ITEM 1. BUSINESS
GENERAL
Smith International, Inc. ("Smith" or the "Company") is a leading downhole drilling tool manufacturer and service company, which manufactures and markets a wide range of products and services used in the drilling of oil and gas wells. Smith provides technologically advanced drill bits, and drilling and completion services to the oil and gas drilling industry. Supplying products and services to the oil and gas drilling industry represents approximately 92% of the Company's revenues, with the remainder to the mining and industrial markets. The following table sets forth the revenues attributable to continuing operations of the Company for its two major product and service groups:
Beginning in March 1994, the Company will also provide drilling fluids and systems to the oil and gas drilling industry as a result of the Company's February 28, 1994 acquisition of a 64% interest in M-I Drilling Fluids Company (M-I). Information about M-I is also provided below.
SALE OF DIRECTIONAL DRILLING BUSINESS
On March 29, 1993, the Company sold its directional drilling systems and services (DDS) business and certain of its subsidiaries and other affiliates to Halliburton Company (Halliburton) for 6,857,000 shares of Halliburton common stock. In April 1993, the Halliburton common stock was sold for $247.7 million. As a result, the Company recorded income from discontinued operations of $73.6 million including the gain from the sale of the DDS business of $80.1 million. The gain includes provisions for various fees, expenses and taxes related to the DDS sale. The DDS business reported revenues of approximately $36.3 million in the first three months of 1993, $158.7 million in 1992 and $151.1 million in 1991. The DDS business reported operating losses of $6.5 million in the first three months of 1993, $3.0 million in 1992 and $4.6 million in 1991.
The Company used a portion of the proceeds of the DDS sale to repay certain debt of the Company. For further discussion, refer to Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources."
ACQUISITIONS OF A-Z/GRANT AND LINDSEY
On December 22, 1993, the Company acquired the product line assets of A-Z International, Grant Oilfield Tools and Lindsey Completion Systems (A-Z/Grant and Lindsey) from Masex Energy Services Group, Inc. for $19.0 million in cash. A-Z/Grant and Lindsey are leading providers of downhole tools, remedial services and liner hangers to the oil and gas industry. A-Z/Grant and Lindsey reported unaudited revenues of $31.6 million in 1993, $29.0 million in 1992, and $31.0 million in 1991. The acquisition was accounted for as a purchase effective December 22, 1993. The unaudited results of A-Z/Grant and Lindsey from December 22, 1993 to December 31, 1993 were not significant to the operations of the Company.
ACQUISITION OF M-I DRILLING FLUIDS COMPANY IN 1994
Effective February 28, 1994, the Company acquired a 64% interest in M-I from Dresser Industries, Inc. (Dresser) for $160 million. M-I was owned 64% by Dresser and 36% by Halliburton prior to the acquisition. M-I is a leading provider of environmentally sensitive drilling fluids and systems to the oil and gas drilling
industry. The Company purchased the 64% interest in M-I using $80 million of its cash and issuing a note payable to Dresser for $80 million due on August 28, 1994. M-I reported unaudited revenues of $405.8 million in 1993, $382.6 million in 1992 and $435.5 million in 1991.
With the completion of the aforementioned acquisitions, the Company has established itself as a leading supplier of expendable drilling products to the oil and gas drilling industry. On an unaudited pro forma basis, the combined total revenues of all of the Company's businesses totaled $658.1 million in 1993.
INDUSTRY OVERVIEW AND BUSINESS OPERATIONS
Substantially all of the Company's products and services are used in the process of drilling oil and natural gas wells. Therefore, the level of drilling activity is a useful general indicator of the demand for the products and services of the Company at any given time. The level of drilling activity is determined by a variety of factors over which the Company has no control, including the current and anticipated market price of crude oil and natural gas, the production levels of the Organization of Petroleum Exporting Countries ("OPEC") and other oil and gas producers, the regional supply and demand for oil and natural gas, the level of worldwide economic activity and the long-term effect of worldwide energy conservation measures. The worldwide average active rig count increased 2.4% from 1,673 in 1992 to 1,713 in 1993, primarily due to the 5.0% increase in the average U.S. rig count between 1992 and 1993. Overall the international active rig count increased slightly as an increase in drilling activity in Canada was partially offset by drilling declines in all major international areas except the Middle East.
Management anticipates drilling activity in 1994 to approximate 1993 activity levels and intense competition to continue. Some additional drilling for natural gas is expected to occur during 1994 in the Gulf of Mexico region of the U.S. due to the increase in natural gas prices over the prior year, the decline in natural gas reserves and the general emphasis of utilizing natural gas as an environmentally preferred fuel. Management believes that the Company is well positioned to benefit from increases in worldwide oil and gas exploration drilling which may develop in 1994 and beyond and that increased drilling activity will positively impact the Company's results in the future.
OTHER BACKGROUND INFORMATION
On March 7, 1986, the Company, exclusive of its subsidiaries, filed for protection under Chapter 11 of the U.S. Bankruptcy Code as a result of a judgment in the amount of $205.4 million in a patent infringement case relating to a drill bit patent that has since expired. The Company initiated the bankruptcy proceedings in order to protect its assets and operations from the judgment. On December 31, 1987, the Company's plan of reorganization became effective, and since that date it has conducted its business in the ordinary course.
During the reorganization, the Company completed an extensive restructuring of its internal operating divisions and sold certain of its operations in order to focus on its core businesses. Because the Company sustained its historical levels of research and engineering expenditures and maintained its share of industry revenues during this period, management believes that the Company was not adversely affected by the reorganization.
Industrial Equity (Pacific) Limited, a Hong Kong Corporation ("IEP") acquired 8,754,892 shares of Common Stock, 933,468 Class A Warrants and 967,133 Class B Warrants in open market purchases beginning in October 1986 and pursuant to the Company's plan of reorganization. Pursuant to a private placement in February 1988, IEP acquired preferred stock that was subsequently converted into the Company's 8.75% Convertible Preferred Stock.
In May 1989, the Board of Directors of the Company was notified by IEP that IEP wished to explore the possibility of acquiring the remaining shares of the Company that it did not own. In response to that announcement, a Special Committee of the Company's Board of Directors was formed. In July 1989, the Special Committee announced that it intended to solicit offers for the Company from third parties and "explore alternatives designed to maximize shareholder value."
The Company agreed to be acquired by Dresser pursuant to an Agreement and Plan of Merger, dated November 13, 1989. On December 28, 1989, Dresser exercised its right to terminate the Merger Agreement based upon circumstances relating to obtaining clearance under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended.
On March 19, 1990, the Company and IEP entered into an agreement pursuant to which the Company and IEP agreed, among other things, that IEP would sell certain of the Company's securities owned by it in a public offering. The offering was successful and closed on May 30, 1990. IEP agreed that it would not acquire any securities in excess of 5% of the Company's Common Stock on a fully diluted basis for a five year period from the closing of the offering.
DRILL BITS
Products. The Company's drill bits group designs, manufactures and markets drill bits used in drilling oil and gas wells and mining applications. The Company offers over 900 drill bits under the Smith Tool(TM), Smith Diamond(TM) and Smith Mining(TM) product lines. Drill bit sizes range from 5 7/8 to 28 inches in diameter for the petroleum industry and from 2 15/16 to 17 1/2 inches in diameter for the mining industry. Most bits manufactured by the Company are three-cone drill bits. The surfaces of the cones are comprised of different types of pointed structures that are referred to as "cutting structures" or "teeth." The cutting structures are either an integral part of the steel cone with a hardmetal applied surface (referred to as "milled tooth") or made of an inserted material (referred to as "insert") which is usually tungsten carbide.
The Company also manufactures and markets shear bits featuring cutters made of polycrystalline diamond ("PDC") or natural diamonds. The Company manufactures PDC's for use in the Company's diamond drill bits, and has patented processes for applying diamonds to a curved surface with multiple transition layers. The Company believes that the curved surface diamond insert significantly improves the ability of diamond shear bits to drill in harder and more abrasive formations. Smith is the only oilfield equipment manufacturer that develops, manufactures and markets its own synthetic diamond materials, which provides the Company a cost and technological advantage with respect to these products. In addition, the Company's in-house diamond research, engineering and manufacturing capabilities enhance the Company's ability to develop the application of diamond technology into Smith drill bits and across other Smith product lines. These diamond enhanced products last longer and increase penetration rates, which decreases overall drilling costs in certain formations. The Company believes that its ability to develop specialized diamond inserts for specific applications will provide new business opportunities as with Diamond Enhanced Insert roller cone bits and Impax(TM) hammer bits.
The cutting structures in mining bits are principally tungsten carbide inserts ("TCI"). Mining bits are typically utilized for shallow drilling to place explosives for blasting in open pit mining operations. Other mining bits using both tungsten carbide and diamond enhanced inserts have been designed for use with air driven percussion tools and are known as hammer bits.
Competition. Besides the Company, Hughes Christensen (a division of Baker-Hughes, Inc.), Security (a division of Dresser), and Reed/Hycalog (a division of Camco International, Inc.) are the three major competitors in the petroleum drill bit business. While the Company and Hughes Christensen maintain the leading shares of worldwide revenues of three-cone mining drill bits, they compete with over 20 other competitors.
Competition for sales of petroleum drill bits is generally based on a number of factors, including performance, quality, reliability, service, price, technological advances and breadth of products. The Company believes its quality and reliability as well as technological advances, such as the Diamond Enhanced Inserts, specialized hardmetal applications and Spinodal bearing features in its drill bits, further enhance the Company's reputation and competitive advantage. Competition for sales of mining drill bits generally is based on a number of factors, including price, performance and availability.
DRILLING AND COMPLETION SERVICES
Products and Services. The Company manufactures tubular drill string components within its Drilco product line. These tubular products include drill collars to provide drilling weight to the bit, Hevi-Wate(TM) drill pipe to provide stress transition between drill collars and conventional drill pipe or to provide drilling weight to the bit in horizontal drilling, connecting subs to attach drill string members of differing diameters and connections and kellys to rotate the drill string on conventional drilling rigs.
The Company manufactures downhole tools which are also used in the drilling process. These downhole tools are sold or rented to the end users, and include stabilizers to centralize the drill string, reamers to maintain a uniform hole diameter and shock subs to reduce the shock and vibration that occurs in the drill string.
The Company also manufactures downhole remedial tools for use in connection with the drill string for specialized drilling and workover operations within its Servco product line. These remedial tools are sold or rented to the end users, and typically include supervision services provided by the Company's employees. These remedial operations include section milling to remove a section of casing permitting the well to be re-drilled using the existing casing string, hole opening and underreaming to enlarge the wellbore for proper cementing of the casing or gravel packing, packer milling to remove production packers, conventional milling to remove wellbore obstructions, pipe cutting to remove the casing when a well is abandoned and fishing services to remove obstructions from well bores primarily during workover operations.
The Company maintains field service centers which provide inspection and repair services for the Company's drill string components, customer owned tubular goods and for the Company's rental tools. These field service centers serve as the distribution points for all the Company's products, and are an important part of the Company's marketing efforts.
In addition to the above, the recently acquired A-Z International and Grant Oilfield Tools provides rotating drilling heads, milling tools, Pack-Stock combination packers and whipstocks for various drilling and remedial activities, and Lindsey Completion Systems has been an industry innovator in the liner hanger, completion and cementing equipment product lines.
Competition. Competition in the drilling and completion services market is primarily based on response time, reliability and price. The Company attributes its competitive position to its commitment to quality and service which is evidenced by the Company maintaining quality equipment and trained personnel at field service centers in almost every major drilling location in the world. The markets for drilling and completion services are highly fragmented.
DRILLING FLUIDS OPERATIONS
Products and Services. Through the acquisition of M-I, the Company will provide drilling fluids products, systems, and technical services to end users engaged in drilling oil, natural gas, and geothermal wells worldwide. Drilling fluids products and systems are used to cool and lubricate the bit during drilling operations, contain formation pressures, keep rock cuttings in suspension to remove them from the hole, and maintain the stability of the wellbore. Technical services are provided at the wellsite to ensure that the products and systems are applied effectively to optimize drilling operations. These services include well-specific products and systems during the planning phase, testing and recommending adjustments to the properties of the fluids during the drilling phase, and analyzing well results to improve the drilling of future wells.
M-I is a global leader in environmentally-sensitive drilling fluids products and systems as well as equipment related to the control of fluids at the wellsite. M-I manufactures and distributes more than 200 minerals products and chemical additives at nearly 30 grinding and chemical plants strategically located near most of the world's major drilling areas. M-I offers water-base, oil-base, and synthetic-base drilling fluids systems, each comprised of a number of individual products designed to ensure that the multiple functions of the drilling fluid are met. These products include weighting agents such as barite which control formation pressures; thickening agents or viscosifiers which improve the carrying capacity of the fluid; thinners and
dispersants, used to thin a drilling fluid which has become too thick from formation cuttings; and fluid loss control agents, lost circulation materials, and other products used to address formation-specific conditions. Major new products and systems introduced in the last three years include NOVADRIL, a synthetic-base drilling fluid system; MCAT(TM), a cationic water-base system; ENVIROTHERM, a high-temperature drilling fluid additive; KLA-CURE(R), an additive used in suppressing shales; and PIPE-LAX(TM) ENV, an environmentally-sensitive spotting fluid.
Through its Swaco Geolograph operations, a complete line of solids control, pressure control, and rig instrumentation products are offered to the worldwide drilling market on both a sale and rental basis. Key products in the pressure control line include the D-Gasser and Super Choke which hold dominant market positions. The solid control product line of shakers, hydroclones, and centrifuges have been designed to offer operators the option to drill "dry locations", where drilling fluid waste is minimized and handled in an environmentally-safe manner. Swaco Geolograph's rig instrumentation line features the SMART Data Acquisition System, an advanced monitoring system that measures, monitors, and displays the drilling status of a well with high speed accuracy.
Competition. Besides M-I, the major competitors in the worldwide drilling fluids industry are Baroid Drilling Fluids (a subsidiary of Baroid Corporation which recently merged with Dresser) and Inteq (a division of Baker-Hughes, Inc.). Together, these three companies supply products and systems to over two-thirds of the worldwide drilling fluids market. While these companies supply a majority of the market, the drilling fluids industry is highly competitive, with a significant number of smaller, locally-based competitors and foreign multinational drilling fluids suppliers. Competition within the industry is based on a number of factors, including drilling performance, quality, reliability, service, price, technological advantages, and breadth of the product line.
INTERNATIONAL OPERATIONS
Sales to the international oil drilling markets are a key strategic focus of Smith management, and the Company markets its products and services through its subsidiaries, joint ventures and sales agents in virtually all petroleum producing areas of the world, including Canada, the North Sea/Europe, the Middle East, Mexico, Central and South America, Asia/Pacific and Africa. As a result, 53% of the Company's total revenues from continuing operations in 1993 were generated from sales in the international markets, compared to 58% in 1992. Approximately 61% of the Company's revenues are denominated in U.S. dollars.
Historically, international drilling activity has been less volatile than in the U.S. due to the relatively high costs of exploration and development programs which can only be undertaken by major oil companies, consortiums and national oil companies. These entities operate under longer term strategic priorities than do the independent drilling operators that are more common in the U.S. market.
SALES AND DISTRIBUTION
The Company markets its products on a worldwide basis, employing Company sales personnel and independent sales agents. Sales are directed to end users in the drilling industry including independent drilling contractors, major and independent oil companies and national oil companies. In the United States, approximately 75% of all sales are made by Company sales personnel and the remainder of which are made by independent sales agents.
The Company's sales force is supported by 15 field service centers in the U.S. and Canada and 27 field service centers outside of North America. The Company considers that its worldwide sales position has been significantly enhanced by its field service centers presently maintained in Bolivia, Brazil, Canada, Colombia, France, Germany, Italy, Mexico, Norway, Singapore, Tunisia, United Kingdom, United States and Venezuela. These field service centers serve as bases for the sales force and rental tool operations and also provide an opportunity to market a wider range of the Company's products than could be marketed by a sales office. The Company's field service centers are also important factors in maintaining good customer relations since they are designed primarily for repair and maintenance of drill string components and rental tools.
MANUFACTURING
The Company's manufacturing operations, along with quality control support, are designed to ensure that all products and services marketed by the Company will meet standards of performance and reliability consistent with the Company's reputation in the industry.
The Company lowered its fixed costs and labor costs by closing its California manufacturing facilities and relocating the manufacturing of the drill bits to Ponca City, Oklahoma and other products to Houston, Texas in 1989. This move has permitted the Company to realize significant annual savings since that date.
Management estimates that the Company has available manufacturing facilities to accommodate a worldwide demand level equivalent to approximately 3,000 average active drilling rigs which compares to 1,700 average active drilling rigs estimated for 1994. In addition, the Company has entered into license agreements and joint ventures with worldwide manufacturers in order to increase its production capacity for drill bits.
RAW MATERIALS
The Company purchases a variety of raw materials, including alloy and stainless steel bars, tungsten carbide inserts and forgings. Generally, the Company is not dependent on any single source of supply for any of its raw materials or purchased components. The Company currently purchases 80% of the tungsten carbide inserts used as cutting structures on drill bit cones, wear pads for stabilizers and hard surface materials for mills and reamers from one supplier pursuant to a supply agreement entered into in connection with the sale of a division by the Company to that supplier. In addition, the Company has also entered into a supply agreement to purchase 80% of its U.S. forging requirements from a single supplier. The Company believes that numerous alternative supply sources are available for all of such materials. The Company also produces PDC synthetic diamonds in Provo, Utah for utilization in various Company products as well as direct customer sales. The Company believes that it enjoys a competitive advantage in the manufacture of diamond drill bits because it is the only diamond drill bit manufacturer producing its own PDC.
PRODUCT DEVELOPMENT, ENGINEERING AND PATENTS
The Company maintains product development and engineering departments in bit technology and downhole tool technology whose activities are directed to developing new products and processes, improving existing product lines and designing specialized products to meet customer requirements. Experimental work in metallurgy also comprises a significant portion of the work of these departments. For example, recent new product developments include: tungsten carbide insert and milled tooth Spinodal(TM) bearing roller cone bits, Diamond Enhanced Insert roller cone bits, steerable motor PDC and roller cone bits; the Smith Diamond Maxidrill(TM) products and Diamond Enhanced Impax(TM) hammer bits; the Servco Millmaster(TM) carbide cutting structure; and the Servco Bearclaw(TM) PDC underreamer. In recent years, the Company has received special meritorious awards for engineering innovations sponsored by Petroleum Engineer International magazine. One such award was for the placement of PDC on curved surfaces for rock bit cutting structure while another was for the development of a new hardfacing material for use on milled tooth drill bits.
During 1991, the Company developed FDS+ Milled Tooth Rock Bits for longer life at higher rates of penetration. The Company continuously attempts to improve the quality, performance and reliability of its products in order to maintain its competitive position in the industries it serves and to develop new tools and materials to meet the evolving market needs.
The Company also maintains a drill bit data base which records the performance of substantially all drill bits used in the U.S. over the last 10 years, including those manufactured by competitors. This database gives the Company the ability to monitor, among other things, drill bit failures and performance improvements with product development. Management believes this proprietary data base gives the Company a competitive advantage in the drill bit business.
The Company has historically maintained its research and engineering expenditures at a high level to enable it to maintain its technological and performance leadership and broaden its product lines in the drilling
tools and services industry. The Company's expenditures for research and engineering activities amounted to $6.6 million in 1993, $6.2 million in 1992 and $8.9 million in 1991. In 1993, research and engineering expenditures approximated 3.0% of revenues.
Although the Company has over 650 patents and regards its patents and patent applications as important in the operation of its business, it does not believe that any significant portion of its business is materially dependent upon any single patent or group of patents or generally upon patent protection.
EMPLOYEES
At December 31, 1993, the Company had approximately 1,750 full time employees throughout the world. None of the Company's employees in the United States are covered by collective bargaining agreements. The Company considers its labor relations to be satisfactory.
ITEM 2.
ITEM 2. PROPERTIES
The principal manufacturing facilities of the Company at December 31, 1993 are shown in the table below.
The Company considers its manufacturing facilities to be in good condition and adequately maintained. Due to the downturn in business in recent years, the Company's manufacturing facilities operated below capacity throughout 1993 and are continuing to operate below capacity levels. A portion of the Houston, Texas facility is currently being held for sale by the Company.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
In January 1991, the Company and several of the Company's competitors were served with a federal grand jury subpoena for documents, principally concerning the Company's sales, marketing and pricing activities for tri-cone rock bits produced and sold by the Company. In June 1992, Baker Hughes entered a plea of guilty to an Information charging it with a single count of violating Section 1 of the Sherman Act for the period March through May 11, 1989 and agreed to pay a $1.0 million fine to the U.S. government. On November 23, 1993, the Company entered a plea of guilty to a violation of Section 1 of the Sherman Act for the same period and paid a fine to the U.S. government of $0.7 million.
After it was served the subpoena by the grand jury, the Company was served with complaints in three civil proceedings. Each action alleged violations of Section 1 of the Sherman Act. The cases were consolidated for discovery purposes with four other cases filed against other tri-cone rock bit manufacturers, but not the Company, in the Southern District of Texas, which made allegations similar to those made against the Company. The consolidated case was captioned Red Eagle Resources Corporation, Inc., et al. v. Baker Hughes, Inc., Baker Hughes Production, Inc., Hughes Tool Company, Reed Tool Company, a/k/a/ Baker RTC, Inc., Camco International, Inc., Smith International, Inc., and Dresser Industries, Inc., Civil Action No. 91-H-627. In September 1992, the district court certified the case as a class action. The class consisted of direct purchasers of rock bits from defendants in the period September 1, 1986, through January 15, 1992.
On August 27, 1993, without admitting any form of liability, the Company entered into an agreement with the plaintiffs to settle all claims against the Company. The Company recorded a special charge of $19.9 million to cover the cost of the settlement of $16.8 million and related estimated legal fees and other costs and expenses. On October 28, 1993, an order was entered which gave final approval to this settlement.
Chevron USA Inc., which opted not to be part of the above mentioned class action, filed suit against the Company in the United States District Court for the Southern District of Texas, Houston Division, entitled Chevron USA Inc., acting by and through its division Chevron USA Production Company v. Baker Hughes, Inc., Reed Tool Company a/k/a Baker RTC, Inc., CAMCO International, Inc., Smith International, Inc. and Dresser Industries, Inc. Cause No. H-93-949, alleging violations of Section 1 of the Sherman Act. This case is in its early phase; little formal discovery has occurred; and docket call for the trial of this matter has been set for January 26, 1996. Management believes that the resolution of this matter will not have a material adverse effect on the Company's financial position or results of operations.
Executive Life
On March 4, 1992, the Company was served with a complaint in the U.S. District Court in the Central District of California, entitled Lynn Martin, Secretary of the U.S. Dept. of Labor v. Smith International, Inc., et al., Case No. CV-92-1196. The complaint alleges violations of the Employee Retirement Income Security Act of 1974 ("ERISA") arising out of the Company's purchase of annuities from Executive Life Insurance Company("Executive Life"), upon the termination of its Pension Plan in August 1985. The Department of Labor ("DOL") filed the lawsuit in order to prevent the expiration of the statute of limitations while it completed its investigation of the Company's purchase of annuities from Executive Life. In 1993, Executive Life emerged from a conservatorship proceeding in California state court. The Company believes that it properly discharged its legal responsibilities with regard to the purchase of annuities from Executive Life and, consequently, that uninsured losses of the Company, if any, resulting from the DOL claims will not be material.
Superfund
The Comprehensive Environmental Response, Compensation and Liability Act of 1980 (the "Superfund Act") generally addresses remedial action at sites from which there has been a "release" of "hazardous substances." Among other things, the Superfund Act authorizes the U.S. Environmental Protection Agency (the "EPA") to take any necessary response actions at these sites and, in certain circumstances, to order those parties liable for the "release" to take response actions. The EPA may seek reimbursement of expenditures of federal funds from parties potentially liable under the Superfund Act. Relevant court decisions have
interpreted the Superfund Act to impose strict, joint and several liability upon all persons liable for response costs under the statute with respect to a particular site, if the harm at such site is indivisible. The Superfund Act requires the EPA to develop a National Priorities List ("NPL") of sites which are the most deserving of prompt investigation and remediation. At present, there are approximately 1,000 sites nationwide on the NPL.
The Sheridan Site. On March 31, 1987, the Sheridan Site Committee (the "Committee") filed a claim in the Company's Chapter 11 case on behalf of itself and 59 potentially responsible parties ("PRPs") at the Sheridan Disposal Services site in Hempstead, Texas, an NPL site. The claim was based on the Company's alleged liability to the claimants for "contribution and potential cost recovery for administrative and remedial work" expenses incurred and to be incurred by them in connection with the Sheridan Disposal site.
On August 28, 1987, the Company reached a settlement with the Committee. The Committee agreed to withdraw its proof of claim. In return, the Company agreed to pay its allocable share of response costs incurred by the Committee, such share to be limited to the lesser of $3 million or 2.93% of actual response costs. The Company's obligations pursuant to the settlement agreement with the Committee were not discharged or affected by confirmation of the Company's plan of reorganization.
The settlement agreement with the Committee further provides that payments by the Company will be made on the same basis and at the same time as they are made by members of the Committee whose members have recently agreed to enter into a judicial consent decree under which they will complete the remedies selected by EPA under its Record of Decision (the "ROD"), issued in December 1988 and supplemented in September 1989. Based upon the ROD, total remediation costs are estimated, on a preliminary basis, to be approximately $28 million. On this basis, the Company's share would be $0.8 million. On October 4, 1989, the Company entered into a Sheridan Site Trust Agreement together with 37 other PRPs, providing a mechanism for the disbursement of funds in connection with remedial action to be performed at the Sheridan Site. Remediation efforts and expenditures at the Sheridan Site will likely extend over the next five years.
The OII Site. Under the Superfund Act, the EPA has been conducting various activities at the Operating Industries, Inc. ("OII") site, a disposal site on the NPL located in Monterey Park, California. The United States, on behalf of the EPA, filed a proof of claim in the Company's Chapter 11 case alleging that it had incurred approximately $8 million in response costs to date, and would continue to incur response costs in the future. Subsequently, the United States alleged that its costs had increased to over $10 million. In addition to the United States, 21 other PRPs for cleanup of the OII site also filed proofs of claim against the Company's estate for contribution or indemnity arising from any claims asserted against them by the United States for response costs. The Company objected to the claims of the United States and the PRPs.
On June 14, 1988, the United States District Court entered an order approving a Stipulation and Agreement to Compromise and Settle EPA's claim against the Company's estate (the "OII Settlement Agreement"). Under the OII Settlement Agreement, the claim of the United States was allowed as an amount (approximately $150,000) sufficient to entitle the EPA to a distribution pursuant to the Company's plan of reorganization. The Company further agreed to pay its allocable share of total future site response costs at the OII site, such share, however, to be limited to the lesser of $5 million or 0.65% of future site response costs.
On July 15, 1988, the District Court entered a further order withdrawing and dismissing the general unsecured claims of the 21 potentially responsible parties and their requests for payment of administrative expenses.
The EPA has issued three ROD's with respect to the OII Site and remediation work under RODs I and II has commenced. The Company may be requested to make interim contributions with respect to these RODs. The EPA issued ROD III with respect to landfill gas control and landfill cover on September 30, 1990. This ROD includes net present work cost estimates for the work covering 30, 45 and 60 years of project life. The EPA has estimated the cost of this work to exceed $100 million. Because of the time span involved in the remedy, EPA is working with certain parties on a South West Early Action Plan ("SWEAP") designed to address landfill gas issues in the southwestern portion of the OII landfill, which is near several homes.
The cost of the final long-term remedy for the clean-up of the OII site is presently unknown and depends on the nature and extent of contamination at the site and the remedy which is ultimately selected. The EPA is still preparing its Remedial Investigation and Feasibility Study ("RI/FS") which will examine the various alternatives for a final remedy of the site;and anticipates that the RI/FS may be completed by mid-1994. Actual remediation expenditures will likely extend for a number of years after a final remedy is selected for the site, subsequent to completion of the RI/FS.
At this time, the Company is unable to determine the amount it may ultimately have to contribute to the OII site pursuant to the OII settlement agreement. This amount will range from the approximately $150,000 that the Company has already paid to the $5.0 million at which the Company's liability is capped under the OII settlement agreement.
The Chemform Site. Chemform, Inc. ("Chemform"), a former wholly owned subsidiary of the Company and, subsequently, the Company itself, operated a business and held a leasehold interest in property located in Pompano Beach, Florida (the "Chemform Site") between May 14, 1976 and March 16, 1979, at which time the Company sold the Chemform business and assigned the lease.
The EPA has been conducting various activities at the Chemform Site under the Superfund Act and placed the Chemform Site on the NPL on October 4, 1989. In October 1989, the Company, along with three other PRPs at the Chemform Site, entered into a consent agreement with the EPA for the preparation of an RI/FS. An Amendment to that consent agreement, which became effective on April 7, 1992, specified that the RI/FS for the Chemform Site would be addressed in two operable units: Operable Unit One addresses Site-related groundwater contamination, and Operable Unit Two addressed source and soil contamination.
On September 22, 1992, the EPA issued the ROD for Operable Unit One at the Site. The ROD selected a "No Action with Monitoring" alternative, under which groundwater would be monitored quarterly for at least one year. On July 13, 1993, the Company, along with two other PRPs and the EPS, executed an Administrative Order on Consent ("AOC") and Scope of Work ("SOW") which will govern the implementation of the ROD for Operable Unit One at the Chemform Site. Under the terms of the AOC and SOW, the Company, along with two other PRPs, agree to undertake the groundwater monitoring work specified in the AOC and SOW. In the ROD, EPA estimated the costs of constructing the required groundwater wells and the cost of one year of groundwater monitoring to be approximately $0.1 million.
On September 16, 1993, EPA issued the ROD for Operable Unit Two at the Chemform Site, which addresses site-related soil contamination. The ROD determined that no further Superfund action is necessary to address Operable Unit Two at the site; however, the State of Florida, as represented by the Florida Department of Environmental Protection, has not yet concurred in the ROD for Operable Unit Two. It is not known whether the State of Florida will do so, or whether any further proceedings will be required due to the State's lack of concurrence. The Company believes that the EPA will demand reimbursement of certain oversight expenses that the EPA allegedly has incurred in administering the Chemform site. The Company intends to scrutinize and, if necessary, vigorously contest any such claims made by the EPA.
As of December 31, 1990, the Company recorded a $5.0 million provision for its estimated liability for clean-up of all of the Company's environmental matters that were known at that time including the estimated costs to be incurred regarding the Superfund sites discussed above. In 1993, 1992 and 1991, the Company paid for various clean-up activities and recorded additional provisions charged to continuing operations of $0.5 million, $0.4 million and $0.8 million, respectively, and a provision of $1.5 million charged to the gain on sale of DDS operations based on revised estimates of required future clean-up costs. At December 31, 1993, the remaining recorded liability for estimated future clean-up costs for the sites discussed above as well as properties currently or previously owned or leased by the Company was $3.6 million. As additional information becomes available, the Company may be required to provide for additional environmental clean-up costs for Superfund sites and for properties currently or previously owned or leased by the Company. However, the Company believes that none of its clean-up obligations will result in liabilities having a material adverse effect on the Company's consolidated financial position or results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
(a) The names and ages of all executive officers of the Company, all positions and offices with the Company presently held by each person named and their business experience during the last five years are stated below. Positions, unless otherwise specified, are with the Company.
(b) All officers of the Company are elected annually by the Board of Directors at the meeting of the Board of Directors regularly held immediately following the annual meeting of shareholders. They hold office until their successors are elected and qualified.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS.
The Common Stock of the Company is traded on the New York Stock Exchange and the Pacific Stock Exchange. The following are the high and low sale prices for the Company's Common Stock as reported on the New York Stock Exchange Composite Tape for the periods indicated.
On March 4, 1994, the Company had approximately 5,380 Common Stock holders of record and the last reported closing price on the New York Stock Exchange Composite Tape was $10.50.
The Company has not paid dividends on its Common Stock since the first quarter of 1986. The Company's indenture relating to its long-term debt contains covenants restricting the payment of cash dividends to the Company's common Stockholders based on net earnings and operating cash flow formulas as defined in the indenture. In addition to compliance with the indenture, the determination of the amount of future cash dividends to be declared and paid on the Common Stock, if any, will depend upon the Company's financial condition, earnings and cash flow from operations, the level of its capital expenditures, its future business prospects and other factors that the Board of Directors deem relevant.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
- --------------- (a) In March 1993, the Company sold its DDS business to Halliburton resulting in income from discontinued operations of $73.6 million. This amount includes the gain from the sale of the DDS business of $80.1 million. As a result, the financial data for the periods 1989 through 1992 has been restated to report the results of the DDS business as discontinued operations. The Company used a portion of the proceeds from the DDS sale to repay its bank debt and $49.0 million of notes payable to insurance companies. The Company's remaining debt, totaling $46.0 million, is presented as long-term debt at December 31, 1993 and 1992. See Notes 2 and 6 of Notes to Consolidated Financial Statements.
(b) In September 1993, the Company agreed to settle a class action civil lawsuit which alleged violations of Section 1 of the Sherman Act. As a result, the Company recorded a special charge of $19.9 million to cover the cost of the settlement and related legal fees and other costs and expenses. See Note 16 of Notes to Consolidated Financial Statements. (Notes continued on following page)
(c) During the first quarter of 1993, the Company adopted SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions." As a result of adopting SFAS No. 106, the Company recorded the total outstanding liability related to such retiree benefits of $1.3 million as the cumulative effect of a change in accounting principle in the Consolidated Statements of Operations. See Note 11 of Notes to Consolidated Financial Statements.
(d) In 1991, the Company recorded $22.2 million of non-recurring charges related primarily to the restructuring of its worldwide operations in response to a decline in U.S. drilling activity. The non-recurring charges consisted of $21.2 million of charges related to the restructuring and an additional $1.0 million tax provision to reflect expected tax settlements of prior year foreign tax liabilities of certain of the Company's subsidiaries. The amount of restructuring charges related to the continuing operations of the Company of $18.4 million in 1991 was charged to income (loss) from continuing operations before interest and taxes. The amount of restructuring charges related to the DDS business of $2.8 million is recorded in the results of discontinued operations in 1991. See Notes 3 and 8 of Notes to the Consolidated Financial Statements.
(e) In 1991, the Company paid off its Series B Notes totaling $44.7 million from the $50.0 million proceeds of its temporary warrant reduction offers and its issuance of 992,000 shares of additional common stock. See Notes 6 and 9 of Notes to Consolidated Financial Statements.
(f) In accordance with APB No. 11, the Company recognized an extraordinary tax credit of $7.5 million in 1990 resulting from utilization of operating loss carryforwards of which approximately $5.2 million related to continuing operations.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
Substantially all of the products and services of the Company are used in the process of drilling an oil or natural gas well. Consequently, drilling activity is closely followed by the oil service industry as it is an indicator of the overall market demand for the Company's products and services. Although the average active drilling rig count is one indicator of the Company's potential market, another important factor is the mix of natural gas and oil wells being drilled.
During 1993, the United States average rig count increased by 5.0% from 1992 activity levels while the 1993 international average rig count increased slightly from 1992 levels. The United States drilling activity rebounded from the record low activity levels experienced during 1992 as a result of the improvement in natural gas prices experienced during 1993. Although the average international rig count did not change substantially from 1992 levels, there were significant activity changes between international drilling markets, as all international areas experienced drilling activity declines except Canada and the Middle East.
Management anticipates drilling activity in 1994 to approximate 1993 activity levels and intense competition to continue. Some additional drilling for natural gas is expected to occur during 1994 in the Gulf of Mexico region of the U.S. due to the increase in natural gas prices during the prior year, the decline in natural gas reserves and the general emphasis utilizing natural gas as an environmentally preferred fuel. Management believes that the Company is well positioned to benefit from increases in worldwide oil and gas exploration drilling which may develop in 1994 and beyond and that greater drilling activity will positively impact the Company's results in the future.
SALE OF DIRECTIONAL DRILLING BUSINESS
On March 29, 1993, the Company sold its directional drilling systems and services (DDS) business and certain of its subsidiaries and other affiliates to Halliburton Company (Halliburton) for 6,857,000 shares of Halliburton common stock. In April 1993, the Halliburton common stock was sold for $247.7 million. As a result, the Company recorded income from discontinued operations of $73.6 million including the gain from the sale of the DDS business of $80.1 million. The gain includes provisions for various fees, expenses and taxes related to the DDS sale. The DDS business reported revenues of approximately $36.3 million in the first three months of 1993, $158.7 million in 1992 and $151.1 million in 1991.
The Company used a portion of the proceeds of the DDS sale to repay certain debt of the Company. For further discussion, refer to "Liquidity and Capital Resources" below.
ACQUISITIONS OF A-Z/GRANT AND LINDSEY
On December 22, 1993, the Company acquired the product line assets of A-Z International, Grant Oilfield Tools and Lindsey Completion Systems (A-Z/Grant and Lindsey) from Masex Energy Services Group, Inc. for $19.0 million in cash. A-Z/Grant and Lindsey are leading providers of downhole tools, remedial services and liner hangers to the oil and gas industry. A-Z/Grant and Lindsey reported unaudited revenues of $31.6 million in 1993, $29.0 million in 1992, and $31.0 million in 1991. The acquisition was accounted for as a purchase effective December 22, 1993. The results of A-Z/Grant and Lindsey from December 22, 1993 to December 31, 1993 were not significant to the operations of the Company.
ACQUISITION OF M-I DRILLING FLUIDS COMPANY IN 1994
Effective February 28, 1994, the Company acquired a 64% interest in M-I Drilling Fluids Company (M-I) from Dresser Industries, Inc. (Dresser) for $160 million. M-I was owned 64% by Dresser and 36% by Halliburton prior to the acquisition. M-I is a leading provider of environmentally sensitive drilling fluids and systems to the oil and gas drilling industry. The Company purchased the 64% interest in M-I using $80 million of its cash and issuing a note payable to Dresser for $80 million due on August 28, 1994. The acquisition will
be accounted for as a purchase. M-I reported unaudited revenues of $405.8 million in 1993, $382.6 million in 1992 and $435.5 million in 1991.
PRO FORMA DATA
The unaudited pro forma revenues and income from continuing operations for the year ended December 31, 1993 assuming the acquisitions of A-Z/Grant and Lindsey and M-I had been made on January 1, 1993 are as follows:
Refer to page 22 for a more complete presentation of the unaudited pro forma statement of income (loss) from continuing operations and unaudited pro forma balance sheet.
RESULTS OF OPERATIONS
Revenues
The tools and equipment manufactured and the services provided by the Company fall into two major product and service groups that are marketed throughout the world. The following table sets forth the amounts and percentages of revenues by major product group and by area:
Drill Bits
Drill bit revenues are generated from the sale of petroleum drill bits and mining bits. Petroleum drill bit revenues increased $18.3 million or 14.4% from $127.5 million in 1992 to $145.8 million in 1993 due primarily to higher sales and improved pricing in the United States and Canada resulting from the increase in North American drilling activity and increased sales into the former Soviet Union. These increases were partially offset by reduced sales in the North Sea area due to lower drilling activity and reduced volume in Mexico and Italy. Petroleum drill bit revenues declined $18.0 million or 12.4% from $145.5 million in 1991 to $127.5 million in 1992 due primarily to the decline in worldwide drilling activity, principally in the U.S. and Canada, and price reductions resulting from competitive pressures. This decrease was partially offset by an increase of 16.0% in diamond bit sales.
Mining drill bit revenues decreased $1.5 million or 8.3% from $18.0 million in 1992 to $16.5 million in 1993 due to reduced sales to Canadian iron ore producers. Mining drill bit revenues decreased $2.6 million or 12.6% from $20.6 million in 1991 to $18.0 million in 1992 due to lower domestic and export activity.
Drilling and Completion Services
Drilling and completion services revenues decreased $6.8 million or 10.4% from $65.2 million in 1992 to $58.4 million in 1993 due to lower international drilling activity primarily in the Europe/Africa region, the Middle East and Mexico. These declines were partially offset by increased sales in Canada. Drilling and completion services revenues decreased $20.7 million or 24.1% from $85.9 million in 1991 to $65.2 million in 1992 due to reduced worldwide drilling activity, primarily the U.S., and lower sales in Australia, the Middle East, Africa and the United Kingdom. The Company also discontinued its inspection business in the United Kingdom and closed certain service centers in the U.S. in 1992.
For the periods indicated, the following table summarizes the results of continuing operations of the Company and presents results as a percentage of total revenues of the continuing operations:
1993 Versus 1992
Revenues for 1993 increased $10.0 million or 4.7% from $210.7 in 1992 to $220.7 in 1993. Revenues in the United States and Canada increased due primarily to increased drilling activity. These increases were partially offset by lower revenues outside of North America due to lower drilling activity. Domestic revenues increased $16.2 million, or 18.4%, from $88.2 million in 1992 to $104.4 million in 1993 due to a 5.0% increase in the average U.S. rig count and improved pricing. International revenues decreased by $6.2 million or 5.1% from $122.5 million in 1992 to $116.3 million in 1993 due to the 9.7% decline in international drilling activity which was partially offset by revenues in Canada and the former Soviet Union.
Product sales increased $10.4 million or 6.2% from $166.6 in 1992 to $177.0 million in 1993 due primarily to the increase in drilling activity in the United States and Canada partially offset by lower sales in the North Sea, the Middle East and Mexico. Rentals, services and other revenues decreased $0.4 million or 0.9% from $44.1 million in 1992 to $43.7 million in 1993 as a result of lower drilling activity in the Europe/Africa region and the Middle East.
Gross profit increased $8.4 million or 11.3% from $74.1 million in 1992 to $82.5 million in 1993. Gross profit on product sales increased $5.7 million or 8.5% from $66.9 million in 1992 to $72.6 million in 1993 due to higher sales and improved pricing in the United States and Canada. Gross profit on rentals, services and other revenues increased $2.7 million or 37.5% from $7.2 million in 1992 to $9.9 million in 1993 due to lower operating costs in the United States and Canada.
Operating expenses, comprised of selling expenses and general and administrative expenses, increased by $0.1 million or 0.2% from $63.8 million in 1992 to $63.9 million in 1993. The increase was due primarily to higher variable selling expenses relating to the higher North American sales and higher legal expenses associated with the drill bit litigation. These increases were reduced by lower personnel levels due to cost reduction actions and lower foreign currency translation losses. Operating expenses as a percentage of revenues decreased from 30.3% in 1992 to 29.0% in 1993.
On August 27, 1993, without admitting any form of liability, the Company entered into an agreement to settle a class action civil lawsuit pending in the federal district court in Houston. The lawsuit alleged that the Company and other defendants violated Section 1 of the Sherman Act. The Company recorded a special charge of $19.9 million to cover the cost of the settlement and related estimated legal fees and other costs and expenses. On October 28, 1993, an order was entered which gave final approval to this settlement.
Interest expense decreased $4.6 million or 43.4% from $10.6 million in 1992 to $6.0 million in 1993 due to the refinancing of long-term debt in the fourth quarter of 1992 and the repayment of debt from the proceeds of the DDS sale. Interest income increased due to a higher level of short-term investments resulting from the investment of the proceeds of the DDS sale.
The tax provision of $0.5 million for 1993 consists primarily of foreign taxes on income. The tax benefit of $1.0 million in 1992 relates primarily to a $2.5 million benefit related to the settlement of a U.S. tax claim with the IRS. The Company provides for U.S. taxes at the statutory rate offset by tax benefits related to the U.S. net operating loss (NOL) carryforwards, available to the Company as well as foreign taxes. During 1993, the Company adopted Statement of Financial Accounting Standard No. 109 for accounting for income taxes. The adoption did not materially affect the 1993 results.
1992 Versus 1991
Revenues for 1992 decreased $41.3 million or 16.4% from $252.0 million in 1991 to $210.7 million in 1992 due primarily to an 11.5% decline in the average worldwide rig count. International revenues decreased $19.3 million or 13.6% from $141.8 million in 1991 to $122.5 million in 1992 due primarily to lower Canadian drilling activity, lower volume in the Middle East, France, the U.K. and Australia and reduced revenues in the Far East due to increased competition and pricing pressure. Domestic revenues decreased $22.0 million, or 20.0%, from $110.2 million in 1991 to $88.2 million in 1992 due to a 16.2% decline in the average U.S. rig count and competitive pricing pressures.
Product sales decreased $28.5 million or 14.6% from $195.1 million in 1991 to $166.6 million in 1992 due primarily to the decline in U.S. and Canadian drilling activity and competitive pricing pressures in the U.S. and Far East. Rentals, services and other revenues decreased $12.8 million or 22.5% from $56.9 million in 1991 to $44.1 million in 1992 due to reduced U.S. drilling activity, lower demand in Africa, Australia and the Middle East and the closing of certain service centers in the United States and the discontinuance of the inspection business in the United Kingdom.
Gross profit decreased $25.9 million or 25.9% from $100.0 million in 1991 to $74.1 million in 1992. Gross profit on product sales decreased by $23.8 million or 26.2% from $90.7 million in 1991 to $66.9 million in 1992 due to lower volumes in aforementioned areas and competitive pricing pressures principally in the U.S. and
Far East. Gross profit on rentals, services and other revenues decreased by $2.1 million or 22.6% from $9.3 million in 1991 to $7.2 million in 1992 due primarily to lower U.S., Australia and the United Kingdom revenue levels.
Operating expenses, comprised of selling expenses and general and administrative expenses, decreased by $7.1 million or 10.0% from $70.9 million in 1991 to $63.8 million in 1992. This decrease was due primarily to lower variable selling expenses associated with reduced revenues offset by currency translation losses in 1992 compared to currency translation gains in 1991. Operating expenses as a percentage of revenues increased from 28.1% in 1991 to 30.3% in 1992.
In 1991, the Company recorded $22.2 million of non-recurring charges related primarily to the restructuring of its worldwide operations in response to the decline in U.S. drilling activity. The non-recurring charges consisted primarily of $21.2 million of restructuring charges composed of $9.9 million for estimated severance and relocation costs, a writedown of $5.7 million related to fixed assets of closed and downsized locations, a provision of $3.7 million to expense certain manufacturing inefficiencies and $1.9 million related to other non-recurring restructuring charges. The Company also recorded an additional $1.0 million tax provision to reflect expected tax settlements of prior year foreign tax liabilities of certain of the Company's subsidiaries. The amount of restructuring charges related to the continuing operations of the Company of $18.4 million was charged to income from continuing operations before interest and taxes. The amount of the restructuring charges related to the DDS business in 1991 of $2.8 million was recorded in the results of discontinued operations. The $1.0 million tax provision was charged against continuing operations.
Interest expense decreased $3.2 million or 23.2% from $13.8 million in 1991 to $10.6 million in 1992 due primarily to lower long-term debt resulting from the repayment of the Series B Notes in December, 1991, the refinancing of long-term debt in the fourth quarter of 1992 and lower short-term interest rates. Interest income decreased $0.5 million or 50.0% from $1.0 million in 1991 to $0.5 million in 1992 due primarily to lower short-term interest rates.
The tax benefit of $1.0 million at December 31, 1992 relates primarily to a $2.5 million benefit related to the settlement of a U.S. tax claim with the IRS. See Note 8 to the Notes to Consolidated Financial Statements. The Company provides for U.S. taxes at the statutory rate offset by tax benefits related to the U.S. NOL carryforwards available to the Company as well as foreign taxes.
In addition to the $1.0 million foreign tax provision discussed above, the tax provision of $2.9 million at December 31, 1991 provides for U.S. taxes at the statutory rate offset by tax credits related to the U.S. NOL carryforwards available to the Company as well as foreign taxes. During 1991, the Company adopted Statement of Financial Accounting Standard No. 96 for accounting for income taxes. The adoption did not materially affect the 1991 results.
LIQUIDITY AND CAPITAL RESOURCES
General
The Company's cash position at December 31, 1993 totaled $101.6 million or an increase of $85.3 million from the Company's cash position at December 31, 1992. The Company's current ratio increased to 3.20 to 1 at December 31, 1993 from 1.77 to 1 at December 31, 1992. The improvement in cash and the current ratio arises due to proceeds received from the sale in 1993 of the DDS business to Halliburton offset by debt repayment of $102.6 million, payments of $19.9 million related to a litigation settlement and the payment of $19.0 million to acquire A-Z/Grant and Lindsey.
The Company was required to repay its bank debt in connection with the DDS sale. The Company also granted options which expired on July 23, 1993 to its insurance company lenders for early repayment of their debt at a reduced make whole premium. On April 12, 1993, the Company used a portion of the proceeds of the DDS sale to retire its domestic credit facility totaling $37.2 million, its domestic bank term loan totaling $16.4 million and $39.0 million of notes payable with insurance companies. On July 23, 1993, the Company repaid an additional $10.0 million of notes payable with insurance companies. The Company's remaining debt totaling $46.0 million at December 31, 1993 is classified as long-term. The accompanying December 31, 1992
balance sheet has also been restated to classify the $46.0 million of debt as long-term. The Company has renegotiated its loan agreements with the insurance companies to amend certain financial covenants as well as to release the collateral under the loan indenture. The Company was in compliance with its loan covenants under the amended loan indenture at December 31, 1993. See Note 6 of the Notes to Consolidated Financial Statements.
Certain of the Company's foreign subsidiaries have short-term lines of credit with various foreign banks totaling approximately $1.7 million. At December 31, 1993, the Company had borrowed $0.7 million under these lines. The majority of these lines are unsecured.
The Company has annual interest requirements of approximately $4.5 million under its existing long-term debt. The Company's indenture relating to its long-term debt contains covenants restricting the payment of cash dividends to the Company's common stockholders based on net earnings and operating cash flow formulas as defined in the indenture. The Company has not paid dividends on its Common Stock since the first quarter of 1986. In addition to compliance with the covenants of the indenture, the determination of the amount of future cash dividends to be declared and paid on the Common Stock, if any, will depend upon the Company's financial condition, earnings and cash flow from operations, the level of its capital expenditures, its future business prospects and other factors that the Board of Directors deem relevant.
On March 2, 1994, the Company used $80.0 million of its cash and issued a note payable totaling $80.0 million to Dresser to acquire its 64% interest in M-I. The note payable to Dresser bears interest at LIBOR +2% and is due on August 28, 1994. The Company has commitments to refinance the Dresser note payable with a $40 million term loan from its insurance company lenders and a $65 million revolving line of credit from a bank group. The term loan will bear interest at 6.02 percent and be payable over a period ending in January 1998. The revolving line of credit will be due in March 1997 and bear interest at a rate ranging from LIBOR + 3/4 percent to LIBOR +1 1/2 percent based upon the debt-to-total capitalization of the Company. Management believes that such financing will be completed by the end of March 1994.
The Company believes that it has sufficient existing manufacturing capacity to meet current demand for its products and services. Projected capital expenditures in 1994, excluding M-I capital expenditures, will approximate $14 million.
The Company currently expects to be able to meet its ongoing working capital and capital expenditure requirements from existing cash on hand, operating cash flow and existing credit facilities or credit facilities to be arranged as discussed above.
The Company has been named as a potentially responsible party in connection with three sites on the U.S. Environmental Protection Agency's National Priorities List. At December 31, 1993, the remaining recorded liability for estimated future clean-up costs for Superfund sites as well as properties currently or previously owned or leased by the Company was $3.6 million. As additional information becomes available, the Company may be required to provide for additional environmental clean-up costs. However, the Company believes that none of its clean-up obligations will result in liabilities having a material adverse effect on the Company's consolidated financial position or results of operations. See Item 3. "Legal Proceedings -- Superfund" for further discussion.
Because of its substantial foreign operations, the Company is exposed to currency fluctuations and exchange risks. The Company tries to limit these risks by matching, to the extent possible, assets and liabilities denominated in foreign currencies and using hedging instruments to cover certain unmatched positions.
Inflation has not had a material effect on the Company in the last few years, and the effect is expected to be minor in the near future. In general, the Company has been able to offset most of the effects of inflation through productivity gains, cost reductions, and price increases.
Net Operating Loss Carryforwards
As of December 31, 1993, for U.S. tax reporting purposes, the Company had NOL carryforwards of approximately $148.5 million, expiring between 2001 and 2007, which should be available to offset future U.S. taxable income. Upon certain changes in equity ownership of the Company, however, the Company's ability to utilize its NOL carryforwards may become subject to limitation under Section 382 of the Internal Revenue Code of 1986, as amended (the "Code"). Management believes that the application of Section 382 will not materially limit the availability of the NOL carryforwards.
UNAUDITED PRO FORMA FINANCIAL STATEMENTS
The following unaudited pro forma statement of income (loss) from continuing operations for the year ended December 31, 1993 presents the acquisitions of M-I and A-Z/Grant and Lindsey as though the acquisitions were effective January 1, 1993. The unaudited pro forma statement of income (loss) from continuing operations gives effect to the acquisitions under the purchase method of accounting and the assumptions included in the accompanying unaudited notes to pro forma financial statements. The unaudited pro forma statement of income (loss) from continuing operations reflect the amortization of estimated goodwill, additional depreciation expense related to the estimated write-up of fixed assets and rental tools of A-Z/Grant and Lindsey and estimated adjustments to interest, taxes and minority interest.
The following unaudited pro forma balance sheet as of December 31, 1993 presents the acquisition of M-I as if the acquisition had occurred at December 31, 1993. The unaudited pro forma balance sheet reflects the acquisition under the purchase method of accounting and the assumptions included in the accompanying unaudited notes to pro forma financial statements. The unaudited pro forma balance sheet reflects only those adjustments relating to the acquisition of M-I, the consolidation of the Company's 64% interest in M-I and certain estimated asset and liability valuation adjustments anticipated to result from the Company's allocation of the purchase price to the accounts of M-I at February 28, 1994.
Management has not fully evaluated all of the consequences of the acquisition of M-I including assessing the fair market value of the assets acquired and the total amount of costs that may be necessary to consolidate the operations of M-I with the Company. As a result, the current estimate of the excess of the purchase price over net assets acquired in the acquisition of M-I totaling $51.2 million has been reflected as goodwill in the unaudited pro forma balance sheet. Upon completion of these evaluations during 1994, any additional asset and liability adjustments and the adjusted excess purchase price over net assets acquired will be recorded in accordance with purchase accounting rules and principles.
The unaudited pro forma financial statements are not intended to be indicative of the results that would have occurred if the acquisitions had been effective as of the dates indicated or that may be obtained in the future. The unaudited pro forma financial statements should be read in conjunction with the Consolidated Financial Statements and notes thereto of the Company included elsewhere in this Form 10-K.
SMITH INTERNATIONAL, INC.
UNAUDITED PRO FORMA STATEMENT OF INCOME (LOSS) FROM CONTINUING OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1993 (DOLLARS IN THOUSANDS)
See accompanying unaudited notes to pro forma financial statements.
SMITH INTERNATIONAL, INC.
UNAUDITED PRO FORMA BALANCE SHEET AS OF DECEMBER 31, 1993 (DOLLARS IN THOUSANDS)
See accompanying unaudited notes to pro forma financial statements.
SMITH INTERNATIONAL, INC.
UNAUDITED NOTES TO PRO FORMA FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) STATEMENT OF INCOME (LOSS) FROM CONTINUING OPERATIONS --
(a) To reclassify M-I freight expenses from selling expense to cost of sales to be consistent with the policies of the Company.
(b) To record annual amortization of goodwill which will be amortized over 40 years
(c) To record additional depreciation expense as a result of adjustments to increase the book value of the A-Z/Grant and Lindsey rental tools and property and equipment to estimated fair value and depreciate the assets over the estimated remaining lives of the respective assets.
(d) To record annual amortization of debt issuance costs which will be amortized over the 4 year life of the debt.
(e) To record interest expense at an interest rate of 6.0 percent on the acquisition-related debt, as refinanced (see Note j below), assuming no principal reduction.
(f) To reduce interest income at an interest rate of 4.0 percent as approximately $101.5 million of the Company's cash was used to fund the acquisitions and, therefore, would not have been available to earn interest income.
(g) To record additional income tax expense related to the earnings of A-Z/Grant and Lindsey, the Company's portion of M-I earnings and the effects of the aforementioned adjustments at the U.S. Alternative Minimum Tax Rate of 2.0 percent. Additional taxes would not be required because of the Company's net operating loss carryforward position.
(h) Income (loss) from continuing operations is presented excluding the cumulative effect of change in accounting principle. The Smith and unaudited pro forma income (loss) from continuing operations of ($3,995) and $1,652, respectively, include the special charge for a litigation settlement of $19,900 ($0.53 per common share). The Smith and unaudited pro forma income from continuing operations excluding the litigation settlement would increase to $15,905 and $21,552, respectively, or $0.40 and $0.55 per common share, respectively. The preferred stock dividends of $868 must be deducted from the applicable income (loss) from continuing operations amounts in order to compute these amounts per common share.
BALANCE SHEET --
(i) The historical balance sheet of the Company includes the accounts of A-Z/Grant and Lindsey on an estimated basis acquired by the Company on December 22, 1993 for $19.0 million. Management has not fully evaluated all of the consequences of the acquisition of A-Z/Grant and Lindsey including completing the appraisals of the assets acquired and assessing the total amount of costs that may be necessary to consolidate the operations of A-Z/Grant and Lindsey with the Company. Upon completion of these evaluations, any additional asset and liability adjustments will be recorded and the excess purchase price over net assets acquired, if any, will be recorded in accordance with purchase accounting rules and principles.
(j) To record the purchase of the 64% interest in M-I using $80.0 million in cash and $80.0 million in debt. The Company has reflected $10.0 million of debt as current portion of long-term debt and $70.0 million of debt as long-term because the Company has commitments to refinance the Dresser note payable with a $40 million term loan from its insurance company lenders and a $65 million revolving line of credit from a bank group. The term loan will bear interest at a rate of 6.02 percent and be payable over a period ending in January 1998. The revolving line of credit will be due in March 1997 and bear interest at a rate ranging
SMITH INTERNATIONAL, INC.
UNAUDITED NOTES TO PRO FORMA FINANCIAL STATEMENTS -- (CONTINUED)
from LIBOR + 3/4 percent to LIBOR +1 1/2 percent based upon the debt-to-total capitalization of the Company. Management believes that such financing will be completed by the end of March 1994.
(k) To record $1.8 million of estimated acquisition costs in connection with the M-I acquisition and $0.7 million of debt issuance costs in connection with the refinanced acquisition debt.
(l) To eliminate the investment in M-I of $160.0 million against the Company's estimated portion of its equity in M-I of $122.7 million with the remaining balance of $37.3 million reported tentatively as goodwill.
(m) To reclassify the minority interest ownership in M-I by Halliburton of $69.0 million from shareholders' equity to minority interest.
(n) To record the Company's portion of the current estimate of adjustments to asset reserves and liabilities required at the acquisition date in connection with the purchase of M-I with the corresponding adjustment recorded as goodwill. Management has not fully evaluated all of the consequences of the acquisition of M-I including assessing the fair market value of the assets acquired and the total amount of costs that may be necessary to consolidate the operations of M-I with the Company. Upon completion of a full evaluation of the Company's purchase price allocation of M-I accounts, additional adjustments may become necessary to the preliminary allocation of the purchase price. The Company expects this evaluation process will be completed in 1994.
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ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Smith International, Inc.:
We have audited the accompanying consolidated balance sheets of Smith International, Inc. (a Delaware corporation) and subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1993. These consolidated financial statements and schedules referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and schedules based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Smith International, Inc. and subsidiaries as of December 31, 1993 and 1992 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1993, in conformity with generally accepted accounting principles.
Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedules listed in the accompanying index of financial statements are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. These schedules have been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.
As discussed in Note 1 to the Notes to Consolidated Financial Statements, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 96 and SFAS No. 109 "Accounting for Income Taxes" in 1991 and 1993, respectively. In 1993, the Company also adopted SFAS No. 106 "Employers Accounting for Postretirement Benefits other than Pensions".
ARTHUR ANDERSEN & CO.
Houston, Texas February 9, 1994, except for the subsequent event discussed in Note 2, as to which the date is March 21, 1994
SMITH INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
The accompanying notes are an integral part of these financial statements.
SMITH INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS
ASSETS
The accompanying notes are an integral part of these financial statements.
SMITH INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS
LIABILITIES AND SHAREHOLDERS' EQUITY
The accompanying notes are an integral part of these financial statements.
SMITH INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of these financial statements.
SMITH INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991
The accompanying notes are an integral part of these financial statements.
SMITH INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (ALL DOLLAR AMOUNTS IN THE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE EXPRESSED IN THOUSANDS, EXCEPT WHERE STATED IN MILLIONS)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and all of its wholly-owned domestic and international subsidiaries. All significant intercompany accounts and transactions have been eliminated. Investments in affiliates of at least a 20% interest but not more than a 50% interest are accounted for using the equity method; all other investments are carried at cost, which does not exceed the estimated net realizable value of such investments.
Cash and Cash Equivalents
For purposes of the consolidated statements of cash flows, the Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents.
The Company's cash balance at December 31, 1993 includes $8.8 million held in escrow or otherwise restricted.
Fixed Assets
Fixed assets, consisting of rental equipment and property, plant and equipment, are stated at cost. The Company computes depreciation on fixed assets using principally the straight-line method. The estimated useful lives used in computing depreciation range from 3 to 40 years for buildings, 3 to 20 years for machinery and equipment, and 3 to 7 years for rental equipment. Leasehold improvements are amortized over the lives of the leases or the estimated useful lives of the improvements, whichever is shorter. For income tax purposes, accelerated methods of depreciation are used.
Cost of major renewals and betterments are capitalized as fixed assets. Expenditures for maintenance, repairs and minor improvements are charged to expense when incurred. When fixed assets are sold or retired, the remaining cost and related reserves are removed from the accounts and the resulting gain or loss is included in the results of operations.
Valuation of Inventories
Inventories are stated at the lower of cost or market. Cost is determined by the last-in, first-out ("LIFO") method for most domestic inventories and by the first-in, first-out ("FIFO") method for all other inventories. Inventory costs consist of materials, labor and factory overhead.
Translation of Foreign Currencies
The accounts of all international operations, except those described in the following paragraph, are translated to United States dollars as follows: cash, receivables and related allowances, current liabilities and long-term debt are translated at year-end exchange rates; income and expense accounts, except for cost of inventory sold and depreciation and amortization are translated at average exchange rates during the year and all other accounts are translated at historical rates. All translation adjustments resulting from the translation of these financial statements to United States dollars are charged or credited to income currently.
The accounts of the Company's operations in Italy are translated to United States dollars as follows: all asset and liability accounts are translated at year-end exchange rates, and income and expense items are translated at the average exchange rates during the year. Cumulative translation adjustments resulting from the translation of the financial statements of these operations to United States dollars are recorded as a separate component of shareholders' equity.
SMITH INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
All foreign currency transaction gains and losses are credited or charged to income currently.
Foreign Exchange Contracts
From time to time, the Company enters into spot and forward contracts under foreign exchange lines as a hedge against accounts payable in foreign currencies. Market value gains and losses on such forward contracts are recognized on a monthly basis, and the resulting amounts offset foreign exchange gains or losses on the related accounts payable as payments are made.
The Company also purchases foreign exchange option contracts to hedge certain operating exposures. Premiums paid under these contracts are expensed over the life of the contract. Gains arising on these options are recognized at the time the options are exercised.
Income Taxes
In the fourth quarter of 1991, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 96, "Accounting for Income Taxes" effective January 1, 1991. This standard changed the criteria for measuring the provision for income taxes and required that a liability approach be used to report the deferred tax liability in the consolidated balance sheet. Deferred income tax assets and liabilities arise from differences between the tax basis of an asset or liability and its reported amount in the consolidated financial statements. Deferred tax balances under this standard are determined by using the tax rate expected to be in effect when the taxes will actually be paid. Under the provisions of SFAS No. 96, the Company elected not to restate prior years' consolidated financial statements and has determined that the cumulative effect of the change in accounting for income taxes was insignificant.
In the first quarter of 1993, the Company adopted SFAS No. 109 "Accounting for Income Taxes". This standard superseded SFAS No. 96, "Accounting for Income Taxes" and required an asset and liability approach for financial accounting and income tax reporting. In connection with the adoption of SFAS No. 109, the Company elected not to restate prior years' consolidated financial statements and has determined that the cumulative effect of the change in accounting for income taxes was insignificant.
Earnings Per Common Share
Earnings per common share are computed on the basis of the weighted average number of common shares and equivalent shares outstanding during each year after deducting preferred dividends. Earnings per common share assuming full dilution, is substantially the same as primary earnings per common share as presented for each of the three years ended December 31, 1993. As the Company incurred a net loss for the years 1992 and 1991, the equivalent shares were antidilutive for those years; therefore, the equivalent shares are not included in the average number of common shares outstanding when calculating the loss per common share in 1992 and 1991.
Income (loss) per common share from discontinued operations was $1.95, $(.08) and $(.16), respectively, for the years ended December 31, 1993, 1992 and 1991. The loss per common share attributable to the change in accounting principle was $(.03) for the year ended December 31, 1993.
Employee Benefits
During the first quarter of 1993, the Company adopted SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions". This standard changed the criteria for recognizing the cost of postretirement benefits from the pay-as-you-go (cash) basis to the recognition of such benefits over the employee service periods. As a result of adopting this standard, the Company recorded the total outstanding liability related to such retiree benefits of $1.3 million as the cumulative effect of a change in accounting principle in the consolidated statements of operations.
SMITH INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2. ACQUISITIONS AND DISPOSITIONS
Sale of Directional Drilling Business
On March 29, 1993, the Company sold its Directional Drilling systems and services (DDS) business and certain of its subsidiaries and other affiliates to Halliburton Company (Halliburton) for 6,857,000 shares of Halliburton common stock. In April 1993, the Halliburton common stock was sold for $247.7 million. As a result, the Company recorded income from discontinued operations of $73.6 million including the gain from the sale of the DDS business of $80.1 million. The gain includes provisions for various fees, expenses and taxes related to the DDS sale.
The DDS sale consisted primarily of the inventory, rental equipment and plant and equipment of the Dyna-Drill and Datadril product lines as well as certain downhole tools used in the DDS business. In addition, the Company retained approximately $23.0 million of receivables, net of payables related to the DDS business as of the date of sale. The following table summarizes the net assets as of December 31, 1992 of the DDS business sold to Halliburton in March 1993.
The consolidated statements of operations reported the net results of the DDS operations as income (loss) from discontinued operations. The DDS business reported revenues of $36.3 million in the first three months of 1993, $158.7 million in 1992 and $151.1 million in 1991. In 1991, restructuring charges relating to the DDS business totalled approximately $2.8 million (See Note 3). In determining the income (loss) from discontinued operations, interest expense of $1.3 million in 1993, $5.6 million in 1992 and $7.6 million in 1991 has been allocated to the discontinued DDS operations based on the ratio of the estimated net assets sold in relation to the sum of the Company's shareholders' equity and the aggregate of outstanding debt at the end of each period.
Acquisitions of A-Z/Grant and Lindsey
On December 22, 1993, the Company acquired the product line assets of A-Z International, Grant Oilfield Tools and Lindsey Completion Systems (A-Z/Grant and Lindsey) from Masex Energy Services Group, Inc. for $19.0 million in cash. A-Z/Grant and Lindsey is a leading provider of downhole tools, remedial services and liner hangers to the oil and gas industry. A-Z/Grant and Lindsey reported unaudited revenues of $31.6 million in 1993, $29.0 million in 1992, and $31.0 million in 1991. This acquisition was accounted for as a purchase effective December 22, 1993. The unaudited results of A-Z/Grant and Lindsey from December 22, 1993 to December 31, 1993, were not significant to the operations of the Company.
The historical balance sheet of the Company at December 31, 1993 includes the accounts of A-Z/Grant and Lindsey on an estimated basis. Management has not fully evaluated all of the consequences of the acquisition of A-Z/Grant and Lindsey including assessing the fair market value of the assets acquired and the total amount of costs that may be necessary to consolidate the operations of A-Z/Grant and Lindsey with the Company. Upon completion of these evaluations during 1994, any additional adjustments will be recorded and the excess purchase price over net assets acquired, if any, will be recorded in accordance with purchase accounting rules and principles.
SMITH INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Subsequent Event -- Acquisition of M-I Drilling Fluids Company
Effective February 28, 1994, the Company acquired a 64% interest in M-I Drilling Fluids Company (M-I) from Dresser Industries, Inc. (Dresser) for $160 million. M-I was owned 64% by Dresser and 36% by Halliburton prior to the acquisition. M-I is a leading provider of drilling fluids and systems to the oil and gas drilling industry. The Company purchased the 64% interest in M-I using $80 million of its cash and issuing a note payable to Dresser for $80 million due on August 28, 1994. This acquisition will be accounted for as a purchase. M-I reported unaudited revenues of $405.8 million in 1993, $382.6 million in 1992 and $435.5 million in 1991.
The Company has commitments to refinance the Dresser note payable with a $40 million term loan from its insurance company lenders and a $65 million revolving line of credit from the bank group. The term loan will bear interest at a rate of 6.02 percent and be payable over a period ending in January 1998. The revolving line of credit will be due in March 1997 and bear interest at a rate ranging from LIBOR + 3/4 percent to LIBOR +1 1/2 percent based upon the debt-to-total capitalization of the Company. Management believes such financing will be completed by the end of March 1994.
The unaudited pro forma revenues and income from continuing operations for the year ended December 31, 1993 assuming the acquisitions of A-Z/Grant and Lindsey and M-I had been made on January 1, 1993 are as follows:
3. RESTRUCTURING CHARGES
During the fourth quarter of 1991, the Company decided to restructure certain of its worldwide operations in response to the continuing decline of U.S. oil and gas drilling activity. The restructuring consisted of closing manufacturing facilities in Mexico City and Veracruz, Mexico, closing various service locations in the U.S. as well as downsizing other worldwide operations and reducing the worldwide workforce by approximately 27%. As a result of the restructuring, the Company recorded a $21.2 million unusual charge to income from continuing operations before interest and taxes in 1991 consisting of $9.9 million for estimated severance and relocation costs, a writedown of $5.7 million related to fixed assets of closed and downsized locations, a provision of $3.7 million to expense certain manufacturing inefficiencies and $1.9 million related to other non-recurring items.
4. INVENTORIES
Inventories consist of the following:
SMITH INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
5. ASSETS HELD FOR SALE
The Company's efforts to combine manufacturing facilities and reduce operating capacity have resulted in certain excess and/or idle assets which are classified as assets held for sale. Assets held for sale are stated at the lower of cost or estimated net realizable value as of December 31, 1993 and 1992 as follows:
6. DEBT
The following summarizes the Company's short-term debt and long-term debt:
On October 2, 1992, the Company refinanced substantially all of its short-term and long-term debt through a private placement of debt and a new syndicated bank credit facility. The private debt offering consisted of $95.0 million of secured long-term debt repayable over a nine year period with interest at 9.83%. The secured domestic bank facility consisted of a $20.0 million three year term loan repayable in quarterly installments and a $40.0 million revolving credit facility expiring on June 30, 1995. The Company used the proceeds of the secured long-term debt, the term loan and $19.6 million of the revolving credit facility to retire the Company's $89.4 million Series A notes due December 31, 1994 with interest at 13%, a term loan of $6.5 million with interest at prime +1 3/4%, an outstanding balance of the Company's domestic credit facility of $30.5 million and $8.2 million of international lines of credit.
In connection with the DDS sale, the Company was required to repay its bank debt. The Company also granted options which expired on July 23, 1993 to its insurance company lenders for early repayment of their debt at a reduced make whole premium. On April 12, 1993, the Company used a portion of the proceeds of the DDS sale to retire its domestic credit facility totaling $37.2 million, its domestic bank term loan totaling $16.4 million and $39.0 million of notes payable with insurance companies. On July 23, 1993, the Company repaid an additional $10.0 million of notes payable with insurance companies. The Company's remaining debt totaling $46.0 million at December 31, 1993 is classified as long-term. The accompanying December 31, 1992
SMITH INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
balance sheet has also been restated to classify the $46.0 million of debt as long-term. The Company has renegotiated its loan agreements with the insurance companies to amend certain financial covenants as well as to release the collateral under the loan indenture. The Company was in compliance with its loan covenants under the amended loan indenture at December 31, 1993.
Certain of the Company's foreign subsidiaries have short-term lines of credit with various foreign banks totaling approximately $1.7 million. At December 31, 1993, the Company had borrowed $0.7 million under these lines. The majority of these lines are unsecured.
The Company's indenture relating to its long-term debt contains covenants restricting the payment of cash dividends to the Company's common stockholders based on net earnings and operating cash flow formulas as defined in the indenture. The Company has not paid dividends on its Common Stock since the first quarter of 1986. In addition to compliance with the covenants of the indenture, the determination of the amount of future cash dividends to be declared and paid on the Common Stock, if any, will depend upon the Company's financial condition, earnings and cash flow from operations, the level of its capital expenditures, its future business prospects and other factors that the Board of Directors deem relevant.
See Note 2 for a discussion of the financing of the M-I acquisition.
In July 1993, the Company entered into a swap agreement with a financial institution. Under this agreement, the Company receives a fixed rate of 4.86% on $46.0 million of borrowings and pays a floating rate based on 6 month LIBOR. Management believes that the fair market value of the swap agreement at December 31, 1993 was insignificant.
Interest paid during the years ended December 31, 1993, 1992, and 1991 amounted to $9.2 million, $15.7 million, and $21.3 million, respectively.
7. FINANCIAL INSTRUMENTS
The carrying values of cash and cash equivalents, receivables, accounts payable and short-term debt approximate the fair market values due to the short-term maturities of these instruments. Management believes that the carrying amount of long-term debt is not materially different from the fair value using rates currently available for debt of similar terms and maturity.
The Company is a party to financial instruments described below with off balance sheet risks which it utilizes in the normal course of business to manage its exposure to fluctuations in interest rates and foreign currency exchange rates.
Foreign Currency Forward Contracts and Options
At December 31, 1993, the Company had outstanding foreign exchange contracts as a hedge against foreign accounts totaling $11.0 million maturing at various dates during 1994. There were no significant unrecorded gains or losses on these contracts at December 31, 1993. The Company has outstanding option contracts of $5.9 million at December 31, 1993 which expire at various dates in 1994. The Company has no loss exposure under these contracts.
Interest Rate Contracts
The Company utilizes an interest rate swap agreement to manage its interest rate exposure. At December 31, 1993 the fair value of the agreement was insignificant. At December 31, 1993, the Company reported as part of cash and cash equivalents $16.9 million as the carrying cost of an investment fund which utilizes financial instruments to manage its interest rate exposure. During the year ended December 31, 1993, the fund's hedge account incurred a net loss of $0.3 million reducing the fair value of the fund to $16.6 million.
SMITH INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
8. INCOME TAXES
See Note 1 regarding changes in the method in recording income taxes during 1991 and 1993. The consolidated income tax provision (benefit) relating to continuing operations are summarized as follows:
Deferred taxes are principally attributable to timing differences related to depreciation expense and net operating loss (NOL) and tax credit carryforwards. Deferred taxes also include, in 1992, the net benefit resulting from a settlement of various outstanding issues with the Internal Revenue Service related to prior year audits and offsetting claims for refunds of prior year taxes and, in 1991, the recording of a $1.0 million tax provision to reflect expected settlements of prior year foreign tax liabilities of certain of the Company's subsidiaries. In 1993 and 1991, the Company reported the tax benefit of operating loss carryforwards as a reduction in the provision for income taxes in accordance with SFAS No. 109 and SFAS No. 96, respectively.
The income tax provision (benefit) computed by applying the U.S. Federal statutory rate to income (loss) from continuing operations before income taxes are reconciled to the actual tax provision (benefit) as follows:
SMITH INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The components of the net deferred tax liability are as follows:
For U.S. tax reporting purposes, the Company has cumulative NOL carryforwards in the amount of approximately $148.5 million. These losses were generated in 1986, 1987, 1988 and 1992 in the amounts of $12.7 million, $91.3 million, $42.3 million and $2.2 million, respectively. Losses in 1986, 1987, 1988 and 1992 are available to reduce future U.S. taxable income that may be generated through the years 2001, 2002, 2003 and 2007, respectively. Upon certain changes in equity ownership of the Company, the ability to utilize NOL carryforwards becomes subject to limitation under Section 382 of the Internal Revenue Code of 1986, as amended. In the opinion of management, the application of Section 382 will not materially limit the availability of net tax loss carryforwards.
Also available to reduce future U.S. income taxes are unused alternative minimum tax credits of $2.8 million and investment tax credits of $7.3 million. The investment tax credits which expire as follows: $2.8 million in 1997, $1.8 million in 1998, $1.6 million in 1999 and $1.1 million in 2000. Income taxes paid during the years ended December 31, 1993, 1992 and 1991 amounted to $0.9 million, $4.4 million, and $7.4 million respectively.
The Company's foreign subsidiaries currently have undistributed earnings of $17.8 million which if repatriated would be generally sheltered from U.S. tax by NOL carryforwards and various foreign tax credits.
9. CAPITAL STOCK
Preferred Stock
The Company's preferred stock carried a cumulative annual dividend of 8.75% ($2.1875 per share based on a $25 value) payable quarterly and was convertible into common stock at $8 per share, subject to certain antidilution adjustments. The Preferred Stock had a liquidation preference of $25 per share plus cash equal to any accumulated and unpaid dividends, and was redeemable at the Company's option at any time at a redemption price of $25 per share plus cash equal to any accumulated and unpaid dividends, provided that the average closing price of the common stock for the 20 trading days ending on the fifth day before mailing the notice of redemption was at least 125% of the conversion price if mailed before February 10, 1994.
In June 1993, the Company called the remaining shares of preferred stock for redemption in accordance with the terms of the Certificate of Designation with regard to the preferred stock. All holders of the preferred stock surrendered their shares for conversion into 2,496,250 shares of common stock of the Company. For
SMITH INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
purposes of the Consolidated Statements of Cash Flows, this conversion of preferred stock to common stock is a non-cash transaction, and, therefore, is not reflected in the Consolidated Statements of Cash Flows. As of December 31, 1993, there were no shares of the preferred stock outstanding.
Common Stock Warrants and Treasury Securities
In November 1991, the Company raised approximately $50.0 million in equity through its temporary warrant reduction offers and the issuance of 992,000 shares of additional common stock. In connection with the temporary warrant reduction offers, 2,758,268 Class A Warrants and 3,619,596 Class B Warrants were exercised to purchase the Company's common stock at a temporarily reduced exercise price of $5.10 per Class A Warrant and $7.35 per Class B Warrant. The proceeds were used to retire the Company's then outstanding Series B Notes and accrued interest thereon totalling $46.8 million in December, 1991.
At December 31, 1993, the Company has outstanding 225,520 Class A Warrants and 1,872,205 Class B Warrants to purchase common stock exercisable until February 28, 1995 at a price of $8.28 per share and $15.00 per share, respectively.
During 1990, the Company issued 300,000 shares of common stock and 451,357 Class C warrants to an international subsidiary. These Class C Warrants are exercisable until February 28, 1995 at a price of $1.00 per share. The Company has recorded these warrants at their estimated value at the date of issue of $16.125 per warrant. This transaction is reflected as treasury securities in the consolidated balance sheets and consolidated statements of shareholders' equity.
In June 1993, the Board of Directors approved a stock repurchase program whereby the Company may buy up to 3 million shares of its outstanding common stock. The program contemplates that the Company may, from time to time, purchase shares in the open market. This program is funded by the Company's cash balances. As of December 31, 1993, the Company had purchased 158,400 shares of common stock under the stock repurchase program at a cost of $1.3 million. These shares are reflected as treasury securities in the Consolidated Balance Sheets and Consolidated Statements of Shareholders' Equity.
The Company did not make dividend payments to common stockholders during 1993, 1992 and 1991. See Note 6.
10. EMPLOYEE STOCK OPTIONS, RESTRICTED STOCK AWARDS AND STOCK APPRECIATION RIGHTS
As of December 31, 1993, the Company has outstanding stock options granted under two plans: the 1989 Long-Term Incentive Compensation Plan ("1989 Plan") and the 1982 Stock Option Plan ("1982 Plan"). No further options may be granted under the 1982 Plan. Options issued in 1982, 1983, 1984 and 1985 under the 1982 Plan were cancelled and reissued effective June of 1986 at an option price which represented the fair market value on the date of reissuance. During 1991, options under the Company's 1971 Stock Option Plan lapsed.
SMITH INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The options, exercisable at various dates through December 2003, are conditioned upon continued employment. A summary of stock option transactions for 1993, 1992 and 1991 are as follows:
Included in the 1993 grants were stock options of 199,500 shares and 240,000 shares at exercise prices of $8.38 and $10.31, respectively. These stock options vest over a four year period from the date of grant.
SMITH INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Included in the 1992 grants were stock options of 257,487 shares and 20,000 shares at exercise prices of $8.38 and $9.25, respectively. Of the total $8.38 stock options, the Company granted 167,497 shares in exchange for certain Stock Appreciation Rights valued at an exercise price of $10.53 - $16.09. The stock options granted at $8.38 vest over a four year period from the date of grant. The stock options granted at $9.25 were fully vested at the date of grant. Included in the 1991 grants were restricted stock options of 80,040 shares at $2.90. These options vested over a two year period from the date of grant but lapsed during 1992.
In addition, as part of the 1989 Plan, the Company granted 82,540 Stock Appreciation Rights in 1991 at an exercise price range of $10.52 - $14.73 and 80,775 Stock Appreciation Rights in 1990 at an exercise price range of $12.56 - $16.09. At December 31, 1993, there were 16,508 of these rights outstanding. These rights vest over a four year period from date of grant, and are exercisable until February 2001. Upon exercise of the rights, appreciation is paid by distributing cash or shares at the option of the Company.
At December 31, 1993, there were no shares of common stock reserved under the 1989 Plan for the future granting of stock options, awarding of additional restricted stock options and/or awarding of additional Stock Appreciation Rights.
11. EMPLOYEE BENEFITS
The Company has non-contributory pension plans in the U.S. and U.K. Benefit accruals under the Company's U.S. pension plan, which have been frozen since 1987, covered substantially all the U.S. employees of the Company at that date. Due to the freezing of domestic pension benefits and fully funding those benefits in 1987, a contribution was not necessary for 1992 or 1991.
The following tables detail the components of pension expense for the three years ended December 31, 1993, the funded status of the plans and major assumptions used to determine these amounts:
SMITH INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
For 1993, the Company reduced its discount rate related to the domestic pension plan from 8.5% to 7.0% to more accurately reflect current market trends. As a result, the projected benefit obligation exceeded the fair value of the plan's assets by $2.5 million. This amount is recorded as an additional minimum liability in the Consolidated Balance Sheets at December 31, 1993.
The Company has several other pension plans covering certain international employees. Pension expense for these plans totaled $0.2 million in 1993, $0.4 million in 1992 and $0.2 million in 1991. Based on the latest available actuarial valuations, total accumulated plan benefits are $2.0 million and net assets available for benefits are $2.4 million.
The Company has an Employee 401(k) Plan which allows eligible participating employees to make contributions in either a Company stock fund or any one of seven mutual funds or a combination thereof. The Company contributes for all eligible employees a percentage of their qualified compensation into the Plan. Contribution percentages range from 2% for employees under the age of 40 to 6% for employees who are 60 years of age or older. Contributions to this plan by the Company totaled approximately $1.7 million in 1993 and $2.0 million for the years ended December 31, 1992 and 1991. Effective January 1, 1990, the Company also initiated an additional plan to fund a matching contribution ranging from 0% to 100% of an individual employee's 401(k) contributions based on the Company achieving a certain level of operating income as a percentage of total revenue for the year. In 1993, the Company recorded an expense of $1.2 million for this plan. No expense was required or recorded for matching contributions for 1992 or 1991 related to this plan.
The Company and its subsidiaries provide certain health care benefits for retired employees. Most of the employees who retire from the Company are eligible for these benefits. The cost of postretirement health care benefits were recognized as an expense as claims were paid in 1992 and 1991. These costs totaled approximately $0.2 million in 1992 and $0.3 million in 1991.
In 1990, the Financial Accounting Standards Board ("FASB") issued SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions." During the first quarter of 1993, the Company adopted this new standard. As a result of adopting SFAS No. 106, the Company recorded the total outstanding liability related to such retiree benefits of $1.3 million as the cumulative effect of a change in accounting principle in the consolidated statements of operations.
Prior to May 1, 1993, the Company had two retiree medical coverage plans. Effective May 1, 1993 the two plans were combined into one plan, the Smith International, Inc. Retiree Medical Plan. The plan provides postretirement medical benefits to retirees and their spouses. The retiree medical plan has an annual limitation (a "cap") on the dollar amount of the Company's portion of the cost of benefits incurred by retirees under the plan. The remaining cost of benefits in excess of the cap is the responsibility of the participants. For 1993, the cap was $25,000. The cap is adjusted annually for inflation, which is currently assumed to be 4 percent.
The following table sets forth the plan's funded status reconciled with the amount shown in the Company's consolidated balance sheets:
SMITH INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Postretirement benefit expense recognized in income from continuing operations for the year ended December 31, 1993 is summarized as follows:
The health care cost trend rate assumption can have a significant effect on the amounts reported. For measurement purposes, a 12% annual rate of increase in the per capita cost of covered health care benefits was assumed for 1993. The rate was assumed to gradually decrease to 7% for 1998 and to remain at that level thereafter. An increase of one percentage point in the health care cost trend rate would not have a material effect on either the accumulated postretirement benefit obligation or the aggregate of the service and interest cost components of the postretirement benefits expense.
The weighted-average discount rates used in determining the accumulated postretirement benefit obligation for 1993 and 1992 were 7.0% and 8.0%, respectively.
12. STOCKHOLDERS' RIGHTS PLAN
On June 19, 1990, the Company adopted a Stockholder Rights Plan ("the Rights Plan"). The Rights Plan provides for a dividend distribution of one preferred stock purchase right ("Right") for each outstanding share of the Company's Common Stock, to shareholders of record at the close of business on June 29, 1990. The Rights Plan is designed to deter coercive takeover tactics and to prevent an acquiror from gaining control of the Company without offering a fair price to all of the Company's shareholders. The Rights will expire on June 19, 2000.
Each Right entitles shareholders to buy one-hundredth of a newly issued share of Series A Junior Participating Preferred Stock of the Company at an exercise price of $50. The Rights are exercisable only if a person or group (a) acquires beneficial ownership of 20% or more of the Common Stock or (b) acquires beneficial ownership of 1% or more of the Company's Common Stock if such person or group is a 20%-or-more shareholder on the date when the Rights dividend distribution is declared or (c) commences a tender or exchange offer which upon consummation such person or group would beneficially own 20% or more of the Common Stock of the Company. However, the Rights will not become exercisable if Common Stock is acquired pursuant to an offer for all shares which a majority of the independent directors, excluding all officers of the Company, determine to be fair to and otherwise in the best interests of the Company and its shareholders.
If any person or group becomes the beneficial owner of 20% or more of the Company's Common Stock, or acquires 1% or more of the Common Stock if such person or group is a 20%-or-more shareholder on the date when the Rights dividend distribution is declared, other than (in either case) pursuant to an offer for all shares as described above, then each Right not owned by such person or group or certain related parties will entitle its holder to purchase, at the Right's then current exercise price, shares of the Company's Common Stock (or, in certain circumstances as determined by the Board, cash, other property, or other securities) having a value of twice the Right's exercise price. In addition, if, after any person becomes the beneficial owner of 20% or more of the Company's Common Stock, or acquires 1% or more of the Common Stock if such person is a 20%-or-more shareholder on the date when the Rights dividend distribution is declared, the Company is involved in the merger or other business combination transaction with another person in which its Common Stock is changed or converted, or sells 50% or more of its assets or earning power to another person, each Right will entitle its holder to purchase, at the Right's then current exercise price, shares of common stock of such other person having a value of twice the Right's exercise price.
SMITH INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company will generally be entitled to redeem the Rights at $.01 cents per Right at any time until the tenth business day (subject to extension) following public announcement that a person has become the beneficial owner of 20% or more of the Company's Common Stock, or acquires 1% or more of the Common Stock if a 20%-or-more shareholder on the date when the Rights dividend distribution is declared.
13. SUPPLEMENTARY INCOME STATEMENT INFORMATION
Amounts charged to expense for continuing operations is as follows:
14. QUARTERLY INFORMATION (UNAUDITED)
Included in third quarter of 1993 results is a special charge of $19.9 million ($0.51 per common share in the third quarter and $0.53 per common share for the full year) relating to the settlement of drill bit litigation (See Note 16). Due to the conversion of the preferred stock into common stock (See Note 9) in the second quarter of 1993, the total year income (loss) per common share amounts do not equal the sum of the quarterly income (loss) per common share amounts.
SMITH INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Included in the income (loss) from continuing operations and net income (loss) for the fourth quarter of 1992 is a benefit of $2.5 million to reflect the settlement of U.S. tax issues and approval of U.S. tax refund claim for prior years. For each of the quarters in 1993 and 1992, fully diluted net income (loss) per common share was the same as the respective primary net income (loss) per common share amount.
15. INDUSTRY SEGMENTS AND INTERNATIONAL OPERATIONS
The Company operates primarily in one industry segment: petroleum services. The products and services of the petroleum services segment are primarily used in the drilling of oil and gas wells. The following chart sets forth information concerning the Company's continuing domestic and international operations:
SMITH INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
General corporate expenses and interest income and expense have been excluded from income from continuing operations before interest and taxes in the table above. Results of operations as reported in the accompanying consolidated financial statements include general corporate expenses of $5.9 million in 1993, $5.7 million in 1992 and $4.7 million in 1991.
Transfers between geographic areas are recorded by the Company and its subsidiaries based on their various intercompany pricing agreements.
United States sales include $29.9 million in 1993, $27.9 million in 1992 and $33.4 million in 1991 exported to various international markets. These markets include North Sea/Europe, Africa, Middle East, Latin America, Far East/Asia, and Canada. With the exception of North Sea/Europe, neither export nor international sales to any one of these individual markets exceeded 10% of consolidated revenues.
No single customer accounts for 10% or more of consolidated revenues for the periods presented.
The Company's revenues are derived principally from uncollateralized sales to customers in the oil and gas industry. This industry concentration has the potential to impact the Company's exposure to credit risk, either positively or negatively, because customers may be similarly affected by changes in economic or other conditions. The creditworthiness of this customer base is strong, and the Company has not experienced significant credit losses on such receivables.
16. COMMITMENTS AND CONTINGENT LIABILITIES
Leases
The Company leases certain facilities and machinery and equipment under operating leases. The Company also leases certain machinery and equipment under capital leases. At December 31, 1993 and 1992, machinery and equipment included $3.0 million and $2.5 million, respectively (before accumulated amortization of $0.7 million and $0.7 million, respectively) related to capital leases. These capital leases are recorded in other current and other long-term liabilities in the accompanying consolidated balance sheets.
Future minimum payments under all non-cancellable leases having initial terms of one year or more are as follows:
SMITH INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Litigation
In January 1991, the Company and several of the Company's competitors were served with a federal grand jury subpoena for documents, principally concerning the Company's sales, marketing and pricing activities for tri-cone rock bits produced and sold by the Company. In June 1992, Baker Hughes entered a plea of guilty to an Information charging it with a single count of violating Section 1 of the Sherman Act for the period March through May 11, 1989 and agreed to pay a $1.0 million fine to the U.S. government. On November 23, 1993, the Company entered a plea of guilty to a violation of Section 1 of the Sherman Act for the same period and paid a fine to the U.S. government of $0.7 million.
After it was served the subpoena by the grand jury, the Company was served with complaints in three civil proceedings. Each action alleged violations of Section 1 of the Sherman Act. The cases were consolidated for discovery purposes with four other cases filed against other tri-cone rock bit manufacturers, but not the Company, in the Southern District of Texas, which made allegations similar to those made against the Company. The consolidated case was captioned Red Eagle Resources Corporation, Inc., et al. v. Baker Hughes, Inc., Baker Hughes Production, Inc., Hughes Tool Company, Reed Tool Company, a/k/a/ Baker RTC, Inc., Camco International, Inc., Smith International, Inc., and Dresser Industries, Inc., Civil Action No. 91-H-627. In September 1992, the district court certified the case as a class action. The class consisted of direct purchasers of rock bits from defendants in the period September 1, 1986, through January 15, 1992.
On August 27, 1993, without admitting any form of liability, the Company entered into an agreement with the plaintiffs to settle all claims against the Company. The Company recorded a special charge of $19.9 million to cover the cost of the settlement of $16.8 million and related estimated legal fees and other costs and expenses. On October 28, 1993, an order was entered which gave final approval to this settlement.
Chevron USA Inc., which opted not to be part of the above mentioned class action, filed suit against the Company in the United States District Court for the Southern District of Texas, Houston Division, entitled Chevron USA Inc., acting by and through its division Chevron USA Production Company v. Baker Hughes, Inc., Reed Tool Company a/k/a Baker RTC, Inc., CAMCO International, Inc., Smith International, Inc. and Dresser Industries, Inc. Cause No. H-93-949, alleging violations of Section 1 of the Sherman Act. This case is in its early phase; little formal discovery has occurred; and docket call for the trial of this matter has been set for January 26, 1996. Management believes that the resolution of this matter will not have a material adverse effect on the Company's financial position or results of operations.
On March 4, 1992, the Company was served with a complaint in the U.S. District Court in the Central District of California by the U.S. Department of Labor ("DOL"). The complaint alleges violations of the Employee Retirement Income Security Act of 1974 ("ERISA") arising out of the Company's purchase of annuities from Executive Life Insurance Company("Executive Life"), upon the termination of its Pension Plan in August 1985. The DOL filed the lawsuit in order to prevent the expiration of the statute of limitations while it completed its investigation of the Company's purchase of annuities from Executive Life. In 1993, Executive Life emerged from a conservatorship proceeding in California state court. The Company believes that it properly discharged its legal responsibilities with regard to the purchase of annuities from Executive Life and, consequently, that uninsured losses of the Company, if any, resulting from the DOL claims will not be material.
The Company also is named in a number of environmental legal actions related to the conduct of its business. The major actions relate to several Superfund sites including the Sheridan Disposal Services site in Hempstead, Texas, the Operating Industries, Inc. site in Monterey Park, California and the Chemform site in Pompano Beach, Florida. The Company has notified its insurance companies of potential claims for each of the above sites and coverage has been denied.
The Company reached a settlement with the Sheridan Site Committee (the Committee) with respect to the Sheridan Disposal Services site in Hempstead, Texas. The Company has agreed to pay its allocable share
SMITH INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
of response costs incurred by the Committee, such share to be limited to the lesser of $3.0 million or 2.93% of actual response costs. The Company has also reached a settlement with the United States Environmental Protection Agency Region IX ("EPA") with respect to the Operating Industries, Inc. ("OII") site. The Company has agreed to pay its allocable share of total future site response costs incurred, such share to be limited to the lesser of $5.0 million or 0.65% of the future site response costs incurred. As of December 31, 1993, the Company anticipates that its ultimate liability for the Sheridan and OII sites will be substantially less than these maximum amounts.
Certain environmental problems may exist at the Chemform site in Pompano Beach, Florida, which is located in a highly industrialized area. The Company held a leasehold interest in this property between May 14, 1976 and March 16, 1979. On October 4, 1989, the EPA listed the Chemform site on the National Priorities List. In October 1989, the Company and three other potential responsible parties entered into an administrative consent decree order with the EPA for the preparation of the Remedial Investigation and Feasibility Study ("RI/FS"). An amendment to the consent decree specified that the RI/FS would be addressed in two operable units: Operable Unit One addresses Site-related groundwater contamination, and Operable Unit Two addressed source and soil contamination. On September 22, 1992, EPA issued the Record of Decision ("ROD") for Operable Unit One, which selected a "No Action with Monitoring" alternative, under which groundwater will be monitored for at least one year. In the ROD, the EPA estimated the costs of constructing the required groundwater wells and the cost of one year of groundwater monitoring to be approximately $0.1 million. On September 16, 1993, EPA issued the ROD for Operable Unit Two at the Chemform Site, which addresses site-related soil contamination. The ROD determined that no further Superfund action is necessary to address Operable Unit Two at the Site; however, the State of Florida, as represented by the Florida Department of Environmental Protection, has not yet concurred in the ROD for Operable Unit Two. The Company believes that the EPA will demand reimbursement of certain oversight expenses that the EPA allegedly has incurred in administering the Chemform site. The Company intends to scrutinize and, if necessary, vigorously contest any such claims made by the EPA.
As of December 31, 1990, the Company recorded a $5.0 million provision for its estimated liability for the clean-up of all of the Company's environmental matters that were known at that time including the estimated costs to be incurred regarding the Superfund sites discussed above. In 1993, 1992 and 1991, the Company paid for various clean up activities and made additional provisions, charged to continuing operations, of $0.5 million, $0.4 million and $0.8 million, respectively, and a provision of $1.5 million charged to the gain on sale of DDS operations in 1993 based on revised estimates of required future clean-up costs. At December 31, 1993, the remaining recorded liability for estimated future clean-up costs for the sites discussed above as well as for properties currently or previously owned or leased by the Company totalled $3.6 million. As additional information becomes available, the Company may be required to provide for additional environmental clean-up costs for the Superfund sites and for properties currently or previously owned or leased by the Company. The Company believes that any additional unrecorded clean-up liabilities will not have a material adverse effect on the Company's consolidated financial position or the results of its operations.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
For information concerning directors of the Registrant, see the information set forth following the caption "ELECTION OF DIRECTORS" in the Company's definitive proxy statement to be filed no later than 120 days after the end of the fiscal year covered by this Form 10-K (the "Proxy Statement"), which information is incorporated herein by reference. For information concerning executive officers of the Registrant, see Item 4A appearing in Part I of this Form 10-K.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information set forth following the caption "EXECUTIVE COMPENSATION AND OTHER INFORMATION CONCERNING EXECUTIVE OFFICERS" in the Company's Proxy Statement is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information set forth following the captions "ELECTION OF DIRECTORS" and "SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS" in the Company's Proxy Statement is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information set forth following the captions "ELECTION OF DIRECTORS" and "EXECUTIVE COMPENSATION AND OTHER INFORMATION CONCERNING EXECUTIVE OFFICERS" in the Company's Proxy Statement is incorporated herein by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(A) FINANCIAL STATEMENTS
All other schedules have been omitted since the required information is not present or not present in amounts sufficient to require submission of the schedule, or because the information required is included in the consolidated financial statements or notes thereto.
(3) EXHIBITS AND INDEX TO EXHIBITS
(B) REPORTS ON FORM 8-K.
No reports on Form 8-K were filed during the last quarter of the period covered by this report.
SMITH INTERNATIONAL, INC.
SCHEDULE V -- PROPERTY, PLANT AND EQUIPMENT FOR THE YEAR ENDED DECEMBER 31, 1993 (AMOUNTS IN THOUSANDS)
SCHEDULE VI -- ACCUMULATED DEPRECIATION OF PROPERTY, PLANT AND EQUIPMENT FOR THE YEAR ENDED DECEMBER 31, 1993 (AMOUNTS IN THOUSANDS)
See Note 1 of Notes to Consolidated Financial Statements for discussion of depreciation methods and rates.
(A) Includes $10,299 and $5,505 of rental equipment and plant and equipment, respectively, related to the acquisition of A-Z/Grant and Lindsey.
(B) Foreign currency translation adjustment arising from the provisions of Statement of Financial Accounting Standards Board No. 52; see Note 1 of Notes to Consolidated Financial Statements.
(C) Amounts primarily represent the reclassification of certain fixed assets to assets held for sale.
SMITH INTERNATIONAL, INC.
SCHEDULE V -- PROPERTY, PLANT AND EQUIPMENT FOR THE YEAR ENDED DECEMBER 31, 1992 (AMOUNTS IN THOUSANDS)
SCHEDULE VI -- ACCUMULATED DEPRECIATION OF PROPERTY, PLANT AND EQUIPMENT FOR THE YEAR ENDED DECEMBER 31, 1992 (AMOUNTS IN THOUSANDS)
See Note 1 of Notes to Consolidated Financial Statements for discussion of depreciation methods and rates.
(A) Foreign currency translation adjustment arising from the provisions of Statement of Financial Accounting Standards Board No. 52; see Note 1 of Notes to Consolidated Financial Statements.
(B) Includes transfer of $61,787 and $12,696 of net book value of rental equipment and plant and equipment, respectively, to net assets of DDS business sold in 1993; see Note 2 of Notes to Consolidated Financial Statements.
(C) Amount represents the reclassification of certain fixed assets to assets held for sale.
SMITH INTERNATIONAL, INC.
SCHEDULE V -- PROPERTY, PLANT AND EQUIPMENT FOR THE YEAR ENDED DECEMBER 31, 1991 (AMOUNTS IN THOUSANDS)
SCHEDULE VI -- ACCUMULATED DEPRECIATION OF PROPERTY, PLANT AND EQUIPMENT FOR THE YEAR ENDED DECEMBER 31, 1991 (AMOUNTS IN THOUSANDS)
See Note 1 of Notes to Consolidated Financial Statements for discussion of depreciation methods and rates.
(A) Foreign currency translation adjustment arising from the provisions of Statement of Financial Accounting Standards Board No. 52; see Note 1 of Notes to Consolidated Financial Statements.
(B) Amount represents a provision to writedown certain fixed assets to their estimated net realizable value and the reclassification of such items to assets held for sale.
SMITH INTERNATIONAL, INC.
SCHEDULE VIII VALUATION AND QUALIFYING ACCOUNTS AND RESERVES (DOLLARS IN THOUSANDS)
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(1) Amount represents the reclassification of certain reserves relating to long-term receivables to trade accounts receivable.
SMITH INTERNATIONAL, INC.
SCHEDULE IX -- SHORT-TERM BORROWINGS (DOLLARS IN THOUSANDS)
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(2) Computed by dividing short-term interest expense by average short-term borrowings.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
SMITH INTERNATIONAL, INC.
By: /s/ DOUGLAS L. ROCK -------------------------------- Douglas L. Rock Chief Executive Officer, President, and Chief Operating Officer
March 21, 1994
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities on the date indicated: