 | ||||||
Net cash provided (used) by investing activities |
(51.2 | ) | 152.1 | |||||
Cash flow from financing activities: |
||||||||
Borrowing against lines of credit and other debt |
3.6 | 143.0 | ||||||
Payments against lines of credit and other debt |
(5.7 | ) | (135.1 | ) | ||||
Proceeds from stock options exercised |
13.2 | 36.5 | ||||||
Excess tax benefit from exercise of nonqualified stock options |
5.2 | | ||||||
Net cash provided by financing activities |
16.3 | 44.4 | ||||||
Effect of
exchange rates on cash |
1.9 | (1.6 | ) | |||||
Increase in cash equivalents |
53.6 | 152.4 | ||||||
Cash and cash equivalents, beginning of period |
209.4 | 142.7 | ||||||
Cash and cash equivalents, end of period |
$ | 263.0 | $ | 295.1 | ||||
Supplemental disclosures of cash flow information: |
||||||||
Cash payments during the period for: |
||||||||
Interest |
$ | 8.9 | $ | 10.4 | ||||
Income taxes |
$ | 39.1 | $ | 16.2 |
See notes to unaudited consolidated financial statements.
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NATIONAL OILWELL VARCO, INC.
Notes to Consolidated Financial Statements (Unaudited)
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 2005 Annual Report on
Form 10K.
In our opinion, the consolidated financial statements include all adjustments, all of which are of
a normal, recurring nature, necessary for a fair presentation of the
results for the interim periods. The results of operations for the three months ended March 31,
2006 are not necessarily indicative of the results to be expected for the full year.
2. Varco Merger
The Varco 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 purchase
price is $2,579.3 million, including the fair value of Varco stock options assumed and merger
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 |
44.1 | |||
Total purchase price |
$ | 2,579.3 | ||
Merger related transaction costs include severance and other external costs directly related to the
merger.
Integration costs of $7.9 million in the first quarter of 2006 were comprised of $6.6 million for
discontinued inventory, $0.5 million for combining operations and $0.8 million of other.
Purchase Price Allocation
Under the purchase method of accounting, the total 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).
Cash and marketable securities |
$ | 163.5 | ||
Trade receivables |
385.3 | |||
Other current assets |
28.5 | |||
Inventory |
377.1 | |||
Property, plant and equipment |
598.4 | |||
Goodwill |
1,496.2 | |||
Intangible assets |
551.3 | |||
Other non-current assets |
11.3 | |||
Accounts payable and accrued
liabilities |
(230.5 | ) | ||
Income taxes payable |
(13.7 | ) | ||
Debt |
(492.8 | ) | ||
Deferred tax liabilities, net |
(240.1 | ) | ||
Other non-current liabilities |
(54.0 | ) | ||
Minority interest |
(1.2 | ) | ||
Total purchase price |
$ | 2,579.3 | ||
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3.
Inventories, net
Inventories consist of (in millions):
March 31, | December 31, | |||||||
2006 | 2005 | |||||||
Raw materials and supplies |
$ | 224.7 | $ | 220.4 | ||||
Work in process |
324.8 | 267.5 | ||||||
Finished goods and purchased products |
804.0 | 710.4 | ||||||
Total |
$ | 1,353.5 | $ | 1,198.3 | ||||
4. Accrued Liabilities
Accrued liabilities consist of (in millions):
March 31, | December 31, | |||||||
2006 | 2005 | |||||||
Compensation |
$ | 98.9 | $ | 111.0 | ||||
Warranty |
27.0 | 24.9 | ||||||
Interest |
16.5 | 11.7 | ||||||
Taxes (non income) |
24.9 | 23.6 | ||||||
Insurance |
21.3 | 30.2 | ||||||
Other |
258.5 | 230.6 | ||||||
Billings in excess of costs |
194.4 | 98.1 | ||||||
Total |
$ | 641.5 | $ | 530.1 | ||||
5. Costs and Estimated Earnings on Uncompleted Contracts
Costs and estimated earnings on uncompleted contracts consist of (in millions):
March 31, | December 31, | |||||||
2006 | 2005 | |||||||
Costs incurred on uncompleted contracts |
$ | 1,098.5 | $ | 1,440.9 | ||||
Estimated earnings |
215.5 | 300.6 | ||||||
1,314.0 | 1,741.5 | |||||||
Less: Billings to date |
1,159.7 | 1,497.7 | ||||||
$ | 154.3 | $ | 243.8 | |||||
Costs and estimated earnings in excess of billings on uncompleted contracts |
$ | 348.7 | $ | 341.9 | ||||
Billings in excess of costs and estimated earnings on uncompleted contracts |
(194.4 | ) | (98.1 | ) | ||||
$ | 154.3 | $ | 243.8 | |||||
6. Comprehensive Income
The components of comprehensive income are as follows (in millions):
Three Months Ended March 31, | ||||||||
2006 | 2005 | |||||||
Net income |
$ | 120.3 | $ | 35.6 | ||||
Currency translation adjustments |
9.3 | (18.2 | ) | |||||
Other |
6.8 | 3.1 | ||||||
Comprehensive income |
$ | 136.4 | $ | 20.5 | ||||
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7. Business Segments
Operating results by segment are as follows (in millions). The 2005 actual results include 20 days
of Varco operations from the acquisition date of March 11, 2005 through March 31, 2005:
Three Months Ended March 31, | ||||||||
2006 | 2005 | |||||||
Revenue: |
||||||||
Rig Technology |
$ | 715.3 | $ | 424.4 | ||||
Petroleum Services & Supplies |
541.0 | 209.1 | ||||||
Distribution Services |
326.5 | 235.9 | ||||||
Elimination |
(71.0 | ) | (54.5 | ) | ||||
Total Revenue |
$ | 1,511.8 | $ | 814.9 | ||||
Operating Profit: |
||||||||
Rig Technology |
$ | 100.8 | $ | 44.9 | ||||
Petroleum Services & Supplies |
118.3 | 35.2 | ||||||
Distribution Services |
20.8 | 7.6 | ||||||
Unallocated expenses and eliminations |
(27.4 | ) | (10.9 | ) | ||||
Integration costs and stock-based
compensation |
(14.7 | ) | (10.9 | ) | ||||
Total operating profit |
$ | 197.8 | $ | 65.9 | ||||
Operating profit %: |
||||||||
Rig Technology |
14.1 | % | 10.6 | % | ||||
Petroleum Services & Supplies |
21.9 | % | 16.8 | % | ||||
Distribution Services |
6.4 | % | 3.2 | % | ||||
Total Operating Profit % |
13.1 | % | 8.1 | % | ||||
8. Debt
Debt consists of (in millions):
March 31, | December 31, | |||||||
2006 | 2005 | |||||||
$100.0 million Senior Notes, interest at 7.5% payable semiannually, principal due
on February 15, 2008 |
$ | 103.1 | $ | 103.6 | ||||
$150.0 million Senior Notes, interest at 6.5% 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 |
217.8 | 218.7 | ||||||
$200.0 million Senior Notes, interest at 5.65% payable semiannually, principal due
on November 15, 2012 |
200.0 | 200.0 | ||||||
$150.0 million Senior Notes, interest at 5.5% payable semiannually, principal due
on November 19, 2012 |
151.8 | 151.8 | ||||||
Other |
16.3 | 17.2 | ||||||
Total debt |
839.0 | 841.3 | ||||||
Less current portion |
4.2 | 5.7 | ||||||
Long-term debt |
$ | 834.8 | $ | 835.6 | ||||
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Senior Notes
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 March 31, 2006.
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 replaced 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 March
31, 2006, there were no borrowings against this facility, and there were $142 million in
outstanding letters of credit. Interest under this multicurrency facility is based upon LIBOR,
NIBOR or EURIBOR plus 0.30% subject to a ratings-based grid, or the prime rate.
Other
Other debt includes approximately $11 million in promissory notes due to former owners of
businesses acquired who remain employed by the company.
9. Stock-Based Compensation
Prior to January 1, 2006 National Oilwell Varco the company accounted for its stock option plans
using the intrinsic value method of accounting provided under APB Opinion No. 25, Accounting for
Stock Issued to Employees, (APB 25) and related interpretations, as permitted by FASB Statement
No. 123, Accounting for Stock-Based Compensation, (SFAS 123) under which no compensation expense
was recognized for stock option grants. Share-based compensation was a pro forma disclosure in the
financial statement footnotes and continues to be for periods prior to fiscal 2006.
Effective January 1, 2006 the company adopted the fair value recognition provisions of FASB
Statement No. 123(R), Share-Based Payment, (SFAS 123(R)) using the modified-prospective
transition method. Under this transition method, compensation cost recognized in first quarter 2006
includes: a) compensation cost for all share-based payments granted
prior to January 1, 2006, but for which the requisite
service period had not been completed as of March 31, 2006 based on the grant date fair value
estimated in accordance with the original provisions of SFAS 123, and b) compensation cost for all
share-based payments granted subsequent to January 1, 2006 based on the grant date fair value
estimated in accordance with the provisions of SFAS 123(R).
The adoption of SFAS 123(R) results in lower diluted shares outstanding than would have been
calculated had compensation cost not been recorded for stock options. This is due to a modification
required by SFAS 123(R) of the treasury stock method calculation utilized to compute the dilutive
effect of stock options.
Prior to the adoption of SFAS 123(R), the company presented all tax benefits of deductions
resulting from the exercise of options as operating cash flows in the Statement of Consolidated
Cash Flows. SFAS 123(R) requires the cash flows resulting from tax deductions in excess of the
compensation cost recognized for those options (excess tax benefits) to be classified as financing
cash flows.
The company provides compensation benefits to employees and non-employee directors under
share-based payment arrangements including various employee stock option plans.
Total compensation cost that has been charged against income for all share-based compensation
arrangements under the Plan was $6.8 million and
$1.1 million for the three months ended March 31, 2006 and
2005, respectively. The total income tax benefit recognized in the income statement for all
share-based compensation arrangements under the Plan was
$2.4 million and $0.4 million for the three months ended
March 31, 2006 and 2005, respectively.
The $16.5 million of unearned stock-based compensation on the companys balance sheet at December
31, 2005 was reclassified to paid-in-capital upon the adoption of SFAS 123(R).
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Pro Forma Net Income
The following table provides pro forma net income and income per share had the company applied the
fair value method of SFAS 123(R) for the period ended March 31, 2005 (in millions, except per share data):
Three Months | ||||
Ended March 31, | ||||
2005 | ||||
Net income, before stock-based employee compensation |
$ | 35.6 | ||
Add: |
||||
Total stock-based employee compensation expense included
in net income, net of related tax effects |
0.7 | |||
Deduct: |
||||
Total stock-based employee compensation expense determined
under fair value based method for all awards, net of
related tax effects |
(3.3 | ) | ||
Pro forma net income |
$ | 33.0 | ||
Net income per common share: |
||||
Basic, as reported |
$ | 0.34 | ||
Basic, pro forma |
$ | 0.31 | ||
Diluted, as reported |
$ | 0.33 | ||
Diluted, pro forma |
$ | 0.31 | ||
Stock Options
Stock options awards are generally granted with an exercise price equal to the closing market price
of the Companys stock price at the date of grant. Stock options generally vest over a three year
period with one third vesting in each successive year so that the option is fully exercisable after
three years and generally have ten year contractual terms.
Upon adoption of FAS 123(R), we began estimating the value of employee stock options on the date of
grant using the Black Scholes model. Prior to the adoption of FAS 123(R), the value of each
employee stock option was estimated on the date of grant using the Black-Scholes model for the
purpose of the pro forma financial information in accordance with FAS 123. The determination of
fair value of share-based payment awards on the date of grant using an option-pricing model is
affected by our stock price as well as assumptions regarding a number of highly complex and
subjective variables. These variables include, but are not limited to the expected stock price
volatility over the term of the awards, and actual and projected employee stock option exercise
behaviors. The use of the Black Scholes model requires the use of extensive actual employee
exercise behavior data and the use of a number of complex assumptions including expected
volatility, risk-free interest rate, expected dividends and expected term.
Three Months Ended | Fiscal | ||||||||
March 31, 2006 | 2005 | ||||||||
Expected volatility |
39.37 | % | 46.0 | % | |||||
Risk-free interest rate |
4.56 | % | 3.68 | % | |||||
Expected dividends |
0.0 | % | 0.0 | % | |||||
Expected term |
3.75 | 5.0 | |||||||
Forfeiture rate |
1.09 | % | 5.0 | % |
We used the actual volatility for traded options on our stock since March 11, 2005 (merger date) as
the expected volatility assumption required in the Black Scholes model, which is consistent with
FAS 123(R) and SAB 107. Prior to the first quarter of fiscal 2006, we used our historical stock
price volatility in accordance with FAS 123 for purposes of our pro forma information. The
selection of the actual volatility approach was based upon the availability of actively traded
options on our stock and our assessment that actual volatility since the merger with Varco is more
representative of future stock price trends.
The risk-free interest rate assumption is based upon observed interest rates appropriate for the
term of our employee stock options. The dividend yield assumption is based on
the history and expectation of dividend payouts. The estimated expected term is based on the actual
employee exercise behaviors for the past ten years.
As stock-based compensation expense recognized in the Consolidated Statement of Income for the
first quarter of 2006 is based on awards ultimately expected to vest, it has been reduced for
estimated forfeitures. FAS 123(R) requires forfeitures to be estimated at the time of grant and
revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.
Forfeitures were estimated based on historical experience.
If factors change and we employ different assumptions in the application of FAS 123(R) in future
periods, the compensation expense that we record under FAS 123(R) may differ significantly from
what we have recorded in the current period.
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The following summary presents information regarding outstanding options as of December 31, 2005
and changes during the first quarter of 2006 with regard to options under all stock option plans:
Weighted | ||||||||||||||||
Average | ||||||||||||||||
Weighted | Remaining | Aggregate | ||||||||||||||
Average | Contractual | Intrinsic | ||||||||||||||
Shares | Exercise Price | Term | Value | |||||||||||||
Outstanding at December 31,
2005 |
4,340,842 | $ | 30.36 | |||||||||||||
Granted |
2,340,000 | 66.58 | ||||||||||||||
Exercised |
(480,633 | ) | 27.42 | |||||||||||||
Cancellations |
(57,333 | ) | 34.67 | |||||||||||||
Outstanding at March 31, 2006 |
6,142,876 | $ | 44.36 | 8.63 | $ | 127,119,967 | ||||||||||
Vested or expected to vest |
6,075,918 | $ | 44.36 | 8.63 | $ | 125,734,359 | ||||||||||
Exercisable at March 31, 2006 |
2,006,470 | $ | 26.76 | 7.18 | $ | 74,962,739 | ||||||||||
The weighted-average grant date fair values of options granted during the three months ended March
31, 2006 and 2005 were $23.79 and $16.85 (excluding options assumed in the Varco merger)
respectively. The total intrinsic value of options exercised during the three months ended March
31, 2006 and 2005 was $20.3 million and $81.5 million, respectively.
As of March 31, 2006, total unrecognized compensation cost related to nonvested stock options was
$78.0 million. This cost is expected to be recognized over a weighted average period of 2.9 years.
The total fair value of stock vested during the three months ended
March 31, 2006 and 2005 was approximately $18.1 million and $28.4 million respectively. Cash received from option exercises for the three months
ended March 31, 2006 and 2005 was $13.2 million and $36.5 million, respectively. The actual tax
benefit realized for the tax deductions from option exercises totaled
$5.2 million and $13.5 million,
respectively, for the three months ended March 31, 2006 and 2005. Cash used to settle equity
instruments granted under all share-based payment arrangements for the three months ended March 31,
2006 and 2005 was immaterial in both periods.
The impact of adopting Statement 123(R) on January 1, 2006, on National Oilwell Varcos income
before income taxes, net income and basic and diluted earnings per share for the three months ended
March 31, 2006 was immaterial.
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10. Recently Issued Accounting Standards
In February 2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 155,
Accounting for Certain Hybrid Financial Instruments, an amendment of SFAS No. 133, Accounting
for Derivative Instruments and Hedging Activities, and SFAS No. 140, Accounting for Transfers and
Servicing of Financial Assets and Extinguishment of Liabilities. SFAS No. 155 simplifies
accounting for certain hybrid instruments under SFAS No. 133 by permitting fair value remeasurement
for financial instruments containing an embedded derivative that otherwise would require
bifurcation. SFAS No. 155 eliminates both the previous restriction under SFAS No. 140 on passive
derivative instruments that a qualifying special-purpose entity may hold and SFAS No. 133
Implementation Issue No. D1, Application of Statement 133 to Beneficial Interests in Securitized
Financial Assets, which provides that beneficial interests are not subject to the provisions of
SFAS No. 133. SFAS No. 155 also establishes a requirement to evaluate interests in securitized
financial assets to identify interests that are freestanding derivatives or that are hybrid
financial instruments that contain an embedded derivative requiring bifurcation, and clarifies that
concentrations of credit risk in the form of subordination are not imbedded derivatives. SFAS No.
155 is effective for all financial instruments acquired, issued, or subject to a remeasurement
event occurring after the beginning of an entitys fiscal year that begins after September 15,
2006. We are currently evaluating the effect SFAS No. 155 will have on our consolidated financial
position, liquidity, or results from operations.
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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
Introduction
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. The following describes
our business segments:
Rig Technology
Our Rig Technology segment designs, manufactures, sells and services complete systems for the
drilling, completion, and servicing of oil and gas wells. The segment offers a comprehensive line
of highly-engineered equipment that automates complex well construction and management operations,
such as offshore and onshore drilling rigs; derricks; pipe lifting, racking, rotating and assembly
systems; coiled tubing equipment and pressure pumping units; well workover rigs; wireline winches;
and cranes. Demand for Rig Technology products is primarily dependent on 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 segments
large installed base of equipment. We have made strategic acquisitions and other investments during
the past several years in an effort to expand our product offering and our global manufacturing
capabilities, including new operations in Canada, Norway, the United Kingdom, China, and Belarus.
Petroleum Services & Supplies
Our Petroleum Services & Supplies segment provides a variety of consumable goods and services used
to drill, complete, remediate and workover oil and gas wells and service pipelines, flowlines and
other oilfield tubular goods. The segment manufactures, rents and sells a variety of products and
equipment used to perform drilling operations, including transfer pumps, solids control systems,
drilling motors and other downhole tools, rig instrumentation systems, and 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. 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 segment sells its tubular goods and services to oil and gas
companies; drilling contractors; pipe distributors, processors and manufacturers; and pipeline
operators. This segment has benefited from several strategic acquisitions and other investments
completed during the past few years, including operations in Canada, the United Kingdom, China,
Kazakhstan, and Mexico.
Distribution Services
Our Distribution Services segment 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 segment supports
major offshore drilling contractors through locations in the Middle East, Europe, Southeast Asia
and South America. Distribution Services employs advanced information technologies to provide
complete procurement, inventory management and logistics services to its customers around the
globe. Demand for the segments services are determined primarily by the level of drilling and
servicing activity, and oil and gas production activities.
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Executive Summary
For the first quarter of 2006, National Oilwell Varco generated earnings of $120.3 million, or
$0.68 per fully diluted share, on reported revenues of $1,511.8 million. These results include
$6.8 million in pre-tax options expense charges ($0.03 per share after tax) related to the
Companys adoption of SFAS 123(R), and $7.9 million in pre-tax charges ($0.03 per share after tax)
related to the Companys integration of the operations of Varco.
The Company underwent a major transformation on March 11, 2005, when National Oilwell and Varco
merged. As a result, the reported financial results for 2005 do not include the 70 days of Varco
operations prior to the merger. The Company has presented supplemental unaudited pro forma results
as if Varco and National Oilwell had been merged throughout 2004 and 2005, to better identify
trends in our businesses and provide more meaningful comparison. The discussion and analysis
below pertain to the results on this pro forma basis, which the Company tends to look at internally
to evaluate results. Additionally, the Companys disclosures since the merger have identified
transaction, integration and stock-based compensation charges, including items such as severance,
restructuring, equipment and inventory rationalization, amortization of options issued to replace
Varco options, and write-offs of discontinued product lines related to the merger. The discussion
of the results that follow generally excludes these items, except where noted, in order to better
identify trends in our business and provide more meaningful comparison. The Company tends to
review its results internally using this same methodology.
Oil & Gas Equipment and Services Market
Activity levels and demand for our products and services continued to improve in most of our
markets during the first quarter of 2006. Recovering economies of developed nations, and the
desire for improved standards of living among many in developing nations, have increased demand for
oil and gas. As a result, oil and gas prices have increased significantly over the past few years,
which has led to rising levels of exploration and development drilling in many oil and gas basins
around the globe. The world-wide rig count, a good indicator of oilfield activity and spending,
increased three percent from the fourth quarter of 2005 and 15 percent from the first quarter of
2005. Oil and gas companies have increased their levels of investment in new oil and gas wells, to
reverse the trend of declining reserves and to grow production to satisfy the rising energy needs
of the world. 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 driven rig dayrates sharply higher over the past several
quarters, which has increased cash flows and available financing to drilling contractors. Rising
dayrates have caused many older rigs to be placed back into service, and we believe virtually every
drilling rig that can operate is now working. The Company has played an important role in
providing the equipment, consumables and services needed to reactivate many of these older rigs.
Sales of individual drilling components have generally trended up over the past several quarters as
operators reactivated rigs for service.
Higher utilization of drilling rigs has tested the capability of the worlds fleet of rigs, much of
which is old and of limited capability. Technology has advanced significantly since most of the
existing rig fleet was built. The industry invested little during the late 1980s and 1990s on
new drilling equipment, but drilling technology progressed steadily nonetheless, as the Company and
its competitors continued to invest in new and better ways of drilling. As a consequence, the
safety, reliability, and efficiency of new, modern rigs surpass the performance of most of the
older rigs at work today. Oil and gas producers demand top performance from drilling rigs,
particularly at the premium dayrates that are being paid today. As a result of this trend, the
Company has benefited from incremental demand for new products (such as our small iron roughnecks
for land rigs, our LXT BOPs, our Safe-T-Lite pump liner systems, among others) to upgrade certain
rig functions to make them safer and more efficient.
Drilling rigs are now being pushed to drill deeper wells, more complex wells, highly deviated wells
and horizontal wells, tasks which require larger rigs with more capabilities. Higher dayrates
magnify the opportunity cost of rig downtime, and rigs are being pushed to maximize revenue days
for their drilling contractor owners. The drilling process effectively consumes the mechanical
components of a rig, which wear out and need periodic repair or replacement. We believe this
process has been accelerated by the high levels of rig utilization seen over the past several
quarters. In preceding years contractors could cannibalize mechanical components from their idle
rigs, rather than purchase new components. As the fleet of idle rigs has dwindled, the
availability of used components has dwindled as well, which has spurred incremental demand for rig
components from the Company.
Changing methods of drilling have further benefited the Companys business. Increasingly,
hydraulic power in addition to conventional mechanical rotary power is being used to apply
torque to the drill bit. This is done using downhole drilling motors powered by drilling fluids.
The Company is a major provider of downhole drilling motors, and has seen demand for this
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application of its drilling motors increase over the last several quarters. This trend has also
increased demand for the Companys high pressure mud pumps, which create the hydraulic power in the
drilling fluids which drive the drilling motors.
While the increasingly efficient equipment provided by the Company has mitigated the effect, high
activity levels have increased demand for personnel in the oilfield. Consequently, the Company,
its customers and its suppliers have experienced wage inflation in certain markets. Hiring
experienced drilling crews has been challenging for the drilling industry; however, the Company
believes crews generally prefer working on newer, more modern rigs. The Companys products which
save labor and increase efficiency (such as its automatic slips and pipe handling equipment) also
make the rig crews jobs easier, and make the rig a more desirable place to work.
Finally, the increase in drilling rig dayrates has made the economics of building new rigs
compelling in many markets. For the first time in many years, the industry is actively building
land rigs and offshore rigs. Many new offshore rig construction projects were announced throughout
2005, and there are approximately 62 new jackup rigs and 27 new floating rigs being constructed
worldwide now. The available supply of offshore rigs declined during the third quarter of 2005 due
to the impact of hurricanes Katrina and Rita, which seriously damaged or sunk several offshore rigs
in the Gulf of Mexico.
Segment Performance
The Companys Rig Technology group has been awarded many new orders for equipment for rigs being
constructed or repaired around the world, and it completed the first quarter with a record backlog
of $3,186.2 million as a result. New orders for capital equipment in to backlog were a record
$1,308.1 million in the first quarter, a 39 percent increase from the fourth quarter of 2005. The
company has the capability to supply up to approximately $48 million of equipment for a typical
jackup rig, more than $150 million of equipment for a new floating rig, and effectively all of a
new land rig (which range in price from less than $1 million to well over $20 million). Our
strategy targets the high end of the market, emphasizing technology, quality and reliability. Most
of the incremental growth in the backlog has been for offshore drilling packages for jackup,
semi-submersible and drillship rigs being constructed or undergoing major refurbishment. The
delivery of this equipment is typically tied to the construction schedule of the rig, which can
take as long as four years to complete. As a result much of our backlog delivery extends well
beyond 2006, and the Company has commissioning and installation work out as far as 2010. The
Company expects to generate revenue of approximately $1.8 to $2.0 billion out of backlog during
2006. Currently approximately 78 percent of the drilling equipment in backlog is for offshore
rigs, and 69 percent of the backlog is destined for international locations.
First quarter revenues for the Rig Technology group were $715.3 million, up 11 percent from the
fourth quarter of 2005 and up 32 percent from the pro forma first quarter of 2005. Operating
profit was $100.8 million or 14.1 percent of sales in the first quarter of 2006, compared to $80.5
million or 12.5 percent of sales in the fourth quarter of 2005 and $61.3 million or 11.3 percent of
sales in the pro forma first quarter of 2005 (excluding merger, transaction and stock-based
compensation from both periods, and including Varco results for the period prior to the closing of
the merger). Operating flow-through or leverage (the period-to-period increase in operating profit
divided by the increase in revenue) was 29 percent from the fourth quarter of 2005 to the first
quarter of 2006, excluding merger, transaction and stock-based compensation from both periods.
First quarter operating profit benefited from higher volumes, improving pricing, and merger-related
cost savings partly offset by higher employee benefit costs and higher costs associated with
purchased components. With record backlogs and improving efficiency our outlook for this business
for the remainder of 2006 continues to be very good, but the nature of capital equipment shipments
will continue to make quarter-to-quarter revenue changes volatile. We continue to expect normal
long-term flowthroughs of 22% for this group, and hope to achieve 15 percent operating margins in
the second quarter of 2006, driven by higher pricing and volumes.
The high oil and gas activity levels discussed above also increased demand for the Companys
Petroleum Services & Supplies group. The segment posted very good results for the first quarter of
2006, generating $541.0 million in revenue and $118.3 million in operating profit, or 21.9 percent
operating margin. Sequential revenue growth from the fourth quarter of 2005 was five percent,
slightly in excess of the growth in rig count worldwide. The group generated 61 percent operating
profit flowthrough, despite higher personnel costs. Revenues grew 35 percent compared to the pro
forma first quarter of 2005, substantially higher than the improvement in worldwide rig count over
the same timeframe. The year-over-year revenue growth generated 39 percent operating profit
flowthrough, due to higher volumes and improved pricing in most areas. The strong results were
broad-based, with most products and services up sequentially and year-over-year, at higher margins.
Our pipeline inspection services were an exception to this, where first quarter seasonal downturns
drove lower sequential results.
Mission Fluid King, Griffith/Vector downhole tools, Brandt solids control equipment and services,
and Quality Tubing coiled tubing brands all posted double-digit growth as compared to the fourth
quarter of 2005. Tuboscope pipe inspection and coating services posted sequential higher operating
margins on higher pricing and volumes, as well. Additionally, our sales of fiberglass and
composite pipe were roughly flat sequentially, as increases in sales to the oilfield were offset by
lower seasonal sales in China, and lower industrial sales. Nevertheless, the fiberglass group
posted sequentially higher operating margins in the first
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quarter as compared to the fourth quarter
of 2005. Most products and services within the Petroleum Services & Supplies group continue to
gain increases in pricing in the range of three to seven percent each quarter, but the margin
impact of these efforts is being mitigated somewhat by inflationary forces across our markets, as
personnel, raw materials costs and energy expenses continue to rise.
We expect continued high levels of oilfield activity, coupled with price increases over the last
few quarters, to drive continued improvement in the Petroleum Services & Supplies group in 2006,
but expect to see our second quarter 2006 results affected by the seasonal breakup in Canada. In
2005 our Petroleum Services & Supplies operations in Canada saw operating profit decline over $10
million from the first quarter to the second, due to breakup. We expect the impact of breakup in
Canada this year on the segments results to be in a similar range.
We continue to invest in the Petroleum Services & Supplies group to satisfy the needs of our
customers for drilling motors, solids control equipment, instrumentation systems and other
machinery we lease to drilling and production operations, to meet the rising demand we see in most
oilfield markets around the world. This quarter, about 70 percent of our capital expenditures went
to the Petroleum Services & Supplies group. Over the long run, and excluding swings in mix and
other factors, we continue to expect operating profit flowthrough from this group to be in the
range of 30 percent. Our overachievement of this level the past few quarters has largely been the
result of the very favorable market and pricing environment we are enjoying.
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 segment performed well in the first
quarter as a result. Revenue improved 6 percent from the fourth quarter, and 38 percent from the
first quarter of 2005, to $326.5 million. Operating profit was $20.8 million in the first quarter.
The group generated 32 percent operating profit flowthrough on the incremental revenue as compared
to the fourth quarter of 2005, lifting margins 160 basis points to 6.4 percent of sales. Compared
to the first quarter of 2005, operating profit flowthrough was 15 percent on the revenue increase.
First quarter operating margins doubled compared to the first quarter of the prior year. The group
has significantly improved its efficiency and reduced the costs of its products, while expanding
selectively into attractive markets. Most of the sequential first quarter growth came from North
America, with the mid-continent, Texas, and Canadian regions posting the largest increases. The
Gulf Coast region saw sales ease slightly during the first quarter as fourth quarter 2005 sales in
support of the hurricane rebuilding effort slowed. Strategic purchasing lifted our base margins by
about 0.5 percent, and we benefited from mix as well. As a result of the strong performance,
after-tax return on capital employed improved this quarter. We expect the Distribution Services
group to continue to perform well throughout 2006, as we continue selective expansion into key
international markets, strengthen alliances with customers, and leverage our buying power and IT
infrastructure to keep costs low. We continue to expect long-term flowthroughs for the
Distribution Services group, excluding swings in mix and other factors, to be around 10 percent.
Outlook
The outlook for the Company in 2006 is positive, as high commodity prices are expected to keep
overall oil and gas activity high, and as the Companys backlog for capital equipment sales has
more than quadrupled since the beginning of 2005. High levels of drilling across the North America land
market and the Middle East, in particular, are expected to continue to drive good results.
Although the warm winter across North America has led to seasonally high gas storage levels which
have reduced spot gas prices lately, we believe in the longer term this region faces significant
gas deliverability issues. North America has been unable to meaningfully increase gas production
despite significantly higher levels of gas drilling over the past few years. Oil remains subject
to significant political risk in many regions as well, and the growth of China and other emerging
economies has added significant demand to the oil markets. The Company expects the high commodity
prices that have resulted to sustain very high levels of oilfield activity in 2006, provided the
worlds major economies remain strong, and commodity prices remain high.
The Company expects to increase its capital spending about 40 percent in 2006, to a level in the
range of $170 million, primarily to add rental equipment in its Petroleum Services & Supplies
segment. Additionally the Company plans to add
coiled tubing manufacturing capacity, and selectively invest in machining, assembly and fabrication
equipment to improve its manufacturing efficiency in its Rig Technology and Petroleum Services &
Supplies segments.
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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 first quarters of 2006 and
2005, and the fourth quarter of 2005 include the following:
% | % | |||||||||||||||||||
1Q06 vs. | 1Q06 vs. | |||||||||||||||||||
1Q06* | 1Q05* | 4Q05* | 1Q05 | 4Q05 | ||||||||||||||||
Active Drilling Rigs: |
||||||||||||||||||||
U.S. |
1,520 | 1,279 | 1,479 | 18.8 | % | 2.8 | % | |||||||||||||
Canada |
665 | 521 | 572 | 27.6 | % | 16.3 | % | |||||||||||||
International |
893 | 876 | 929 | 1.9 | % | (3.9 | %) | |||||||||||||
Worldwide |
3,078 | 2,676 | 2,980 | 15.0 | % | 3.3 | % | |||||||||||||
Active Workover Rigs: |
||||||||||||||||||||
U.S. |
1,527 | 1,261 | 1,457 | 21.1 | % | 4.8 | % | |||||||||||||
Canada |
707 | 769 | 777 | (8.1 | %) | (9.0 | %) | |||||||||||||
North America |
2,234 | 2,030 | 2,234 | 10.0 | % | | ||||||||||||||
West Texas Intermediate
Crude Prices (per barrel) |
$ | 63.18 | $ | 49.88 | $ | 60.42 | 26.7 | % | 4.6 | % | ||||||||||
Natural Gas Prices ($/mmbtu) |
$ | 7.71 | $ | 6.42 | $ | 12.25 | 20.1 | % | (37.1 | %) |
* | 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 March 31, 2006 on a quarterly basis:
![(BAR GRAPH)](https://www.sec.gov/Archives/edgar/data/0001021860/000095012906005162/h35893h3589301.gif)
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Source: Rig count: Baker Hughes, Inc. (www.bakerhughes.com); West Texas Intermediate Crude Price:
Department of Energy, Energy Information Administration (www.eia.doe.gov).
The worldwide and U.S. quarterly average rig count increased 15.0% (from 2,676 to 3,078) and 18.8%
(from 1,279 to 1,520), respectively, in the first quarter of 2006 compared to the first quarter of
2005. The average per barrel price of West Texas Intermediate Crude increased 26.7% (from $49.88
per barrel to $63.18 per barrel) while natural gas prices increased 20.1% (from $6.42 per mmbtu to
$7.71 per mmbtu) in the first quarter of 2006 compared to the first quarter of 2005.
U.S. rig activity at April 28, 2006 was 1,608 rigs compared to the first quarter average of 1,520
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.
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Results of Operations
Operating results by segment are as follows. The 2005 actual results include 20 days of Varco
operations from the acquisition date of March 11, 2005 (in millions):
Three Months Ended March 31, | ||||||||
2006 | 2005 | |||||||
Revenue: |
||||||||
Rig Technology |
$ | 715.3 | $ | 424.4 | ||||
Petroleum Services & Supplies |
541.0 | 209.1 | ||||||
Distribution Services |
326.5 | 235.9 | ||||||
Elimination |
(71.0 | ) | (54.5 | ) | ||||
Total Revenue |
$ | 1,511.8 | $ | 814.9 | ||||
Operating Profit: |
||||||||
Rig Technology |
$ | 100.8 | $ | 44.9 | ||||
Petroleum Services & Supplies |
118.3 | 35.2 | ||||||
Distribution Services |
20.8 | 7.6 | ||||||
Unallocated expenses and eliminations |
(27.4 | ) | (10.9 | ) | ||||
Integration costs and stock-based
compensation |
(14.7 | ) | (10.9 | ) | ||||
Total operating profit |
$ | 197.8 | $ | 65.9 | ||||
Operating profit %: |
||||||||
Rig Technology |
14.1 | % | 10.6 | % | ||||
Petroleum Services & Supplies |
21.9 | % | 16.8 | % | ||||
Distribution Services |
6.4 | % | 3.2 | % | ||||
Total Operating Profit % |
13.1 | % | 8.1 | % | ||||
Rig Technology
Revenue from Rig Technology was $715.3 million, an increase of $290.9 million (68.5%) compared to
the first quarter of 2005. The acquisition of Varco contributed approximately $118.9 million to
the increase in revenue. 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, and price
increases implemented in 2005.
First quarter 2006 actual operating profit for Rig Technology was $100.8 million compared to $44.9
million for the first quarter of 2005, an increase of $55.9 million (124.5%). The acquisition of
Varco contributed approximately $16.4 million of the increase in operating profit. In addition,
operating profit benefited from higher volumes, improved pricing, and merger-related cost savings
partly offset by higher employee benefit costs and higher costs associated with purchased
components.
Petroleum Services & Supplies
Revenue from Petroleum Services & Supplies was $541.0 million for the first quarter of 2006
compared to $209.1 million for the first quarter of 2005, an increase of $331.9 million (158.7%).
The majority of the increase is attributable to the addition of product lines acquired from Varco,
which totaled approximately $192.9 million. The remaining increase is attributable to higher
demand for virtually all products and services offered by the segment. These increases were the
result of strong U.S. and worldwide drilling markets, as reflected by rig count increases of 18.8%
and 15.0%, respectively, in the first quarter 2006 compared to the same period 2005. Petroleum
Services & Supplies also benefited from price increases implemented during 2005.
Operating profit from Petroleum Services & Supplies was $118.3 million for the first quarter of
2006 compared to $35.2 million for the first quarter of 2005, an
increase of $83.1 million (236.1%).
The majority of the increase was attributable to the addition of product lines acquired from Varco.
Incremental operating profit from these product lines was approximately $28.4 million.
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The remaining increase was attributable to higher profitability across all products,
driven by higher volumes and improved pricing.
Distribution Services
Revenue
from Distribution Services was $326.5 million, an increase of
$90.6 million (38.4%) during
the first quarter of 2006 over the comparable 2005 period. The revenue growth was led by a strong
demand for products in the US which was up 48%, followed by Canada up 28% and International
revenues up 12%. US operations were especially impacted by robust increases in rig count activity
in the Mid-Continent and Rocky Mountain regions where there is higher concentrations of drilling
activity. Revenues generated from maintenance, repair and operating supplies were up 39%, spare
parts up 36% and Tubular sales up 28%.
Operating
income of $20.8 million in the first quarter of 2006 increased
$13.2 million (173.7%) over the
prior year results due to gross margin improvement on higher revenue volumes coupled with absorbing
the revenue increase across an already established distribution infrastructure and expense base.
Unallocated expenses and eliminations
Unallocated expenses and eliminations were $27.4 million and $10.9 million for the quarters ended
March 31, 2006 and 2005, respectively. The increase in operating costs was due to costs associated
with Varco operations since the acquisition date and greater inter-segment profit eliminations.
Interest expense
Interest expense was $13.6 million for the first quarter of 2006 compared to $10.7 million for the
same period of 2005. The increase was primarily due to interest costs associated with debt assumed
in the Varco transaction. See summary of outstanding debt at March 31, 2006 under Liquidity and
Capital Resources.
Provision for income taxes
The effective tax rate for the three months ended March 31, 2006 was 33.5% (33.6% excluding
transactions costs associated with the Merger) compared to 35.1% for the same period in 2005 (32.7%
excluding transaction costs associated with the merger), reflecting a lower percentage of earnings
in foreign jurisdictions with lower tax rates and reduced benefits in the U.S. associated with
export sales. The U.S. laws granting this tax benefit were repealed as part of the American Jobs
Creation Act of 2004 and this benefit will be phased out after 2006. A new tax benefit associated
with U.S. manufacturing operations passed into law under the same Act and 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 2006 to be approximately 33.5% for continuing operations.
Liquidity and Capital Resources
At March 31, 2006, the Company had cash and cash equivalents of $263.0 million, and total debt of
$839.0 million. At December 31, 2005, cash and cash equivalents were $209.4 million and total debt
was $841.3 million. The Companys outstanding debt at March 31, 2006 consisted of $200.0 million
of 5.65% senior notes due 2012, $200.0 million of 7.25% senior notes due 2011, $150.0 million of
6.5% senior notes due 2011, $150.0 million of 5.5% senior notes due 2012, $100.0 million of 7.5%
senior notes due 2008, and other debt $39.0 million. Included in other debt is the revaluation of
the Varco debt assumed in the acquisition which resulted in additional debt recognition of $22.7
million. The difference is being amortized to interest expense over the remaining life of the
debt.
For the
first quarter of 2006, cash provided by operating activities was $86.6 million compared to
cash used for operating activities of $42.5 million in the same period of 2005. Cash was provided
by operations primarily through net income of $120.3 million plus non-cash charges of $38.4
million, and increases in billings in excess of costs of $96.3 million. These positive cash flows
were offset by increases in receivables of $65.3 million, inventories of $155.2 million, and costs
in excess of billings of $6.8 million. Receivables and costs in excess of billings increased due
to greater revenue and activity in the first quarter of 2006 compared to the fourth quarter of
2005, while inventory increased due to growing backlog orders.
For the first quarter of 2006, cash used by investing activities was $51.2 million compared to cash
provided of $152.1 million for the same period of 2005. Capital expenditures totaled approximately
$30.2 million in the first quarter of 2006, primarily related to the Petroleum Services & Supplies
service and rental businesses.
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For the first quarter of 2006, cash provided by financing activities was $16.3 million compared to
cash provided of $44.4 million for the same period of 2005. Cash proceeds from exercised stock
options was $13.2 million.
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 replaced the Companys $175 million North American
revolving credit facility and our Norwegian facility. The facility is available for general
corporate purposes and acquisitions, including letters of credit and performance bonds. 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 March 31, 2006, there were no borrowings against this
facility, and there were $142 million in outstanding letters of credit. Interest under this
multicurrency facility is based upon LIBOR, NIBOR or EURIBOR plus 0.30% subject to a ratings-based
grid, or the prime rate.
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 any significant increases in
capital expenditures caused by any need to increase manufacturing capacity can be funded from
operations or through debt financing.
We intend to pursue additional acquisition candidates, but the timing, size or success of any
acquisition effort and the related potential capital commitments cannot be predicted. We expect to
fund future cash acquisitions primarily with cash flow from operations and borrowings, including
the unborrowed portion of the credit facility or new debt issuances, but may also issue additional
equity either directly or in connection with acquisitions. There can be no assurance that
additional financing for acquisitions will be available at terms acceptable to us.
Inflation has 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
2005 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 uses the percentage-of-completion method to account for certain long-term construction
contracts that are built or constructed to the customers specifications, and are manufactured
outside the Companys normal manufacturing process and marketed outside of the Companys normal
marketing channels. Projects recognized under the percentage-of-completion
method include the following characteristics: 1) the contracts include custom designs for customer
specific applications; 2) components are often modified with change orders throughout the project;
3) the structural design is unique and requires significant engineering efforts; and 4)
construction projects often have progress payments. This method requires us to make estimates
regarding the total costs of the project, our progress against the project schedule and the
estimated completion date, all of which impact the amount of revenue and gross margin we recognize
in each reporting period. Changes in job performance, job conditions, and estimated profitability,
including those arising from contract penalty provisions, and final contract settlements may result
in revisions to costs and income and are recognized in the period in which the revisions are
determined.
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Profit incentives are included in revenues when their realization is reasonably
assured. Provisions for anticipated losses on uncompleted contracts are recorded in full when such
losses become evident. The Company measures the extent of progress towards completion on these
projects using either input or output based methods that are appropriate to the contract
circumstances. The output methods are based upon engineering estimates and the input measures are
based upon the ratio of costs incurred to the total projected costs.
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.
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.
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We currently have recorded 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 recognized in the
period when we determine the reserves are no longer necessary. If the tax liabilities relate to tax
uncertainties existing at the date of the acquisition of a business, the adjustment of such tax
liabilities will result in an adjustment to the goodwill recorded at the date of acquisition.
Pensions and Other Postretirement Benefits
The Company accounts for our defined benefit pension plans in accordance with Statement of
Financial Accounting Standards No. 87, Employers Accounting for Pensions (FAS 87), which requires
that amounts recognized in the financial statements be determined on an actuarial basis.
Significant elements in determining our pension income or expense in accordance with FAS 87 are the
discount rate assumption and the expected return on plan assets. The discount rate used
approximates the weighted average rate of return on high-quality fixed income investments whose
maturities match the expected payouts. The expected return on plan assets is based upon the
geometric mean of historical returns of a number of different equities, including stocks, bonds and
U.S. treasury bills. The assumed long-term rate of return on assets is applied to a calculated
value of plan assets which results in an estimated return on plan assets that is included in
current year pension income or expense. The difference between this expected return and the actual
return on plan assets is deferred and amortized against future pension income or expense. The
total net expense associated with the Companys defined benefit pension and postretirement benefit
plans was approximately $1.2 million for the three months ended March 31, 2006, compared to $1.2
million for the same period of 2005.
Recently Issued Accounting Standards
In February 2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 155,
Accounting for Certain Hybrid Financial Instruments, an amendment of SFAS No. 133, Accounting
for Derivative Instruments and Hedging Activities, and SFAS No. 140, Accounting for Transfers and
Servicing of Financial Assets and Extinguishment of Liabilities. SFAS No. 155 simplifies
accounting for certain hybrid instruments under SFAS No. 133 by permitting fair value remeasurement
for financial instruments containing an embedded derivative that otherwise would require
bifurcation. SFAS No. 155 eliminates both the previous restriction under SFAS No. 140 on passive
derivative instruments that a qualifying special-purpose entity may hold and SFAS No. 133
Implementation Issue No. D1, Application of Statement 133 to Beneficial Interests in Securitized
Financial Assets, which provides that beneficial interests are not subject to the provisions of
SFAS No. 133. SFAS No. 155 also establishes a requirement to evaluate interests in securitized
financial assets to identify interests that are freestanding derivatives or that are hybrid
financial instruments that contain an embedded derivative requiring bifurcation, and clarifies that
concentrations of credit risk in the form of subordination are not imbedded derivatives. SFAS No.
155 is effective for all financial instruments acquired, issued, or subject to a remeasurement
event occurring after the beginning of an entitys fiscal year that begins after September 15,
2006. We are currently evaluating the effect SFAS No. 155
will have on our consolidated financial position, liquidity, or results from operations.
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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 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 Annual Report on Form 10-K for the year ending December 31, 2005,
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 Unaudited Pro Forma Comparison
The pro forma information reflects results as if the Varco acquisition occurred at the beginning of
the first quarter of 2005. 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.
Pro forma operating results by segment are as follows (in millions):
Three Months Ended March 31, | ||||||||
2006 | 2005 | |||||||
Revenue: |
||||||||
Rig Technology |
$ | 715.3 | $ | 543.3 | ||||
Petroleum Services & Supplies |
541.0 | 402.0 | ||||||
Distribution Services |
326.5 | 235.9 | ||||||
Elimination |
(71.0 | ) | (58.4 | ) | ||||
Total Revenue |
$ | 1,511.8 | $ | 1,122.8 | ||||
Operating Profit: |
||||||||
Rig Technology |
$ | 100.8 | $ | 61.3 | ||||
Petroleum Services & Supplies |
118.3 | 63.6 | ||||||
Distribution Services |
20.8 | 7.6 | ||||||
Unallocated expenses and
eliminations |
(27.4 | ) | (22.0 | ) | ||||
Transaction Costs |
| | ||||||
Total operating profit |
$ | 212.5 | $ | 110.5 | ||||
Operating profit %: |
||||||||
Rig Technology |
14.1 | % | 11.3 | % | ||||
Petroleum Services & Supplies |
21.9 | % | 15.8 | % | ||||
Distribution Services |
6.4 | % | 3.2 | % | ||||
Total Operating Profit % |
14.1 | % | 9.8 | % | ||||
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Rig Technology revenue on a pro forma basis increased $172.0 million (31.7%), from $543.3 million
in the first quarter of 2005 to $715.3 million for the quarter ended March 31, 2006. This was
principally due to the growing capital equipment market for drilling, workover and coiled tubing
products discussed above. Rig Technology operating profit was $100.8 million for the first
quarter, an increase of $39.5 million over the same period of 2005 on a pro forma basis. The
increase was due to higher sales volumes and merger-related cost savings which were partly offset
by increases in employee benefit costs and higher material costs. Backlog of the Rig Technology
capital products was $3.2 billion at March 31, 2006, an increase of 39% over backlog of $2.3
billion at December 31, 2005. Pro forma orders for the period ending March 31, 2006 were $1.3
billion, reflective of the growing demand for the Companys drilling and well servicing products.
Revenue from Petroleum Services & Supplies was $541.0 million for the first quarter of 2006
compared to $402.0 million for the first quarter of 2005 on a pro forma basis, an increase of
$139.0 million (34.6%). The increase is attributable to a significant increase in U.S. and
worldwide drilling activity; price increases implemented during 2005; and strong spare parts and
consumable sales to support increased drilling. Operating profit for Petroleum Services & Supplies
was $118.3 million for the first quarter of 2006 compared to $63.6 million for the first quarter of
2005 on a pro forma basis, an increase of $54.7 million (86.0%). Improved year-over-year results
were posted across all products and services.
Revenue from Distribution Services was $326.5 million, an increase of $90.6 million (38.4%), during
the first quarter of 2006 over the comparable 2005 period as all geographic regions showed
improvement. Operating income of $20.8 million in the first quarter of 2006 increased $13.2 million
over the prior year results, due to the increased revenue and higher base margins resulting from
price increases on certain products.
Unallocated expenses and eliminations on a pro forma basis were $27.4 million and $22.0 million for
the first quarter of 2006 and 2005. The increase in operating loss was due to greater
inter-segment profit eliminations, greater employee benefit costs, 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 certain 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 losses in our income statement of approximately $0.6 million in the first
three months of 2006, compared to $0.5 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 March 31, 2006, we had also entered into several foreign currency forward contracts with
notional amounts aggregating $299.8 million to hedge exposure to currency fluctuations in various
foreign currencies, including the British Pound Sterling, the Euro, Norwegian Kroner and the
Singapore Dollar. These exposures arise when local currency operating expenses are not in balance
with local currency revenue collections. These foreign currency forward contracts are designated
as cash flow hedging instruments and are fully effective. Based on quoted market prices as of
March 31, 2006 for contracts with similar terms and maturity dates, we have recorded a gain for the
first three months of $0.3 million, net of tax of $0.1 million, to adjust these foreign currency
forward contracts to their fair market value. This gain is included in other comprehensive income
in the consolidated balance sheet. We do not believe that a hypothetical 10% movement in these
foreign currencies would have a material impact on our earnings related to these forward contracts.
The company also had several foreign currency forward contracts with notional amounts aggregating
$611.9 million designated and qualifying as fair value hedges to hedge exposure to the British
Pound Sterling, Euro, Norwegian Kroner and the Singapore Dollar. Based on quoted market prices as
of March 31, 2006 for contracts with similar terms and maturity dates, we recorded a gain of $1.3
million to adjust these foreign currency forward contracts to their fair market value. This gain
offsets designated
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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 related to these forward
contracts.
The Company has other financial market risk sensitive instruments denominated in foreign currencies
totaling $32.1 million as of March 31, 2006 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 $2.1 million.
The counterparties to forward contracts are major financial institutions. The credit ratings and
concentration of risk of these financial institutions are monitored on a continuing basis. In the
unlikely event that the counterparties fail to meet the terms of a foreign currency contract, our
exposure is limited to the foreign currency rate differential.
Interest Rate Risk
At March 31, 2006 our long term borrowings consisted of $100 million in 7.5% senior notes, $150
million in 6.5% senior notes, $200 million in 7.25% senior notes, $200 million in 5.65% senior
notes and $150 million in 5.5% senior notes. We 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 March 31, 2006, 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 are 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 $1.0 million increase in interest expense for the quarter
ended March 31, 2006.
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. We implemented a worldwide
financial reporting system in the first quarter of 2006. As a result,
we made a variety of changes in our internal control structure. These
changes did not impact the overall effectiveness of our controls.
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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: May 8, 2006
|
/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 |
31.1 | Certification pursuant to Rule 13a-14a and Rule 15d-14(a) of the Securities and Exchange Act, as amended | |
31.2 | Certification pursuant to Rule 13a-14a and Rule 15d-14(a) of the Securities and Exchange Act, as amended | |
32.1 | Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
32.2 | Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
27