================================================================================
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002
COMMISSION FILE NUMBER 001-15423
GRANT PRIDECO, INC.
(SEE TABLE OF ADDITIONAL REGISTRANTS ON NEXT PAGE)
(Exact name of Registrant as specified in its Charter)
DELAWARE 76-0312499
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1330 POST OAK BLVD.
SUITE 2700
HOUSTON, TEXAS 77056
(Address of principal executive offices) (Zip Code)
(832) 681-8000
(Registrant's telephone number, include area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicated by check mark whether the issuer is an accelerated filer (as
defined in Rule 12b-3 of the Exchange Act Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date:
TITLE OF CLASS OUTSTANDING AT NOVEMBER 11, 2002
- ---------------------------------------- --------------------------------
Common Stock, par value $0.01 111,253,466
================================================================================
TABLE OF ADDITIONAL REGISTRANTS
<Table>
<Caption>
JURISDICTION OF
NAME** FORMATION EMPLOYER ID
- ------------------------------------------ ---------------- -------------
GP Expatriate Services, Inc............... Delaware 76-0632330
Grant Prideco Holding, LLC................ Delaware 76-0635560
Grant Prideco, LP......................... Delaware 76-0635557
Grant Prideco USA, LLC.................... Delaware 51-0397748
Star Operating Company.................... Delaware 76-0655528
TA Industries, Inc........................ Delaware 76-0497435
Texas Arai, Inc........................... Delaware 74-2150314
Tube-Alloy Capital Corporation............ Texas 76-0012315
Tube-Alloy Corporation.................... Louisiana 72-0714357
XL Systems International, Inc............. Delaware 76-0602808
XL Systems, LP............................ Texas 76-0324868
</Table>
- ----------
** Except for Grant Prideco USA, LLC, the address, telephone number and zip
code for each of the additional Registrants is the same as for Grant
Prideco, Inc. The address, telephone number and zip code for Grant Prideco
USA, LLC is 500 Delaware Avenue, Suite 900, Wilmington, DE 19801.
Grant Prideco, Inc. (the "Company") owns directly or indirectly all of the
outstanding capital stock of each of the additional Registrants listed above.
Each of the additional Registrants is a guarantor of the Company's obligations
under its 9 5/8% Senior Notes Due 2007 (the "Senior Notes"). No separate
financial statements for the additional Registrants have been provided or
incorporated because: (1) the financial statements of the Company included in
this report include the operations of each of the additional Registrants and (2)
Note 15 to the Company's accompanying unaudited financial statements includes
unaudited condensed consolidating financial statements of the Company separating
the financial results for the additional Registrants from the Company and any
subsidiaries that are not guarantors of the Company's obligations under the
Senior Notes.
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
GRANT PRIDECO, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PAR VALUE AMOUNT)
<Table>
<Caption>
DECEMBER 31, SEPTEMBER 30,
2001 2002
------------ -------------
(UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash and Cash Equivalents .................................................... $ 10,384 $ 16,083
Restricted Cash .............................................................. 5,383 5,555
Accounts Receivable, Net of Allowance for Uncollectible Accounts of $1,407 and
$2,501 at December 31, 2001 and September 30, 2002, respectively ........... 148,223 125,638
Inventories .................................................................. 198,814 178,604
Current Deferred Tax Asset ................................................... 16,275 15,444
Other Current Assets ......................................................... 13,284 16,390
--------- ---------
392,363 357,714
PROPERTY, PLANT AND EQUIPMENT, AT COST:
Machinery and Equipment ...................................................... 249,023 268,016
Land, Buildings and Other Property ........................................... 110,072 122,225
--------- ---------
359,095 390,241
Less: Accumulated Depreciation ........................................ 134,588 149,181
--------- ---------
224,507 241,060
GOODWILL, NET .................................................................. 231,521 245,464
INVESTMENT IN AND ADVANCES TO UNCONSOLIDATED AFFILIATES ........................ 55,289 47,287
DEFERRED TAX ASSET ............................................................. 108 487
INTANGIBLE ASSETS, NET ......................................................... 3,473 2,889
OTHER ASSETS ................................................................... 8,337 7,709
--------- ---------
$ 915,598 $ 902,610
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Short-Term Borrowings and Current Portion of Long-Term Debt .................. $ 61,154 $ 9,356
Accounts Payable ............................................................. 62,689 45,307
Current Deferred Tax Liability ............................................... 5,051 6,470
Accrued Labor and Benefits ................................................... 15,927 20,254
Other Accrued Liabilities .................................................... 41,360 58,712
--------- ---------
186,181 140,099
LONG-TERM DEBT ................................................................. 205,024 201,398
DEFERRED INCOME TAXES .......................................................... 40,948 37,836
MINORITY INTEREST .............................................................. 1,615 9,388
OTHER LONG-TERM LIABILITIES .................................................... 12,863 11,628
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common Stock, $0.01 Par Value ................................................ 1,093 1,111
Capital in Excess of Par Value ............................................... 361,699 385,496
Treasury Stock, at Cost ...................................................... (2,551) (3,983)
Retained Earnings ............................................................ 125,199 138,583
Deferred Compensation Obligation ............................................. 6,078 7,380
Accumulated Other Comprehensive Loss ......................................... (22,551) (26,326)
--------- ---------
468,967 502,261
--------- ---------
$ 915,598 $ 902,610
========= =========
</Table>
The accompanying notes are an integral part of these financial statements.
3
GRANT PRIDECO, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ ------------------------
2001 2002 2001 2002
--------- --------- --------- ---------
REVENUES ..................................................... $ 198,989 $ 162,237 $ 548,549 $ 482,889
--------- --------- --------- ---------
COSTS AND EXPENSES:
Cost of Sales .............................................. 145,833 130,644 429,128 376,709
Selling, General and Administrative Attributable to Segments 12,799 14,411 37,676 41,857
Corporate General and Administrative ....................... 5,765 7,885 16,306 20,740
Equity Income in Unconsolidated Affiliates ................. (1,394) (1,273) (6,226) (4,913)
Other Charges .............................................. 1,475 -- 33,755 7,045
--------- --------- --------- ---------
164,478 151,667 510,639 441,438
--------- --------- --------- ---------
OPERATING INCOME ............................................. 34,511 10,570 37,910 41,451
--------- --------- --------- ---------
OTHER INCOME (EXPENSE):
Interest Expense ........................................... (6,902) (5,795) (20,795) (18,053)
Other, Net ................................................. (398) (462) (1,122) (688)
--------- --------- --------- ---------
(7,300) (6,257) (21,917) (18,741)
--------- --------- --------- ---------
INCOME BEFORE INCOME TAXES ................................... 27,211 4,313 15,993 22,710
INCOME TAX PROVISION ......................................... (9,524) (1,337) (5,485) (7,040)
--------- --------- --------- ---------
NET INCOME BEFORE MINORITY INTEREST .......................... 17,687 2,976 10,508 15,670
MINORITY INTEREST ............................................ (353) (1,031) (994) (2,286)
--------- --------- --------- ---------
NET INCOME ................................................... $ 17,334 $ 1,945 $ 9,514 $ 13,384
========= ========= ========= =========
NET INCOME PER SHARE:
Basic ...................................................... $ 0.16 $ 0.02 $ 0.09 $ 0.12
========= ========= ========= =========
Diluted .................................................... $ 0.16 $ 0.02 $ 0.09 $ 0.12
========= ========= ========= =========
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic ...................................................... 109,738 111,620 109,435 110,974
========= ========= ========= =========
Diluted .................................................... 110,531 112,685 110,685 112,420
========= ========= ========= =========
</Table>
The accompanying notes are an integral part of these financial statements.
4
GRANT PRIDECO, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
<Table>
<Caption>
NINE MONTHS ENDED
SEPTEMBER 30,
-----------------------
2001 2002
-------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income .................................................... $ 9,514 $ 13,384
Adjustments to Reconcile Net Income to Net Cash
Provided by Operating Activities:
Depreciation and Amortization .............................. 22,836 22,924
Goodwill Amortization ...................................... 4,727 --
Deferred Income Tax ........................................ 1,469 (68)
Equity Income in Unconsolidated Affiliates, Net of Dividends 5,411 11,175
Non-Cash Portion of Other Charges .......................... 30,248 2,580
Changes in Operating Assets and Liabilities, Net of
Effect of Businesses Acquired:
Accounts Receivable, Net .............................. (39,103) 34,493
Inventories ........................................... (25,109) 30,150
Other Current Assets .................................. (4,267)
5,296
Other Assets .......................................... 522 473
Accounts Payable ...................................... (4,829) (17,946)
Other Accrued Liabilities ............................. 9,021 7,801
Customer Advances ..................................... (189) (635)
Other, Net ............................................ (1,319) (1,715)
-------- ---------
Net Cash Provided by Operating Activities ........... 8,932 107,912
-------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisitions of Businesses, Net of Cash Acquired .............. (1,000)
(3,527)
Investments in and Advances to Unconsolidated Affiliates ...... -- (2,429)
Capital Expenditures for Property, Plant and Equipment ........ (26,329) (34,459)
-------- ---------
Net Cash Used by Investing Activities ............... (27,329) (40,415)
-------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings (Repayments) on Credit Facility .................... 42,490 (54,423)
Repayments on Debt, Net ....................................... (16,847) (6,740)
Proceeds from Stock Option Exercises .......................... 565 1,164
Purchases of Treasury Stock ................................... (1,222) (1,799)
-------- ---------
Net Cash Provided (Used) by Financing Activities .... 24,986 (61,798)
-------- ---------
NET INCREASE IN CASH AND CASH EQUIVALENTS ....................... 6,589 5,699
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR .................. 8,315 10,384
-------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD ...................... $ 14,904 $ 16,083
======== =========
</Table>
The accompanying notes are an integral part of these financial statements.
5
GRANT PRIDECO, INC.
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
1. GENERAL
Basis of Presentation
The accompanying consolidated financial statements of Grant Prideco, Inc.
(the Company or Grant Prideco) have been prepared in accordance with accounting
principles generally accepted in the United States for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. Accordingly, they do not include all disclosures required by generally
accepted accounting principles for complete financial statements. All
significant transactions among Grant Prideco and its consolidated subsidiaries
have been eliminated. The interim financial statements have not been audited.
However, in the opinion of management, all adjustments, consisting only of
normal recurring adjustments, necessary for a fair presentation of the financial
statements have been included. Results of operations for interim periods are not
necessarily indicative of the results of operations that may be expected for the
entire year. These interim financial statements should be read in conjunction
with the audited financial statements and notes thereto included in our Annual
Report on Form 10-K for the year ended December 31, 2001.
The Annual Report on Form 10-K for the year ended 2001 includes disclosures
related to significant accounting policies including revenue recognition,
account receivables valuation, inventory valuation, business combinations,
impairment of long-lived assets and estimates related to contingent liabilities
and future claims. Subsequent to December 31, 2001, the Company has added an
additional critical accounting policy related to impairment testing for goodwill
and intangible assets.
Goodwill and intangible assets that have indefinite useful lives are
subject to annual impairment tests. Goodwill will be tested for impairment using
a two-step process that begins with an estimation of the fair value of each of
the Company's reporting units with its carrying value. If the carrying amount
exceeds the fair value of a reporting unit, a second step test is completed
comparing the implied fair value of the reporting unit's goodwill to its
carrying value to measure the amount of impairment. Intangible assets that are
not amortized will be tested for impairment at least annually by comparing the
fair values of those assets to their carrying values.
Certain reclassifications of prior year balances have been made to conform
such amounts to corresponding 2002 classifications and are of a normal recurring
nature. These reclassifications have no impact on net income.
2. COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) includes changes in stockholders' equity during
the periods that do not result from transactions with stockholders. The
Company's total comprehensive income (loss) is as follows:
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- ---------------------
2001 2002 2001 2002
-------- ------- ------- --------
(IN THOUSANDS)
Net Income .............................................................. $ 17,334 $ 1,945 $ 9,514 $ 13,384
Foreign Currency Translation Adjustments, net of tax of ($2,904), ($899),
($1,473) and ($1,623) ................................................ (5,394) (2,000) (2,859) (3,611)
Change in Derivatives, net of tax of $856, $4, ($21) and ($74) ......... 1,589 8 (40) (164)
Unrealized (Gain) Loss on Marketable Securities, net of tax of ($121) and
($106) ............................................................... (224) -- (205) --
-------- ------- ------- --------
Total Comprehensive Income (Loss) .................................. $ 13,305 $ (47) $ 6,410 $ 9,609
======== ======= ======= ========
</Table>
3. INVENTORIES
Inventories by category are as follows:
<Table>
<Caption>
DECEMBER 31, SEPTEMBER 30,
2001 2002
------------ -------------
(IN THOUSANDS)
Raw materials, components and supplies ..... $130,166 $117,294
Work in process ............................ 24,038 19,178
Finished goods ............................. 44,610 42,132
-------- --------
$198,814 $178,604
======== ========
</Table>
6
4. OTHER CHARGES
2000 Charges
The Company incurred $41.3 million of pre-tax charges, $26.9 million net of
tax, in the fourth quarter of 2000 relating primarily to inventory write-offs
and other asset impairments and reductions. Of this amount, $7.9 million related
to accrued liabilities. The accrued liability balances as of September 30, 2002
are summarized below:
<Table>
<Caption>
DRILLING PREMIUM MARINE
PRODUCTS CONNECTIONS PRODUCTS LIABILITY
AND AND TUBULAR AND TOTAL CASH BALANCE
SERVICES PRODUCTS SERVICES CHARGES PAYMENTS 9/30/02
-------- -------- -------- ------- -------- -------
(IN THOUSANDS)
Litigation Accrual................ $ -- $ -- $ 2,500 $ 2,500 $ 647 $ 1,853
Contingent Liability Accrual...... 4,650 -- -- 4,650 -- 4,650
Other Accrued Liabilities......... 594 115 -- 709 709 --
--------- ----- -------- --------- ------- --------
Total........................... $ 5,244 $ 115 $ 2,500 $ 7,859 $ 1,356 $ 6,503
========= ===== ======== ========= ======= ========
</Table>
The remaining accrued liabilities are expected to be paid during the next 12
months, except for the open litigation issue, which is under appeal.
2001 Other Charges
During 2001, the Company incurred approximately $44.8 million of pre-tax
charges, $29.1 million net of tax. These charges included $11.1 million, $7.2
million net of tax, related to inventory write-offs and capitalized
manufacturing variance write-offs which were classified as costs of sales, $17.7
million, $11.5 million net of tax, pertaining to the write-off of assets related
to the Company's manufacturing arrangement with Oil Country Tubular Ltd. (OCTL)
in India, severance and related expenses of $14.5 million, $9.4 million net of
tax, and a fixed asset impairment of $1.5 million, $1.0 million net of tax,
related to the decision to discontinue the manufacturing of industrial flanges.
These charges are summarized in the following chart:
<Table>
<Caption>
DRILLING PREMIUM MARINE
PRODUCTS CONNECTIONS PRODUCTS
AND AND TUBULAR AND
SERVICES PRODUCTS SERVICES OTHER CORPORATE TOTAL
-------- -------- -------- ----- --------- -----
(IN THOUSANDS)
OCTL Write-Off(a)............. $ 17,727 $ -- $ -- $ -- $ -- $ 17,727
Inventory Write-Off(b)........ 3,657 -- 1,692 1,125 -- 6,474
Fixed Asset Impairment(c)..... 1,475 -- -- -- -- 1,475
Write-Off of Capitalized
Manufacturing Variances(d).... 1,024 509 272 2,767 -- 4,572
Severance(e).................. 108 -- 205 75 14,165 14,553
--------- ----- ------- -------- -------- ---------
Total..................... $ 23,991 $ 509 $ 2,169 $ 3,967 $ 14,165 $ 44,801
========= ===== ======= ======== ======== =========
</Table>
(a) In connection with the Company's operational review conducted in 2001, the
Company reassessed the viability of restructuring its relationship with
OCTL in India and determined that a continued relationship was no longer
viable. As a result of this determination, the Company wrote-off the
remaining $17.7 million of unpaid receivables and advances owed to it by
OCTL.
(b) The inventory write-off was reported as cost of sales and was made
pursuant to a review of the Company's planned dispositions of inventory in
an effort to reduce inventory levels of older, slow-moving products. The
amount was determined by use of internal appraisals and evaluations to
assess the estimated net realizable value upon disposal and also included
a charge related to certain inventory purchase contract obligations with
above market prices.
(c) The flange machinery and equipment impairment was reported as other
charges and relates to the Company's decision to discontinue the
manufacturing of industrial flanges. The amount was determined by use of
internal appraisals and evaluations to assess the net realizable value
upon disposal.
(d) Certain capitalized manufacturing cost variances were expensed as cost of
sales in connection with the Company's operational review and revisions of
manufacturing standards and costing during 2001.
(e) The severance charge relates to executive, manufacturing, and marketing
employees terminated in connection with the Company's restructuring plan
that was implemented in 2001. The total number of employees severed was
24, and the amount accrued for severance was based upon the positions
eliminated and the Company's severance policy, all of which were paid in
2001.
7
2002 Charges
Results for the nine months ended September 30, 2002 included $7.0 million
of pre-tax charges, $4.9 million net of tax, which were incurred during the
second quarter of 2002. These charges included $2.6 million related to fixed
asset write-downs and $4.5 million for executive severance payments and related
expenses and are summarized in the following chart (in thousands):
<Table>
<Caption>
DRILLING PREMIUM
PRODUCTS CONNECTIONS
AND AND TUBULAR
SERVICES PRODUCTS CORPORATE TOTAL
--------- ----------- --------- ---------
Fixed Asset Write-Downs(a)....................... $ 2,360 $ 220 $ -- $ 2,580
Severance(b)..................................... -- -- 4,465 4,465
--------- --------- --------- ---------
Total........................................ $ 2,360 $ 220 $ 4,465 $ 7,045
========= ========= ========= =========
</Table>
- ----------
(a) The fixed asset write-downs relate to idle assets taken out of service
pursuant to the Company's ongoing automation and efficiency initiatives
and are classified as held for sale. The amount was determined by use of
internal appraisals and evaluations to assess the estimated fair value
upon disposition. The equipment, which has a carrying value of $0.2
million, is expected to be disposed of in the next 12 months.
(b) The severance charge relates to an executive employee terminated during
June 2002. The amount accrued for severance was based upon the terminated
employee's employment contract, which was paid in July 2002.
5. NET INCOME PER SHARE
Basic net income per share is computed by dividing net income by the
weighted average number of common shares outstanding for the period. Diluted
earnings per share reflects the potential dilution from the exercise or
conversion of securities into common stock. Common stock equivalent shares are
excluded from the computation if their effect was antidilutive. The effect of
stock options was not included in the diluted computation for periods in which a
loss occurs because to do so would have been antidilutive. The computation of
diluted earnings per share for the three and nine months ended September 30,
2001 did not include options to purchase 6.2 million and 4.8 million shares,
respectively, of common stock because their exercise prices were greater than
the average market price of the common stock for the applicable period. The
computation of diluted earnings per share for the three and nine months ended
September 30, 2002 did not include options to purchase 5.9 million and 4.9
million shares, respectively, of common stock because their exercise prices were
greater than the average market price of the common stock for the applicable
period.
6. CREDIT FACILITY
In April 2000, the Company entered into a revolving credit facility with a
syndicate of U.S. banks (the "Credit Facility"), through April 14, 2003, with
automatic one-year renewals thereafter, unless either party terminates the
agreement. Originally, the committed amount was $100 million. In February 2002,
the Company increased this committed amount to $135 million. The Credit Facility
is secured by the Company's U.S. and Canadian inventories, equipment and
receivables and is guaranteed by Grant Prideco's domestic subsidiaries. The
Company is required to comply with various affirmative and negative covenants
which limit its ability to incur new debt, make certain investments and
acquisitions, sell assets, grant liens, and other related items. The Company is
also subject to financial covenants which require it to maintain a certain
tangible net worth and fixed charge coverage ratio. As of September 30, 2002,
the Company was in compliance with the various covenants under the Credit
Facility agreement. As of September 30, 2002, the Company had no outstanding
borrowings under the Credit Facility and $3.9 million had been used to support
outstanding letters of credit, resulting in unused borrowing capacity of $131.1
million.
Additionally, at September 30, 2002, there were outstanding borrowings of
$0.3 million under a miscellaneous credit facility and $1.6 million of
outstanding letters of credit had been supported under various available letter
of credit facilities that are not related to the Credit Facility.
7. FINANCIAL INSTRUMENTS
Effective January 1, 2001, the Company adopted Statement of Financial
Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and
Hedging Activities", as amended. SFAS No. 133 requires the Company to recognize
all derivatives on the balance sheet at fair value. The adoption of SFAS No. 133
on January 1, 2001 did not have a material impact on results of operations but
resulted in the cumulative effect of an accounting change of $0.3 million
pre-tax being recognized as a loss in "Accumulated Other Comprehensive Loss" in
the accompanying Consolidated Balance Sheets.
8
The Company uses foreign currency forwards and call options to hedge
certain of its exposures to changes in foreign exchange rates. The forwards and
call options have only nominal value at the time of purchase. The counterparties
to these derivative foreign exchange contracts are creditworthy multinational
commercial banks. Management believes that the risk of counterparty
nonperformance is minimal. The Company does not engage in derivative activity
for speculative or trading purposes. The Company does not have any off-balance
sheet hedging or financing arrangements or contracts, other than operating
leases which primarily relate to office space and equipment.
CASH FLOW HEDGES
As of September 30, 2002, all of the Company's cash flow hedges had
expired.
During the first quarter of 2001, the Company recognized losses of $0.6
million in "Other, Net" in the accompanying Consolidated Statements of
Operations related to foreign currency forward contracts that resulted from an
overhedge position with respect to anticipated Euro-denominated purchases of
inventory.
The following table summarizes activity in other comprehensive income
(loss) related to derivatives that were classified as cash flow hedges held by
the Company (in thousands):
<Table>
<Caption>
NINE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
2001 2002
--------------- ----------
Balance as of January 1, net of tax of $122 and $74............................. $216 $ 164
Net deferred loss reclassified into earnings from other
comprehensive income (loss), net of tax of ($251) and ($76)................... (775) (168)
Change in fair value of derivatives, net of tax of $1,046 and $2................ 599 4
------ --------
Accumulated other comprehensive (income) loss, net of tax of $917 and ($4)...... $ 40 $ --
====== ========
</Table>
FAIR VALUE HEDGES
The Company had two forward contracts in place to purchase a total of 2.9
million Euros for a notional amount of $2.9 million at December 31, 2001. In
January 2002, one of the forward contracts expired, and the remaining forward
contract related to the 3 1/2 year Voest-Alpine debt was cancelled. There was no
material impact on income as a result of these transactions.
8. GOODWILL AND OTHER INTANGIBLE ASSETS
Effective January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and
Other Intangible Assets". Under SFAS No. 142, goodwill and intangible assets
deemed to have indefinite lives are no longer amortized but will be subject to
annual impairment tests. Goodwill amortization was $6.4 million in 2001. Other
intangible assets will continue to be amortized over their useful lives.
In accordance with SFAS No. 142, prior period amounts were not restated. A
reconciliation of the previously reported net income and earnings per share for
the three and nine months ended September 30, 2001 to the amounts adjusted for
the reduction of amortization expense, net of the related income tax effect, is
as follows (in thousands, except per share amounts):
<Table>
<Caption>
THREE MONTHS ENDED SEPTEMBER 30, 2001 NINE MONTHS ENDED SEPTEMBER 30, 2001
---------------------------------------- --------------------------------------
NET INCOME BASIC EPS DILUTED EPS NET INCOME BASIC EPS DILUTED EPS
---------- --------- ----------- ---------- --------- -----------
Reported results....................... $ 17,334 $ 0.16 $ 0.16 $ 9,514 $ 0.09 $ 0.09
Goodwill amortization.................. 1,571 0.01 0.01 4,727 0.04 0.04
---------- --------- ----------- ---------- --------- ----------
Adjusted results....................... $ 18,905 $ 0.17 $ 0.17 $ 14,241 $ 0.13 $ 0.13
========== ========= =========== ========== ========= ==========
</Table>
Intangible assets of $5.8 million, including accumulated amortization of
$2.9 million, as of September 30, 2002 are recorded at cost and are amortized on
a straight-line basis. The Company's intangible assets primarily consist of
covenants-not-to-compete, technology licenses and patents that are amortized
over the definitive terms of the related agreement or the Company's estimate of
the useful life if there are no definitive terms. Amortization expense for the
three and nine months ended September 30, 2002 was $0.1 million and $0.7
million, respectively, and for the three and nine months ended September 30,
2001 was $0.3 million and $0.8 million, respectively. Amortization expense for
the full year 2002 is estimated to be approximately $0.8 million. Excluding the
impact of future acquisitions, estimated annual amortization expense related to
existing intangible assets for years 2003 through 2006 is expected to be
approximately $0.6 million, $0.5 million, $0.3 million and $0.2 million,
respectively.
9
SFAS No. 142 provides for a two-step transitional goodwill impairment test
with respect to existing goodwill. The first step of the test involved a
comparison of the fair value of each of the Company's reporting units, as
defined under SFAS No. 142, with its carrying value. If the carrying amount
exceeded the fair value of a reporting unit, the Company is required to complete
the second step of the transitional goodwill impairment test for this reporting
unit by December 31, 2002. The Company's reporting units are as follows: 1)
Drilling Products and Services, 2) Premium Connections and Tubular Products
(excluding Texas Arai and Tube-Alloy(TM)), 3) Texas Arai, 4) Tube-Alloy(TM) 5)
Marine Products and Services and 6) Industrial.
Completion of the first step of the test indicated the carrying value of
the Industrial reporting unit exceeded its fair value and the Company will be
required to perform the second step of the impairment test for this reporting
unit by December 31, 2002. The total amount of goodwill related to the
Industrial reporting unit is approximately $11 million. The fair value of the
Industrial reporting unit was determined using a combination of discounted cash
flow projections and comparable company market value multiples. The
circumstances leading to the goodwill impairment in the Industrial reporting
unit are overall weak market conditions in the telecommunications industry which
have contributed to declining revenues and profitability and a reduction in the
estimated future expected performance of this reporting unit, which manufactures
drill pipe and other products used in the industrial markets for fiber optic
cable installation and water well drilling.
The second step of the test will be based on a comparison of the implied
fair value of the Industrial reporting unit's goodwill to its carrying value to
measure the amount of impairment. Once the impairment charge is determined, it
will be treated as a non-cash charge and will be recorded as a cumulative effect
of a change in accounting principle in the Consolidated Statements of
Operations. SFAS No. 142 requires goodwill to be tested annually and also on an
interim basis if events occur or circumstances change that would more likely
than not reduce the fair value of a reporting unit below its carrying amount.
The Company has elected to perform its annual tests for potential goodwill
impairment as of October 1st of each year. Subsequent impairment losses, if any,
will be reflected in income from continuing operations. The carrying amount of
goodwill by reporting unit is as follows:
<Table>
<Caption>
PREMIUM MARINE
DRILLING CONNECTIONS PRODUCTS
PRODUCTS AND TUBULAR TEXAS TUBE- AND
AND SERVICES PRODUCTS ARAI ALLOY(TM) SERVICES INDUSTRIAL TOTAL
------------ ----------- ------- --------- --------- ------- ---------
(IN THOUSANDS)
Balance, December 31, 2001 . $ 114,485 $46,010 $17,612 $28,442 $14,130 $10,842 $ 231,521
Acquisitions ............... 14,203 588 -- -- 2,786 -- 17,577
Translation and other
adjustments .............. (3,987) -- -- -- 353 -- (3,634)
--------- ------- ------- ------- ------- ------- ---------
Balance, September 30, 2002 $ 124,701 $46,598 $17,612 $28,442 $17,269 $10,842 $ 245,464
========= ======= ======= ======= ======= ======= =========
</Table>
9. RESTRICTED CASH
At September 30 2002, the Company had $5.6 million of restricted cash
related to its 54% interest in H-Tech that is subject to dividend and
distribution restrictions.
10. SEGMENT INFORMATION
BUSINESS SEGMENTS
The Company operates primarily through three business segments: drilling
products and services, premium connections and tubular products, and marine
products and services. The Company's drilling products and services segment
manufactures and sells a full range of proprietary and API drill pipe, drill
collars, heavy weight drill pipe and accessories. The Company's premium
connections and tubular products segment designs, manufactures and sells a
complete line of premium connections and associated premium tubular products and
accessories. The Company's marine products and services segment manufactures and
sells a variety of products used in subsea construction and installations. In
addition to the products and services provided through the three primary
segments, the Company also manufactures drill pipe and other products used in
the industrial markets for fiber optic cable installation, construction and
water well drilling. The Company is also involved in joint ventures for the
development of telemetry drill pipe and composite motors and pumps, which are
classified in "other".
10
<Table>
<Caption>
PREMIUM MARINE
DRILLING CONNECTIONS PRODUCTS
PRODUCTS AND TUBULAR AND
THREE MONTHS ENDED: AND SERVICES PRODUCTS SERVICES OTHER CORPORATE TOTAL
------------ ----------- --------- --------- --------- -----------
(IN THOUSANDS)
SEPTEMBER 30, 2001
Revenues from unaffiliated customers........ $ 106,056 $ 70,922 $ 13,836 $ 8,175 $ -- $ 198,989
Operating income (loss)..................... 26,068 13,185 2,024 (1,001) (5,765) 34,511
SEPTEMBER 30, 2002
Revenues from unaffiliated customers........ $ 77,362 $ 58,680 $ 19,086 $ 7,109 $ -- $ 162,237
Operating income (loss)..................... 15,732 2,386 949 (612) (7,885) 10,570
<Caption>
PREMIUM MARINE
DRILLING CONNECTIONS PRODUCTS
PRODUCTS AND TUBULAR AND
NINE MONTHS ENDED: AND SERVICES PRODUCTS SERVICES OTHER CORPORATE TOTAL
------------ ----------- --------- -------- --------- -----------
(IN THOUSANDS)
SEPTEMBER 30, 2001
Revenues from unaffiliated customers........ $ 268,286 $ 216,160 $ 30,898 $ 33,205 $ -- $ 548,549
Operating income (loss)..................... 35,748 40,868 (1,148) (7,087) (30,471) 37,910
SEPTEMBER 30, 2002
Revenues from unaffiliated customers........ $ 244,752 $ 169,940 $ 47,086 $ 21,111 $ -- $ 482,889
Operating income (loss)..................... 57,982 11,703 323 (3,352) (25,205) 41,451
</Table>
11. RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS
No. 141, "Business Combinations". SFAS No. 141 eliminates pooling-of-interest
accounting and requires all business combinations initiated after June 30, 2001
to be accounted for using the purchase method. The adoption of SFAS No. 141 had
no impact on the Company's consolidated results of operations and financial
position.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets". This statement supercedes SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of", and the accounting and reporting provisions of
Accounting Principles Board Opinion (APB) No. 30, "Reporting the Results of
Operations -- Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions". This
statement retains the fundamental provisions of SFAS No. 121 and the basic
requirements of APB No. 30; however, it establishes a single accounting model to
be used for long-lived assets to be disposed of by sale and it expands the
presentation of discontinued operations to include more disposal transactions.
The provisions of this statement are effective for financial statements issued
for fiscal years beginning after December 15, 2001. Effective January 1, 2002,
the Company adopted SFAS No. 144. The adoption of SFAS No. 144 had no material
impact on the Company's consolidated results of operations and financial
position.
In April 2002, SFAS No. 145, "Rescission of FASB Statements No. 4, 44 and
64, Amendment of FASB Statement No. 13, and Technical Corrections," was issued.
SFAS No. 145 rescinds SFAS No. 4 and SFAS No. 64 related to classification of
gains and losses on debt extinguishment such that most debt extinguishment gains
and losses will no longer be classified as extraordinary. SFAS No. 145 also
amends SFAS No. 13 with respect to sale-leaseback transactions. The Company
adopted the provisions of SFAS No. 145 effective April 1, 2002, and the adoption
had no impact on the Company's consolidated results of operations and financial
position.
On July 29, 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS No. 146 requires companies to
recognize costs associated with exit or disposal activities when they are
incurred rather than at the date of a commitment to an exit plan or disposal
plan. Examples of costs covered by the standard include lease termination costs
and certain employee severance costs that are associated with a restructuring,
discontinued operation, plant closing, or other exit or disposal activity.
Previous accounting guidance was provided by Emerging Issues Task Force (EITF)
Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)." SFAS No. 146 replaces EITF Issue No. 94-3 and is to be applied
prospectively to exit or disposal activities initiated after December 31, 2002.
The Company will adopt SFAS No. 146 as of January 1, 2003. At this time, the
Company does not believe that the adoption of SFAS No. 146 will have a material
impact on its consolidated results of operations and financial position.
11
12. ACQUISITIONS
On September 13, 2002, the Company acquired the assets of Grey-Mak Pipe,
Inc. (Grey-Mak), a company headquartered in Casper, Wyoming that specializes in
the threading of casing and tubing and provides related accessories. The Company
paid approximately $4.8 million in cash, and goodwill recognized in the
acquisition was approximately $0.6 million. Grey-Mak's results of operations
will be included in the Company's Premium Connections and Tubular Products
segment.
On March 26, 2002, the Company acquired an additional 48.5% interest in
Jiangsu Shuguang Grant Prideco Tubular Limited (JSG), a Chinese entity engaged
in the manufacture and sale of drill pipe to the Chinese and related markets,
thereby giving the Company a 70% controlling interest in JSG. The Company
previously owned approximately 21.5% of JSG and accounted for its investment
under the equity method. The Company paid approximately $0.5 million in cash and
issued 1.3 million shares of Grant Prideco common stock for the additional
interest. Goodwill recognized in the step acquisition of JSG was approximately
$11.3 million. Subsequent to acquiring a controlling interest, the Company's
consolidated financial statements included the accounts of JSG. Previously
recorded goodwill of $2.9 million related to the Company's initial 21.5%
investment has been reclassified from "Investments in and Advances to
Unconsolidated Affiliates" to "Goodwill" in the Consolidated Balance Sheets.
The Company also has entered into a joint venture with Tianjin Pipe Company
(TPCO) for the manufacture of unfinished upset to grade pipe in China, with the
intent of this joint venture to supply JSG with all of its tubular requirements.
The Company currently owns a 60% interest in the joint venture with TPCO and
plans to invest approximately $5 million in 2002 for machinery and equipment
representing the Company's contribution to the joint venture. As of September
30, 2002, the Company had invested approximately $2.5 million into this joint
venture.
On May 7, 2002, the Company acquired 65% of Rotator AS (Rotator), a
Norwegian company that manufactures control valves and systems for the offshore
oil and gas industry. The Company has the right to acquire the remaining 35% of
Rotator two years following its purchase, with the price being based on
Rotator's results of operations during this two-year period. The Company issued
approximately 0.3 million shares of Grant Prideco common stock with a value of
approximately $5.1 million for the initial 65% interest. Goodwill recognized in
the acquisition of Rotator was approximately $2.7 million. The terms of the
agreement also provided a guarantee by the Company to the selling shareholders
that they would receive 41,500,000 NOK upon their disposition of the Grant
Prideco common stock. Any price deficiency would be paid in cash by the Company
to the selling shareholders, and any price excess would be applied towards the
purchase price to be paid by the Company for the additional 35% interest. In
July 2002, the selling shareholders sold the Grant Prideco common stock at a
price deficiency upon disposition and the Company was required to make a cash
payment of $0.9 million.
On November 6, 2001, the Company acquired a license to Plexus
International's patented POS-GRIP(TM) wellhead and related technology for subsea
well applications and certain exploration and development wells. The Company
also acquired the assets and customer base for the associated wellhead rental
business. The purchase price was $2 million in cash and the Company has agreed
to fund an additional $4 million in working capital to support the POS-GRIP(TM)
technology and the wellhead rental business. Additional consideration will be
paid no later than April 2003 on a multiple of Plexus' actual earnings for the
annual period ending December 31, 2002, not to exceed $5.5 million.
The acquisitions discussed above were accounted for using the purchase
method of accounting, and the purchase prices were allocated to the net assets
acquired based upon their estimated fair market values at the date of
acquisition. The purchase price allocations are based upon the best estimates
using information currently available and is subject to changes when final asset
and liability valuations are obtained. The results of operations of all
acquisitions are included in the Consolidated Statements of Operations from
their respective dates of acquisition. The 2002 acquisitions were not material
to the Company individually or in the aggregate. Therefore, pro forma
information is not presented. See Note 13 for supplemental cash flow information
concerning acquisitions.
12
13. SUPPLEMENTAL CASH FLOW INFORMATION
The following table summarizes investing activities relating to
acquisitions (in thousands):
<Table>
<Caption>
NINE MONTHS
ENDED
SEPTEMBER 30, 2002
------------------
Fair value of assets, net of cash acquired ............... $ 28,065
Goodwill ................................................. 14,710
Total liabilities ........................................ (18,336)
Grant Prideco common stock issued ........................ (20,912)
--------
Net cash paid ........................................ $ 3,527
========
</Table>
14. SUBSEQUENT EVENT
On October 25, 2002, the Company signed a definitive agreement to acquire
Reed-Hycalog from Schlumberger. Reed-Hycalog, based principally in Houston,
Texas, is a global leader in drill bit technology, manufacturing, sales and
service to the worldwide oil and gas industry. Under the terms of the agreement,
consideration will include $255 million cash, approximately 9.7 million shares
of Grant Prideco common stock, and the assumption of approximately $5 million of
non-current liabilities. The total value of the transaction is approximately
$350 million. In addition to the approximately $90 million in Grant Prideco
stock included in the purchase price, financing for this transaction (and for
Grant Prideco's general corporate purposes) is expected to be provided through a
new credit facility of approximately $240 million (replacing the Company's
existing Credit Facility) and other public or private placements of debt
securities of up to $175 million. The transaction is expected to be completed
before year-end and is subject to regulatory approvals.
13
15. SUBSIDIARY GUARANTOR FINANCIAL INFORMATION
The following unaudited condensed consolidating balance sheet as of
September 30, 2002, condensed consolidating statements of operations for the
three and nine months ended September 30, 2001 and 2002 and condensed
consolidating statements of cash flows for the nine months ended September 30,
2001 and 2002 are provided for the Company's domestic subsidiaries that are
guarantors of the Company's $200 million principal amount of the 9 5/8% Senior
Notes due 2007.
CONDENSED CONSOLIDATING BALANCE SHEET
AS OF SEPTEMBER 30, 2002
(UNAUDITED)
(IN THOUSANDS)
<Table>
<Caption>
NON-
PARENT GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED
-------- ---------- ---------- ------------ ------------
ASSETS
CURRENT ASSETS:
Cash and Cash Equivalents ..................... $ -- $ 3,595 $ 12,488 $ -- $ 16,083
Restricted Cash ............................... -- -- 5,555 -- 5,555
Accounts Receivable, Net ...................... -- 83,868 41,770 -- 125,638
Inventories ................................... -- 144,213 34,391 -- 178,604
Current Deferred Tax Asset .................... -- 14,894 550 -- 15,444
Other Current Assets .......................... -- 7,458 8,932 -- 16,390
-------- --------- --------- --------- ---------
-- 254,028 103,686 -- 357,714
-------- --------- --------- --------- ---------
PROPERTY, PLANT AND EQUIPMENT ................... -- 280,841 109,400 -- 390,241
Less: Accumulated Depreciation ................ -- (119,226) (29,955) -- (149,181)
-------- --------- --------- --------- ---------
-- 161,615 79,445 -- 241,060
-------- --------- --------- --------- ---------
GOODWILL, NET ................................... -- 146,352 99,112 -- 245,464
INVESTMENT IN AND ADVANCES TO SUBSIDIARIES ...... 47,287 -- -- -- 47,287
INVESTMENT IN UNCONSOLIDATED AFFILIATES ......... 672,860 -- -- (672,860) --
INTANGIBLE ASSETS, NET .......................... -- 1,400 1,489 -- 2,889
OTHER ASSETS .................................... 4,958 2,670 568 -- 8,196
-------- --------- --------- --------- ---------
$725,105 $ 566,065 $ 284,300 $(672,860) $ 902,610
======== ========= ========= ========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Short-Term Borrowings and Current Portion
of Long-Term Debt ........................... $ -- $ 1,305 $ 8,051 $ -- $ 9,356
Accounts Payable .............................. -- 44,397 910 -- 45,307
Current Deferred Tax Liability ................ -- -- 6,470 -- 6,470
Other Accrued Liabilities ..................... 16,416 36,893 25,657 -- 78,966
-------- --------- --------- --------- ---------
16,416 82,595 41,088 -- 140,099
-------- --------- --------- --------- ---------
LONG-TERM DEBT .................................. 199,083 2,012 303 -- 201,398
DEFERRED INCOME TAXES ........................... -- 22,478 15,358 -- 37,836
MINORITY INTEREST ............................... -- -- 9,388 -- 9,388
OTHER LONG-TERM LIABILITIES ..................... 7,345 2,875 1,408 -- 11,628
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY ............................ 502,261 456,105 216,755 (672,860) 502,261
-------- --------- --------- --------- ---------
$725,105 $ 566,065 $ 284,300 $(672,860) $ 902,610
======== ========= ========= ========= =========
</Table>
14
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 2001
(UNAUDITED)
(IN THOUSANDS)
<Table>
<Caption>
NON-
PARENT GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED
--------- ---------- ---------- ------------ ------------
REVENUES ....................................... $ -- $ 165,977 $ 33,012 $ -- $ 198,989
--------- --------- -------- --------- ---------
COSTS AND EXPENSES:
Cost of Sales ................................ -- 127,965 17,868 -- 145,833
Selling, General and Administrative .......... -- 15,018 3,546 -- 18,564
Equity Income in Unconsolidated Affiliates ... (1,394) -- -- -- (1,394)
Other Charges ................................ -- -- 1,475 -- 1,475
--------- --------- -------- --------- ---------
(1,394) 142,983 22,889 -- 164,478
--------- --------- -------- --------- ---------
OPERATING INCOME ............................... 1,394 22,994 10,123 -- 34,511
--------- --------- -------- --------- ---------
OTHER INCOME (EXPENSE):
Interest Expense ............................. (5,249) (1,492) (161) -- (6,902)
Equity in Subsidiaries, Net of Taxes ......... 19,840 -- -- (19,840) --
Other, Net ................................... -- (28) (370) -- (398)
--------- --------- -------- --------- ---------
14,591 (1,520) (531) (19,840) (7,300)
--------- --------- -------- --------- ---------
INCOME (LOSS) BEFORE INCOME TAXES .............. 15,985 21,474 9,592 (19,840) 27,211
INCOME TAX (PROVISION) BENEFIT ................. 1,349 (6,265) (4,608) -- (9,524)
--------- --------- -------- --------- ---------
NET INCOME (LOSS) BEFORE MINORITY INTEREST ..... 17,334 15,209 4,984 (19,840) 17,687
MINORITY INTEREST .............................. -- -- (353) -- (353)
--------- --------- -------- --------- ---------
NET INCOME (LOSS) .............................. $ 17,334 $ 15,209 $ 4,631 $ (19,840) $ 17,334
========= ========= ======== ========= =========
</Table>
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 2002
(UNAUDITED)
(IN THOUSANDS)
<Table>
<Caption>
NON-
PARENT GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED
--------- ---------- ---------- ------------ ------------
REVENUES ....................................... $ -- $ 105,645 $ 56,592 $ -- $ 162,237
--------- --------- -------- --------- ---------
COSTS AND EXPENSES:
Cost of Sales ................................ -- 89,295 41,349 -- 130,644
Selling, General and Administrative .......... -- 16,806 5,490 -- 22,296
Equity Income in Unconsolidated Affiliates ... (1,273) -- -- -- (1,273)
Other Charges ................................ -- -- -- -- --
--------- --------- -------- --------- ---------
(1,273) 106,101 46,839 -- 151,667
--------- --------- -------- --------- ---------
OPERATING INCOME (LOSS) ........................ 1,273 (456) 9,753 -- 10,570
--------- --------- -------- --------- ---------
OTHER INCOME (EXPENSE):
Interest Expense ............................. (5,066) (470) (259) -- (5,795)
Equity in Subsidiaries, Net of Taxes ......... 4,694 -- -- (4,694) --
Other, Net ................................... -- 304 (766) -- (462)
--------- --------- -------- --------- ---------
(372) (166) (1,025) (4,694) (6,257)
--------- --------- -------- --------- ---------
INCOME (LOSS) BEFORE INCOME TAXES .............. 901 (622) 8,728 (4,694) 4,313
INCOME TAX (PROVISION) BENEFIT ................. 1,044 337 (2,718) -- (1,337)
--------- --------- -------- --------- ---------
NET INCOME (LOSS) BEFORE MINORITY INTEREST ..... 1,945 (285) 6,010 (4,694) 2,976
MINORITY INTEREST .............................. -- -- (1,031) -- (1,031)
--------- --------- -------- --------- ---------
NET INCOME (LOSS) .............................. $ 1,945 $ (285) $ 4,979 $ (4,694) $ 1,945
========= ========= ======== ========= =========
</Table>
15
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 2001
(UNAUDITED)
(IN THOUSANDS)
<Table>
<Caption>
NON-
PARENT GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED
--------- ---------- ---------- ------------ ------------
REVENUES ....................................... $ -- $ 466,704 $ 81,845 $ -- $ 548,549
--------- --------- -------- --------- ---------
COSTS AND EXPENSES:
Cost of Sales ................................ -- 386,024 43,104 -- 429,128
Selling, General and Administrative .......... -- 43,123 10,859 -- 53,982
Equity Income in Unconsolidated Affiliates ... (6,226) -- -- -- (6,226)
Other Charges ................................ -- 32,280 1,475 -- 33,755
--------- --------- -------- --------- ---------
(6,226) 461,427 55,438 -- 510,639
--------- --------- -------- --------- ---------
OPERATING INCOME ............................... 6,226 5,277 26,407 -- 37,910
--------- --------- -------- --------- ---------
OTHER INCOME (EXPENSE):
Interest Expense ............................. (15,821) (4,487) (487) -- (20,795)
Equity in Subsidiaries, Net of Taxes ......... 15,363 -- -- (15,363) --
Other, Net ................................... -- (1,041) (81) -- (1,122)
--------- --------- -------- --------- ---------
(458) (5,528) (568) (15,363) (21,917)
--------- --------- -------- --------- ---------
INCOME (LOSS) BEFORE INCOME TAXES .............. 5,768 (251) 25,839 (15,363) 15,993
INCOME TAX (PROVISION) BENEFIT ................. 3,746 3,565 (12,796) -- (5,485)
--------- --------- -------- --------- ---------
NET INCOME (LOSS) BEFORE MINORITY INTEREST ..... 9,514 3,314 13,043 (15,363) 10,508
MINORITY INTEREST .............................. -- -- (994) -- (994)
--------- --------- -------- --------- ---------
NET INCOME (LOSS) .............................. $ 9,514 $ 3,314 $ 12,049 $ (15,363) $ 9,514
========= ========= ======== ========= =========
</Table>
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 2002
(UNAUDITED)
(IN THOUSANDS)
<Table>
<Caption>
NON-
PARENT GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED
--------- ---------- ---------- ------------ ------------
REVENUES ...................................... $ -- $ 365,320 $ 117,569 $ -- $ 482,889
--------- --------- --------- --------- ---------
COSTS AND EXPENSES:
Cost of Sales ............................... -- 298,124 78,585 -- 376,709
Selling, General and Administrative ......... -- 49,179 13,418 -- 62,597
Equity Income in Unconsolidated Affiliates .. (4,913) -- -- -- (4,913)
Other Charges ............................... -- 5,745 1,300 -- 7,045
--------- --------- --------- --------- ---------
(4,913) 353,048 93,303 -- 441,438
--------- --------- --------- --------- ---------
OPERATING INCOME .............................. 4,913 12,272 24,266 -- 41,451
--------- --------- --------- --------- ---------
OTHER INCOME (EXPENSE):
Interest Expense ............................ (15,272) (2,268) (513) -- (18,053)
Equity in Subsidiaries, Net of Taxes ........ 20,532 -- -- (20,532) --
Other, Net .................................. -- 540 (1,228) -- (688)
--------- --------- --------- --------- ---------
5,260 (1,728) (1,741) (20,532) (18,741)
--------- --------- --------- --------- ---------
INCOME (LOSS) BEFORE INCOME TAXES ............. 10,173 10,544 22,525 (20,532) 22,710
INCOME TAX (PROVISION) BENEFIT ................ 3,211 2,315 (12,566) -- (7,040)
--------- --------- --------- --------- ---------
NET INCOME (LOSS) BEFORE MINORITY INTEREST .... 13,384 12,859 9,959 (20,532) 15,670
MINORITY INTEREST ............................. -- -- (2,286) -- (2,286)
--------- --------- --------- --------- ---------
NET INCOME (LOSS) ............................. $ 13,384 $ 12,859 $ 7,673 $ (20,532) $ 13,384
========= ========= ========= ========= =========
</Table>
16
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 2001
(UNAUDITED)
(IN THOUSANDS)
<Table>
<Caption>
NON-
PARENT GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED
--------- ---------- ---------- ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Cash Provided (Used) by Operating Activities $ 15,218 $(21,593) $ 15,307 $ -- $ 8,932
-------- -------- -------- ---------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of Businesses, Net of Cash Acquired . -- -- (1,000) -- (1,000)
Capital Expenditures for Property, Plant &
Equipment ..................................... -- (20,600) (5,729) -- (26,329)
-------- -------- -------- ---------- --------
Net Cash Used by Investing Activities ..... -- (20,600) (6,729) -- (27,329)
-------- -------- -------- ---------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings on Revolving Credit Facility ......... -- 41,400 1,090 -- 42,490
Repayments on Debt .............................. (14,561) (1,832) (454) -- (16,847)
Proceeds from Stock Option Exercises ............ 565 -- -- -- 565
Purchases of Treasury Stock ..................... (1,222) -- -- -- (1,222)
-------- -------- -------- ---------- --------
Net Cash (Used) Provided by Financing
Activities .............................. (15,218) 39,568 636 -- 24,986
-------- -------- -------- ---------- --------
NET (DECREASE) INCREASE IN CASH AND
CASH EQUIVALENTS ................................ -- (2,625) 9,214 -- 6,589
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR .... -- 4,154 4,161 -- 8,315
-------- -------- -------- ---------- --------
CASH AND CASH EQUIVALENTS AT END OF THE PERIOD .... $ -- $ 1,529 $ 13,375 $ -- $ 14,904
======== ======== ======== ========== ========
</Table>
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 2002
(UNAUDITED)
(IN THOUSANDS)
<Table>
<Caption>
NON-
PARENT GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED
-------- ---------- ---------- ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Cash Provided by Operating Activities ...... $ 13,955 $ 87,069 $ 6,888 $ -- $ 107,912
-------- -------- -------- ----------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisitions of Businesses, Net of Cash Acquired (4,835) 1,308 -- -- (3,527)
Investments in Unconsolidated Affiliates ....... (2,429) -- -- -- (2,429)
Capital Expenditures for Property, Plant &
Equipment .................................... -- (25,719) (8,740) -- (34,459)
-------- -------- -------- ----------- ---------
Net Cash Used by Investing Activities .... (7,264) (24,411) (8,740) -- (40,415)
-------- -------- -------- ----------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayments on Revolving Credit Facility ........ -- (54,300) (123) -- (54,423)
Repayments on Debt ............................. (6,056) (6,668) 5,984 -- (6,740)
Purchases from Stock Option Exercises .......... 1,164 -- -- -- 1,164
Purchases of Treasury Stock .................... (1,799) -- -- -- (1,799)
-------- -------- -------- ----------- ---------
Net Cash (Used) Provided by Financing
Activities ............................. (6,691) (60,968) 5,861 -- (61,798)
-------- -------- -------- ----------- ---------
NET INCREASE IN CASH AND CASH EQUIVALENTS ........ -- 1,690 4,009 -- 5,699
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR ... -- 1,905 8,479 -- 10,384
-------- -------- -------- ----------- ---------
CASH AND CASH EQUIVALENTS AT END OF THE PERIOD ... $ -- $ 3,595 $ 12,488 $ -- $ 16,083
======== ======== ======== =========== =========
</Table>
17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion is intended to assist you in understanding our
financial position as of December 31, 2001 and September 30, 2002, and our
results of operations for each of the three and nine months ended September 30,
2001 and 2002. This discussion should be read with our financial statements and
their notes included elsewhere in this report as well as our financial
statements and related Management's Discussion and Analysis of Financial
Condition and Results of Operations for the year ended December 31, 2001,
previously filed with the Securities and Exchange Commission in our Annual
Report on Form 10-K.
Our discussion of our results of operations and financial condition
contains statements relating to our future results, including certain
projections and trends, which constitute forward-looking statements. Certain
risks and uncertainties may cause actual results to be materially different from
projected results contained in these forward-looking statements and other
disclosures. These risks and uncertainties are more fully described under
"Forward-Looking Statements and Exposures" below. As used herein, unless
otherwise required by the context, the term "Grant Prideco" refers to Grant
Prideco, Inc. and the terms "we," "our," and similar words refer to Grant
Prideco and its subsidiaries. The use herein of such terms as "group,"
"organization," "we," "us," "our," and "its," or references to specific
entities, are not intended to be a precise description of corporate
relationships.
GENERAL
Grant Prideco is the world's largest manufacturer and supplier of oilfield
drill pipe and other drill stem products and one of the leading North American
providers of high-performance premium connections and tubular products. We also
provide a variety of products and services to the growing world-wide offshore
and deepwater market through our marine products and services segment. Our drill
stem products are used to drill oil and gas wells, while our premium connections
and tubular products are used primarily to complete oil and gas wells once they
have been successfully drilled. Our marine products and services are used for
subsea construction, installation, and production. Our customers include major,
independent, and state-owned oil companies, drilling contractors, oilfield
service companies, and North American oil country tubular goods (OCTG)
distributors. We currently operate 25 manufacturing facilities located in the
United States, Mexico, Canada, China, Norway, Europe, and Asia, and 30 sales,
service, and repair locations globally.
We operate through three primary business segments: (1) drilling products
and services, (2) premium connections and tubular products and (3) marine
products and services. We also provide drill pipe and casing used in the fiber
optic, construction, and water well industries and are involved in several joint
ventures to develop various drilling and production technologies, which we
report in our "other" segment.
For the nine months ended September 30, 2002, 51% of our revenues were
derived from our drilling products and services segment, 35% from our premium
connections and tubular products segment, 10% from our marine products and
services segment, and 4% from our other operations. Substantially all of our
revenues in our premium connections and tubular products segment are generated
in North America. Although most of our drilling product sales are made from our
North American locations, we estimate that the majority of our oilfield drill
stem revenues in the third quarter of 2002 were for use in the international and
offshore markets.
On October 25, 2002, we signed a definitive agreement to purchase the
Reed-Hycalog drill bits business from Schlumberger Technology Corporation and
its affiliates for approximately $350 million, consisting of $255 million in
cash, approximately $90 million in Grant Prideco common stock and approximately
$5 million of assumed non-current liabilities. Reed-Hycalog is a leading
designer, manufacturer and distributor of fixed-cutter and roller-cone drill
bits to the global oil and gas industry as one of four major competitors who,
combined, hold over 90% of the drill bit market. Reed-Hycalog has been
designing, manufacturing and distributing drill bits for over 80 years. The
Reed-Hycalog business earned combined revenues and earnings before interest,
taxes, depreciation and amortization of approximately $159 and $39 million,
respectively, in the nine months ended September 30, 2002.
We believe that Reed-Hycalog provides us with a number of strategic,
financial and operational benefits. Reed-Hycalog is a particularly attractive
addition to our existing business for the following reasons:
o Logical product line extension with strong strategic and industrial
fit -- Numerous similarities exist between the operational,
metallurgical and technical challenges facing the research,
development, design and manufacture of drill pipe and drill bits. We
believe logical synergies exist that will allow us to assimilate
Reed-Hycalog's manufacturing and sales operations into our company and
to expand the technological and operational capabilities of these
product lines.
18
o Critical product line with an existing customer base -- While the
investment in drill bit products and services represents a relatively
insignificant portion of the total exploration and development costs
of drilling a well, the selection of the appropriate drill bits can
have a significant impact on the timing, and thus the overall cost, of
an exploration and drilling project. The Reed-Hycalog acquisition
further expands our ability to provide the industry with high-quality,
technologically advanced, brand name products that reduce overall
drilling costs. We believe the relatively low cost and high value
impact of drill bit products and services will continue to increase in
importance as exploration and drilling programs continue to migrate
towards more expensive and complex wells in increasingly harsh
environments.
o Diversified customer base and strong international market presence --
Reed-Hycalog markets and sells drill bits in virtually every major oil
and gas producing region in the world through an integrated
manufacturing and sales network. Reed-Hycalog's strong sales force and
distribution network directly support a diversified customer base,
with no single customer representing more than 3% of total 2001
revenue. We believe this strong international presence, combined with
Reed-Hycalog's established market presence and excellent reputation
for superior products, will provide an expanded platform for future
growth of our products, especially in international locations.
o Financial strength and diversification of earnings and cash flow -- We
believe the Reed-Hycalog acquisition will improve the stability of our
earnings and cash flow while allowing us to realize growth in
revenues. Reed-Hycalog has a history of strong profitability and cash
flow during both strong and weak market conditions, which we believe
will provide us with additional cash flow throughout the market cycle.
Reed-Hycalog's revenues and profitability closely follow fluctuations
in worldwide rig counts, complementing our drill pipe revenues and
profitability that have historically lagged changes in rig counts by
three to six months. In addition, Reed-Hycalog's exposure to
international markets should reduce our dependence upon domestic
markets, which historically have been less stable than international
markets. During the nine months ended September 30, 2002,
approximately 69% of Reed-Hycalog's consolidated revenues were
generated from international sales and approximately 31% were from
domestic sales.
We intend to close the pending acquisition of Reed-Hycalog, which is
subject to customary conditions and approval by the Federal Trade Commission and
certain foreign antitrust authorities, by December 31, 2002. Schlumberger has
agreed to provide transition services for a period of up to twelve months after
the closing of the Reed-Hycalog acquisition. In addition, we have retained the
former president and the former chief financial officer of Reed-Hycalog to
assist us in successfully transitioning and operating the newly acquired
operations. We believe that a strong management team with significant
familiarity with Reed-Hycalog's business, assets and personnel will help
streamline this process and provide us with significant ongoing benefits.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
In our annual report on Form 10-K for the year ended December 31, 2001, we
identified our most critical accounting policies upon which our financial status
depends as those relating to revenue recognition, accounts receivables
valuation, inventory valuation, business combinations, impairment of long-lived
assets and estimates related to contingent liabilities and future claims.
Subsequent to December 31, 2001, we have added an additional critical accounting
policy related to impairment testing for goodwill and intangible assets.
Goodwill and intangible assets that have indefinite useful lives are subject
to annual impairment tests. Goodwill will be tested for impairment using a
two-step process that begins with an estimation of the fair value of each of our
reporting units with its carrying value. If the carrying amount exceeds the fair
value of a reporting unit, a second step test is completed comparing the implied
fair value of the reporting unit's goodwill to its carrying value to measure the
amount of impairment. Intangible assets that are not amortized will be tested
for impairment at least annually by comparing the fair values of those assets to
their carrying values.
MARKET TRENDS AND OUTLOOK
Our business is materially dependent on the level of oil and gas drilling
activity worldwide, which, in turn, depends on the level of capital spending by
major, independent and state-owned exploration and production companies. This
capital spending is driven by current prices for oil and gas and the perceived
stability and sustainability of those prices. All of our business segments
follow domestic and international rig counts levels, however their revenues,
cash flows and profitability follow the rig count at different stages within the
market cycles. Drill pipe demand is also a function of customer inventory levels
and typically lags changes in the rig counts by approximately three to six
months. Results from our premium connection and tubular segment should closely
follow changes in
19
North American rig counts, but short-term demand can also be affected by
inventories held by OCTG distributors. Demand for our marine products and
services follows the level of offshore and deepwater drilling activity, which,
although dependent upon prices for oil and gas, is less likely to follow
short-term changes in oil and gas prices as these projects are more capital
intensive and are typically based upon long-term forecasts for oil and gas
prices. Historically, drill bit demand and Reed-Hycalog's earnings and cash
flows have closely tracked the domestic and international rig count, which we
believe will offset somewhat the cyclicality and mid-cycle returns from our
drill products segment once the Reed-Hycalog acquisition is consummated.
Prices for oil and natural gas have been and continue to be volatile, and
material declines adversely affect the demand for our products and services. The
following table sets forth certain information with respect to oil and natural
gas prices and the North American (U.S. and Canadian) and international rig
counts:
<Table>
<Caption>
THREE MONTHS ENDED
-------------------------------------------------------------
SEPTEMBER 30, 2001 DECEMBER 31, 2001 SEPTEMBER 30, 2002
------------------ ----------------- ------------------
WTI Oil(a)
Average............................. $ 26.73 $ 20.46 $ 28.30
Ending.............................. 23.43 19.84 30.45
Henry Hub Gas(b)
Average............................. $ 2.77 $ 2.42 $ 3.20
Ending.............................. 1.82 2.70 4.07
North American Rig Count(c)
Average............................. 1,561 1,282 1,103
Ending.............................. 1,510 1,165 1,110
International Rig Count(c)
Average............................. 757 748 718
Ending.............................. 766 752 727
</Table>
- ----------
(a) Price per barrel of West Texas Intermediate (WTI) crude. Source: U.S.
Energy Information Administration.
(b) Price per MMBtu. Source: U.S. Energy Information Administration.
(c) Source: Baker Hughes Rig Count (International Rig Count excludes China
and the former Soviet Union).
In addition, the historical results of operations from each of our business
segments have been impacted by internal management initiatives and other changes
within Grant Prideco, including our manufacturing and operational reorganization
that began at the beginning of 2001. These significant internal changes and
initiatives included the following:
o Introduction of new products and services. In 1999, we introduced our
proprietary and patented line of eXtreme(R) drilling products, which
were specifically designed for harsh and complex drilling conditions
such as extended reach, directional, horizontal, deep gas, offshore
and ultra-deepwater drilling, as well as high-temperature,
high-pressure and corrosive well conditions. We also have improved
upon our other premium drill stem product lines designed for
challenging drilling environments. Operators and drilling contractors
have embraced these product lines as a way to improve their efficiency
and ensure performance when drilling under extreme conditions. Unlike
more commodity type drill stem products, demand for and sales of these
high-end premium products are less susceptible to declines in rig
counts and have permitted us to maintain higher profitability and cash
flow levels during the current reduction in drilling activity when
compared to prior periods of reduced activity. During the nine months
ended September 30, 2002, sales of premium drill stem products
represented approximately 45% of our drill stem segment's revenues.
o Improved pricing discipline. During the decline in market conditions
that occurred in 1999 and the first part of 2000, the average prices
for our drill stem products eroded significantly, which adversely
affected our profitability and cash flow during such periods as well
as our ability to regain favorable pricing when market conditions
began to improve during 2000 and the first half of 2001. As a result,
during the first quarter of 2001, we implemented strict pricing
policies for our drill stem products that significantly increased the
prices we received for these products, and we have maintained our
pricing policies and discipline during the current downturn in market
conditions.
o Capital improvement program. At the beginning of 2001, we implemented
a capital improvement plan with the objective of reducing costs and
improving operating efficiencies. In connection with this plan, we
also reallocated manufacturing facilities to
20
increase our manufacturing absorption rates, increase production
volumes, and improve processes to focus on gaining efficiencies. We
currently are in the final stages of installing a state-of-the-art
pipe handling equipment in our Navasota facility and other automated
processes throughout our organization. We believe these initiatives
will reduce costs and allow us to more efficiently operate during poor
market conditions and efficiently ramp-up operations when market
conditions improve. In particular, we believe these state-of-the-art
improvements have reduced our overall reliance on personnel.
o Improved manufacturing processes and working capital management
strategy. During 2001, we shifted from a manufacturing mentality
focused principally upon maximizing plant utilization to a more
efficient business practice focused on producing almost solely for
order fulfillment while minimizing cost and working capital
requirements.
FUTURE MARKET TRENDS AND EXPECTATIONS
Looking forward at our expectations for our results of operations during
the remainder of 2002 and fiscal 2003, we believe our results of operations will
continue to be affected by rig count levels and our customers' perceptions
regarding future prices for oil and gas and drilling activity. Based upon our
expectations for an average North American rig count during the fourth quarter
of 2002 of 860, we expect to earn between $0.01 and $0.04 per share during the
fourth quarter (excluding any constributions from the Reed-Hycalog acquisition
or expenses associated therewith). For 2003, we intend to structure our
operating costs assuming a gradual rig count recovery in the U.S. averaging in
the low-to-mid 900's for the year, an average Canadian rig count of
approximately 300 and a flat international rig count outside of Canada. We also
are in the process of reviewing certain of our non-core operations within our
"other" and marine products and services segments, with the intent of disposing
or discontinuing any operations that we do not believe represent strategic fits
with our long-term growth strategy.
The above forward-looking information with respect to our outlook for
fiscal 2002 is subject to various assumptions that are more specifically set
forth below under "Forward-Looking Statements and Exposures." There can be no
assurance that our expectations for future results will in fact occur or that
our results will not be materially different than our expectations or historical
results. We do, however, believe that our current expectations are reasonable.
21
RESULTS OF OPERATIONS
2001 Other Charges
During 2001, we incurred approximately $44.8 million of pre-tax charges,
$29.1 million net of tax. These charges included $11.1 million, $7.2 million net
of tax, related to inventory write-offs and capitalized manufacturing variance
write-offs which were classified as costs of sales, $17.7 million, $11.5 million
net of tax, pertaining to the write-off of assets related to our manufacturing
arrangement with Oil Country Tubular Ltd. (OCTL) in India, severance and related
expenses of $14.5 million, $9.4 million net of tax, and a fixed asset impairment
of $1.5 million, $1.0 million net of tax, related to the decision to discontinue
the manufacturing of industrial flanges. These charges are summarized in the
following chart:
<Table>
<Caption>
DRILLING PREMIUM MARINE
PRODUCTS CONNECTIONS PRODUCTS
AND AND TUBULAR AND
SERVICES PRODUCTS SERVICES OTHER CORPORATE TOTAL
-------- -------- -------- ----- --------- -----
(IN THOUSANDS)
OCTL Write-Off(a)............. $ 17,727 $ -- $ -- $ -- $ -- $ 17,727
Inventory Write-Off(b)........ 3,657 -- 1,692 1,125 -- 6,474
Fixed Asset Impairment(c)..... 1,475 -- -- -- -- 1,475
Write-Off of Capitalized
Manufacturing Variances(d).... 1,024 509 272 2,767 -- 4,572
Severance(e).................. 108 -- 205 75 14,165 14,553
--------- ----- ------- -------- -------- ---------
Total..................... $ 23,991 $ 509 $ 2,169 $ 3,967 $ 14,165 $ 44,801
========= ===== ======= ======== ======== =========
</Table>
(a) In connection with our operational review conducted in 2001, we reassessed
the viability of restructuring our relationship with OCTL in India and
determined that a continued relationship was no longer viable. As a result
of this determination, we wrote-off the remaining $17.7 million of unpaid
receivables and advances owed to us by OCTL.
(b) The inventory write-off was reported as cost of sales and was made pursuant
to a review of our planned dispositions of inventory in an effort to reduce
inventory levels of older, slow-moving products. The amount was determined
by use of internal appraisals and evaluations to assess the estimated net
realizable value upon disposal and also included a charge related to
certain inventory purchase contract obligations with above market prices.
(c) The flange machinery and equipment impairment was reported as other charges
and relates to our decision to discontinue the manufacturing of industrial
flanges. The amount was determined by use of internal appraisals and
evaluations to assess the net realizable value upon disposal.
(d) Certain capitalized manufacturing cost variances were expensed as cost of
sales in connection with our operational review and revisions of
manufacturing standards and costing during 2001.
(e) The severance charge relates to executive, manufacturing, and marketing
employees terminated in connection with our restructuring plan that was
implemented in 2001. The total number of employees severed was 24, and the
amount accrued for severance was based upon the positions eliminated and
our severance policy, all of which were paid in 2001.
2002 Charges
Results for the nine months ended September 30, 2002 included $7.0 million
of pre-tax charges, $4.9 million net of tax, incurred during the second quarter
of 2002. These charges included $2.6 million related to fixed asset write-downs
and $4.5 million for executive severance payments and related expenses and are
summarized in the following chart (in thousands):
<Table>
<Caption>
DRILLING PREMIUM
PRODUCTS CONNECTIONS
AND AND TUBULAR
SERVICES PRODUCTS CORPORATE TOTAL
-------- ----------- --------- ---------
Fixed Asset Write-Downs(a)....................... $ 2,360 $ 220 $ -- $ 2,580
Severance(b)..................................... -- -- 4,465 4,465
--------- --------- --------- ---------
Total........................................ $ 2,360 $ 220 $ 4,465 $ 7,045
========= ========= ======== =========
</Table>
(a) The fixed asset write-downs relate to idle assets taken out of service
pursuant to our ongoing automation and efficiency initiatives and are
classified as held for sale. The amount was determined by use of internal
appraisals and evaluations to assess the estimated fair value upon
disposition. The equipment, which has a carrying value of $0.2 million, is
expected to be disposed of in the next 12 months.
(b) The severance charge relates to an executive employee terminated during
June 2002. The amount accrued for severance was based upon the terminated
employee's employment contract, which was paid in July 2002.
22
THREE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED TO THE THREE MONTHS ENDED
SEPTEMBER 30, 2001
General
CONSOLIDATED RESULTS
Net income was $1.9 million ($0.02 per share) on revenues of $162.2 million
in the third quarter of 2002, compared to net income of $17.3 million ($0.16 per
share) on revenues of $199.0 million in the third quarter of 2001. Third quarter
of 2001 earnings include charges totaling $1.8 million ($0.02 per share) related
to fixed asset impairments of $1.5 million and inventory write-offs of $0.3
million, both of which are related to the decision to discontinue the
manufacturing of industrial flanges and goodwill amortization of $1.6 million
($0.01 per share). We adopted the new goodwill accounting standard, which ceases
the amortization of goodwill, as of January 1, 2002.
<Table>
<Caption>
THREE MONTHS ENDED SEPTEMBER 30,
----------------------------------------
2001 2002
-------------------- ----------------
(IN THOUSANDS)
Revenues............................................. $ 198,989 $ 162,237
Gross Profit......................................... 53,156(a) 31,593
Selling, General, and Administrative................. 18,564 22,296
Operating Income..................................... 34,511(a)(b) 10,570
Net Income........................................... 17,334 1,945
EBITDA, Before Other Charges(d)...................... 45,455(c) 18,262
</Table>
- ----------
(a) Includes $0.3 million of charges, which were classified as cost of sales,
in the third quarter of 2001 for inventory write-offs in connection with
the decision to discontinue the manufacturing of industrial flanges.
(b) Includes $1.5 million of charges in the third quarter of 2001 for fixed
asset impairments in connection with the decision to discontinue the
manufacturing of industrial flanges.
(c) Excludes $1.8 million of charges discussed in (a) and (b) above.
(d) We calculate EBITDA by taking operating income and adding back depreciation
and amortization, excluding the impact of other charges. Calculations of
EBITDA should not be viewed as a substitute to calculations under GAAP, in
particular operating income and net income. In addition, EBITDA
calculations by one company may not be comparable to another company.
SEGMENT RESULTS
Drilling Products and Services Segment
The following table sets forth certain data regarding the results of our
drilling products and services segment for the three months ended September 30,
2001 and 2002:
<Table>
<Caption>
THREE MONTHS ENDED SEPTEMBER 30,
----------------------------------------
2001 2002
-------------------- ----------------
(IN THOUSANDS)
Revenues.......................................... $ 106,056 $ 77,362
Gross Profit...................................... 31,004(a) 18,995
Selling, General, and Administrative.............. 4,988 5,704
Operating Income.................................. 26,068(a)(b) 15,732
EBITDA, Before Other Charges(d)................... 31,617(c) 18,759
</Table>
- ----------
(a) Includes $0.3 million of charges, which were classified as cost of sales,
in the third quarter of 2001 for inventory write-offs in connection with
the decision to discontinue the manufacturing of industrial flanges.
(b) Includes $1.5 million of charges in the third quarter of 2001 for fixed
asset impairments in connection with the decision to discontinue the
manufacturing of industrial flanges.
(c) Excludes $1.8 million of charges discussed in (a) and (b) above.
23
(d) We calculate EBITDA by taking operating income and adding back depreciation
and amortization, excluding the impact of other charges. Calculations of
EBITDA should not be viewed as a substitute to calculations under GAAP, in
particular operating income and net income. In addition, EBITDA
calculations by one company may not be comparable to another company.
Revenues. Our drilling products and services revenues decreased $28.7
million, or 27%, in the third quarter of 2002 as compared to the same period in
2001. This decrease was primarily due to the 29% decline in the North American
rig count, and resulting overall weak demand for our drill stem products.
However, the decrease in demand was partially offset by an increase in average
pricing for drill pipe in 2002 due to sales mix toward international and
offshore markets, which tend to purchase our higher-priced, more
technologically-advanced products, coupled with an overall price increase
implemented in 2001. Additionally, our Chinese joint venture, in which we
purchased a controlling interest at the end of the first quarter of 2002,
contributed revenues of $13.4 million in the third quarter of 2002.
Gross Profit. Our drilling products and services gross profit decreased
$12.0 million, or 39%, in the third quarter of 2002 as compared to the same
period in 2001. The third quarter of 2001 gross profit included $0.3 million of
charges for inventory write-offs related to the discontinuance of the
manufacturing of industrial flanges. This decrease in gross profit was primarily
due to the 29% decline in the North American rig count, and resulting overall
weak demand for our drill stem products, partially offset by an increase in
average pricing for drill pipe and gross profit contributed by our Chinese joint
venture.
Selling, General, and Administrative. Our selling, general, and
administrative expenses for our drilling products and services segment increased
as a percentage of revenues from 5% in the third quarter of 2001 to 7% in the
third quarter of 2002 primarily due to increased international sales commissions
coupled with a lower revenue base related to decreased oil and gas drilling
activity.
Operating Income. Our drilling products and services segment operating
income decreased $10.3 million, or 40%, in the third quarter of 2002 as compared
to the same period in 2001. Included in operating income in the third quarter of
2001 are fixed asset write-downs of $1.8 million related to fixed asset
impairments of $1.5 million and inventory write-offs of $0.3 million and
goodwill amortization of $0.8 million. This decrease in operating income was
primarily due to the 29% decline in the North American rig count, and resulting
overall weak demand for our drill stem products, partially offset by an increase
in average pricing for drill pipe and operating income contributed by our
Chinese joint venture.
Premium Connections and Tubular Products Segment
The following table sets forth certain data regarding the results of our
premium connections and tubular products segment for the three months ended
September 30, 2001 and 2002:
<Table>
<Caption>
THREE MONTHS ENDED SEPTEMBER 30,
----------------------------------------
2001 2002
-------------------- ----------------
(IN THOUSANDS)
Revenues............................................... $ 70,922 $ 58,680
Gross Profit........................................... 17,716 6,512
Selling, General, and Administrative................... 4,531 4,126
Operating Income....................................... 13,185 2,386
EBITDA, Before Other Charges(a)........................ 16,546 5,505
</Table>
- ----------
(a) We calculate EBITDA by taking operating income (loss) and adding back
depreciation and amortization, excluding the impact of other charges.
Calculations of EBITDA should not be viewed as a substitute to calculations
under GAAP, in particular operating income, and net income. In addition,
EBITDA calculations by one company may not be comparable to another
company.
Revenues. Our premium connections and tubular products revenues decreased
$12.2 million, or 17%, in the third quarter of 2002 as compared to the same
period in 2001. Revenues in this segment were negatively affected by the 29%
decline in the United States gas rig count when compared to last year's third
quarter. Additionally, OCTG distributors have been purchasing at low levels in
light of the weak and uncertain market conditions.
Gross Profit. Our premium connections and tubular products gross profit
decreased $11.2 million, or 63%, in the third quarter of 2002 as compared to the
same period in 2001. This decrease reflects the 29% decline in the United States
gas rig count when compared to last year's third quarter, unabsorbed
manufacturing costs incurred to maintain capacity for an expected industry
upturn
24
and unfavorable product mix. We currently are in the process of reviewing the
cost structure in our premium connections and tubular products segment with the
intent of bringing its cost structure more in line with current industry
conditions.
Selling, General, and Administrative. Our selling, general, and
administrative expenses for our premium connections and tubular products segment
increased as a percentage of revenues from 6% in the third quarter of 2001 to 7%
in the third quarter of 2002. This increase was primarily due to the lower
revenue base related to decreased oil and gas drilling activity.
Operating Income. Our premium connections and tubular products operating
income decreased $10.8 million, or 82%, in the third quarter of 2002 as compared
to the same period in 2001. This decrease reflects the 29% decline in the United
States gas rig count when compared to last year's third quarter, unabsorbed
manufacturing costs incurred to maintain capacity for an expected industry
upturn, and unfavorable product mix. Included in the third quarter of 2001 was
goodwill amortization of $0.6 million.
Marine Products and Services Segment
The following table sets forth certain data regarding the results of our
marine products and services segment for the three months ended September 30,
2001 and 2002:
<Table>
<Caption>
THREE MONTHS ENDED SEPTEMBER 30,
----------------------------------------
2001 2002
-------------------- ----------------
(IN THOUSANDS)
Revenues......................................... $ 13,836 $ 19,086
Gross Profit..................................... 3,946 4,878
Selling, General, and Administrative............. 1,922 3,929
Operating Income ................................ 2,024 949
EBITDA, Before Other Charges(a).................. 2,999 2,036
</Table>
- ----------
(a) We calculate EBITDA by taking operating income (loss) and adding back
depreciation and amortization, excluding the impact of other charges.
Calculations of EBITDA should not be viewed as a substitute to calculations
under GAAP, in particular operating income and net income. In addition,
EBITDA calculations by one company may not be comparable to another
company.
Revenues. Our marine products and services revenues increased $5.3 million,
or 38%, in the third quarter of 2002 as compared to the same period in 2001.
This increase was primarily attributable to the acquisition of Rotator AS
(Rotator) in the second quarter of 2002 coupled with increased sales related to
our XL Systems(TM) products.
Gross Profit. Our marine products and services gross profit increased $0.9
million in the third quarter of 2002 as compared to the same period in 2001
primarily due to the acquisition of Rotator in the second quarter of 2002. This
increase was partially offset by a decrease related to our XL Systems(TM)
product line due to sales of lower margin products when compared to last year's
quarter.
Selling, General, and Administrative. Our selling, general, and
administrative expenses for our marine products and services segment increased
as a percentage of revenues from 14% in the third quarter of 2001 to 21% in the
third quarter of 2002. This increase was due to increased selling, general, and
administrative expenses associated with the Rotator and Plexus acquisitions
coupled with costs incurred to develop infrastructure for future growth of this
segment.
Operating Income. Our marine products and services operating income
decreased $1.1 million, or 53%, in the third quarter of 2002 as compared to the
same period in 2001. This decrease was primarily attributable to increased
selling, general, and administrative costs which were partially offset by
operating income from our Rotator acquisition. Included in the third quarter of
2001 was goodwill amortization of $0.1 million.
25
Other Operations
The following table sets forth certain data regarding the results of our
other business operations for the three months ended September 30, 2001 and
2002:
<Table>
<Caption>
THREE MONTHS ENDED SEPTEMBER 30,
----------------------------------------
2001 2002
-------------------- ----------------
(IN THOUSANDS)
Revenues............................................ $ 8,175 $ 7,109
Gross Profit........................................ 490 1,208
Selling, General, and Administrative................ 1,358 652
Operating Loss...................................... (1,001) (612)
EBITDA, Before Other Charges(a)..................... (32) (403)
</Table>
- ----------
(a) We calculate EBITDA by taking operating income (loss) and adding back
depreciation and amortization, excluding the impact of other charges.
Calculations of EBITDA should not be viewed as a substitute to calculations
under GAAP, in particular operating income and net income. In addition,
EBITDA calculations by one company may not be comparable to another
company.
Revenues. Our other operations revenues decreased $1.1 million, or 13%, in
the third quarter of 2002 as compared to the same period in 2001. This decrease
in revenues was from our industrial drill pipe operations due to decreased
activity levels related to depressed fiber optic installation and construction
markets.
Gross Profit. Our gross profit in our other operations increased $0.7
million as compared to the same period in 2001. This increase reflects sales of
higher margin products in the third quarter of 2002 as compared to the same
period in 2001.
Selling, General, and Administrative. Our selling, general, and
administrative expenses for our other operations decreased as a percentage of
revenues from 17% in the third quarter of 2001 to 9% in the third quarter of
2002. This decrease was primarily due to the closing of our Stephenville, Texas
plant in the fourth quarter of 2001.
Operating Loss. Our other operations operating loss decreased $0.4 million
as compared to the same period in 2001. This decrease reflects sales of higher
margin products in the third quarter of 2002 when compared to the same period
last year coupled with efficiencies obtained in our organizational restructuring
that took place in the fourth quarter of 2001. Also included in our other
operations for the third quarter of 2002 were approximately $1.2 million in
research and development costs associated with our two technology joint ventures
as compared to $0.1 million in the same period in 2001. Included in the third
quarter of 2001 was goodwill amortization of $0.1 million.
OTHER ITEMS
Corporate General and Administrative. Our corporate general and
administrative expenses increased as a percentage of revenues from 3% in the
third quarter of 2001 to 5% in the third quarter of 2002. This percentage
increase was due primarily to decreased revenues and higher costs associated
with senior management.
Interest Expense. Our interest expense decreased $1.1 million in the third
quarter of 2002 due to a decrease in the interest rate related to our Credit
Facility, from an average of 6.9% in the third quarter of 2001 to an average of
4.6% in the third quarter of 2002, and lower debt balances.
Tax Provision. Our effective tax rate for the third quarter of 2002 was 31%
as compared to 35% for the same period in 2001. This decrease in the effective
tax rate was due primarily to the effects of ceasing goodwill amortization
effective January 1, 2002.
26
NINE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED TO THE NINE MONTHS ENDED
SEPTEMBER 30, 2001
General
CONSOLIDATED RESULTS
Net income was $13.4 million ($0.12 per share) on revenues of $482.9
million for the nine months ended September 30, 2002, compared to $9.5 million
($0.09 per share) on revenues of $548.5 million for the same period in 2001. For
the nine months ended September 30, 2002, earnings include charges totaling $4.9
million ($0.04 per share) related to fixed asset write-downs of $1.8 million and
severance costs of $3.1 million. For the nine months ended September 30, 2001,
earnings include charges of $29.1 million ($0.26 per share) related to our 2001
restructuring plan to improve profitability and efficiency and include goodwill
amortization of $4.7 million ($0.04 per share). We adopted the new goodwill
accounting standard, which ceases the amortization of goodwill, as of January 1,
2002.
<Table>
<Caption>
NINE MONTHS ENDED SEPTEMBER 30,
----------------------------------------
2001 2002
-------------------- ----------------
(IN THOUSANDS)
Revenues................................................ $ 548,549 $ 482,889
Gross Profit............................................ 119,421(a) 106,180
Selling, General, and Administrative.................... 53,982 62,597
Operating Income........................................ 37,910(a)(b)(c) 41,451(e)
Net Income.............................................. 9,514 13,384
EBITDA, Before Other Charges(g)......................... 110,274(d) 71,420(f)
</Table>
- ----------
(a) Includes other charges of $11.1 million related to inventory write-offs and
capitalized manufacturing variance write-offs, which were classified as
cost of sales.
(b) Includes other charges of $14.5 million related to severance of executive,
manufacturing, and marketing employees terminated in connection with our
restructuring plan that was implemented in the first quarter of 2001.
(c) Includes other charges of $19.2 million to write-off our assets related to
our manufacturing arrangement with OCTL in India of $17.7 million and a
fixed asset impairment of $1.5 million.
(d) Excludes $44.8 million of other charges discussed in (a), (b), and (c)
above.
(e) Includes other charges of $7.0 million in the second quarter of 2002
related to fixed asset write-downs of $2.6 million ($2.4 million drilling
products and $0.2 million premium connections) and $4.4 million of charges
related to Corporate for executive severance costs.
(f) Excludes $7.0 million of charges discussed in (e) above.
(g) We calculate EBITDA by taking operating income (loss) and adding back
depreciation and amortization, excluding the impact of other charges.
Calculations of EBITDA should not be viewed as a substitute to calculations
under GAAP, in particular operating income and net income. In addition,
EBITDA calculations by one company may not be comparable to another
company.
27
SEGMENT RESULTS
Drilling Products and Services Segment
The following table sets forth certain data regarding the results of our
drilling products and services segment for the nine months ended September 30,
2001 and 2002:
<Table>
<Caption>
NINE MONTHS ENDED SEPTEMBER 30,
----------------------------------------
2001 2002
-------------------- ----------------
(IN THOUSANDS)
Revenues................................................ $ 268,286 $ 244,752
Gross Profit............................................ 62,916(a) 69,028
Selling, General, and Administrative.................... 14,308 16,329
Operating Income........................................ 35,748(a)(b) 57,982(d)
EBITDA, Before Other Charges(f)......................... 71,109(c) 69,505(e)
</Table>
- ----------
(a) Includes other charges of $4.7 million related to inventory write-offs and
capitalized manufacturing variance write-offs which were classified as cost
of sales.
(b) Includes other charges of $19.3 million to write-off our assets related to
our manufacturing arrangement with OCTL in India of $17.7 million, fixed
asset impairment of $1.5 million, and severance and related expenses of
$0.1 million.
(c) Excludes $24.0 million of other charges discussed in (a) and (b) above.
(d) Includes other charges of $2.4 million in the second quarter of 2002
related to fixed asset write-downs.
(e) Excludes $2.4 million of other charges discussed in (d) above.
(f) We calculate EBITDA by taking operating income (loss) and adding back
depreciation and amortization, excluding the impact of other charges.
Calculations of EBITDA should not be viewed as a substitute to calculations
under GAAP, in particular operating income and net income. In addition,
EBITDA calculations by one company may not be comparable to another
company.
Revenues. Our drilling products and services revenues decreased $23.5
million for the nine months ended September 30, 2002 as compared to the same
period in 2001 due primarily to a 31% decline in the North American rig count,
and resulting overall weak demand for our drill stem products. However, the
decrease in demand was partially offset by an increase in average pricing for
drill pipe in 2002 due to sales mix toward international and offshore markets,
which tend to purchase our higher-priced, more technologically-advanced
products, coupled with an overall price increase implemented in 2001.
Additionally, our Chinese joint venture, in which we purchased a controlling
interest at the end of the first quarter of 2002, contributed revenues of $27.6
million.
Gross Profit. Our drilling products and services gross profit increased
$6.1 million for the nine months ended September 30, 2002 as compared to the
same period in 2001. Excluding other charges of $4.7 million in 2001, gross
profit increased $1.4 million in 2002 due primarily to the contribution by our
Chinese joint venture and higher average pricing for drill pipe for the nine
months ended September 30, 2002 as compared to the same period in 2001.
Selling, General, and Administrative. Selling, general, and administrative
expenses in our drilling products and services segment increased as a percentage
of revenues from 5% for the nine months ended September 30, 2001 to 7% for the
same period in 2001. This increase was due primarily to a lower revenue base
related to decreased oil and gas drilling activity.
Operating Income. Our drilling products and services operating income
increased $22.2 million for the nine months ended September 30, 2002 as compared
to the same period in 2001. Included in operating income for the nine months
ended September 30, 2001 are $24.0 million of non-recurring charges and goodwill
amortization of $2.4 million. Included in operating income for the nine months
ended September 30, 2002 are charges of $2.4 million related to our efficiency
and automation initiatives primarily at our operations located in Mexico.
Excluding charges and goodwill amortization mentioned above, operating income
decreased $1.8 million year over year. This decrease was attributable to weak
demand for our drill stem products, partially offset by an increase in average
pricing for drill pipe in 2002, incremental operating income contributed by our
Chinese joint venture and increased equity earnings from our investment in
Voest-Alpine.
28
Premium Connections and Tubular Products Segment
The following table sets forth certain data regarding the results of our
premium connections and tubular products segment for the nine months ended
September 30, 2001 and 2002:
<Table>
<Caption>
NINE MONTHS ENDED SEPTEMBER 30,
----------------------------------------
2001 2002
-------------------- ----------------
(IN THOUSANDS)
Revenues............................................... $ 216,160 $ 169,940
Gross Profit........................................... 54,137(a) 24,231
Selling, General, and Administrative................... 13,269 12,308
Operating Income....................................... 40,868(a) 11,703(c)
EBITDA, Before Other Charges(e)........................ 51,092(b) 21,070(d)
</Table>
- ----------
(a) Includes other charges of $0.5 million related to inventory write-offs and
capitalized manufacturing variance write-offs, which were classified as
cost of sales.
(b) Excludes $0.5 million of other charges discussed in (a) above.
(c) Includes other charges of $0.2 million in the second quarter of 2002
related to fixed asset write-downs.
(d) Excludes $0.2 million of other charges discussed in (c) above.
(e) We calculate EBITDA by taking operating income (loss) and adding back
depreciation and amortization, excluding the impact of other charges.
Calculations of EBITDA should not be viewed as a substitute to calculations
under GAAP, in particular operating income, and net income. In addition,
EBITDA calculations by one company may not be comparable to another
company.
Revenues. Our premium connections and tubular products revenues decreased
$46.2 million, or 21%, for the nine months ended September 30, 2002 as compared
to the same period in 2001. Revenues in this segment were negatively affected by
a 29% decline in the United States gas rig count when compared to the same
period last year. Additionally, OCTG distributors have been purchasing at low
levels in light of the weak and uncertain market conditions.
Gross Profit. Our premium connections and tubular products gross profit
decreased $29.9 million, or 55%, for the nine months ended September 30, 2002 as
compared to the same period in 2001, which includes $0.5 million of
non-recurring charges for the nine months ended September 30, 2001. This
decrease reflects the 29% decline in the United States gas rig count when
compared to the same period last year, unabsorbed manufacturing costs incurred
to maintain capacity for an expected industry upturn and unfavorable product
mix. We currently are in the process of reviewing the cost structure in our
premium connections and tubular products segment with the intent of bringing its
cost structure more in line with current industry conditions.
Selling, General, and Administrative. Our selling, general, and
administrative expenses for our premium connections and tubular products segment
increased as a percentage of revenues from 6% for the nine months ended
September 30, 2001 to 7% for the same period in 2002. This increase was
primarily due to the lower revenue base related to decreased oil and gas
drilling activity.
Operating Income. Our premium connections and tubular products operating
income decreased $29.2 million, or 71%, for the nine months ended September 30,
2002 as compared to the same period in 2001, which includes $0.5 million of
non-recurring charges for the nine months ended September 30, 2001. Included in
operating income for the nine months ended September 30, 2002 are fixed asset
write-downs of $0.2 million related to assets held for sale. This decrease
reflects the 29% decline in the United States gas rig count when compared to the
same period in 2001, unabsorbed manufacturing costs incurred to maintain
capacity for an expected industry upturn and unfavorable product mix,
particularly at TCA(TM) and Texas Arai.
29
Marine Products and Services Segment
The following table sets forth certain data regarding the results of our
marine products and services segment for the nine months ended September 30,
2001 and 2002:
<Table>
<Caption>
NINE MONTHS ENDED SEPTEMBER 30,
----------------------------------------
2001 2002
-------------------- ----------------
(IN THOUSANDS)
Revenues................................................. $ 30,898 $ 47,086
Gross Profit ............................................ 4,592(a) 11,184
Selling, General, and Administrative..................... 5,535 10,861
Operating Income (Loss).................................. (1,148)(a)(b) 323
EBITDA, Before Other Charges(d).......................... 3,869(c) 3,323
</Table>
- ----------
(a) Includes other charges of $2.0 million related to inventory write-offs and
capitalized manufacturing variance write-offs, which were classified as
cost of sales.
(b) Includes other charges of $0.2 million for severance and related expenses.
(c) Excludes $2.2 million of other charges discussed in (a) and (b) above.
(d) We calculate EBITDA by taking operating income (loss) and adding back
depreciation and amortization, excluding the impact of other charges.
Calculations of EBITDA should not be viewed as a substitute to calculations
under GAAP, in particular operating income and net income. In addition,
EBITDA calculations by one company may not be comparable to another
company.
Revenues. Our marine products and services revenues increased $16.2
million, or 52%, for the nine months ended September 30, 2002 as compared to the
same period in 2001. In the first quarter of 2001, we began to strengthen our XL
Systems(TM) products and services sales force, consolidated certain offshore
selling activities, and began to build a broader product line. Additionally, in
the fourth quarter of 2001, we added a new management team and acquired the
Plexus POS-GRIP(TM) wellhead rental product line. These actions, coupled with
the acquisition of Rotator in the second quarter of 2002, resulted in increased
revenues for this segment despite the 30% decrease in the United States offshore
rig count.
Gross Profit. Our marine products and services gross profit increased $6.6
million for the nine months ended September 30, 2002 as compared to the same
period in 2001, which includes $2.0 million of non-recurring charges in the
first quarter of 2001. This improvement reflects the additional focus initiated
in 2001 for this segment, despite the 30% decrease in the United States offshore
rig count.
Selling, General, and Administrative. Our selling, general, and
administrative expenses for our marine products and services segment increased
as a percentage of revenues from 18% for the nine months ended September 30,
2001 to 23% for the same period in 2002. This increase was due to increased
selling, general, and administrative expenses associated with the Rotator and
Plexus acquisitions coupled with costs incurred to develop infrastructure for
future growth of this segment.
Operating Income (Loss). Our marine products and services segment reported
an operating loss of $1.1 million for the nine months ended September 30, 2001
as compared to operating income of $0.3 million for the same period in 2002.
Included in the results for 2001 was a non-recurring charge of $2.2 million and
goodwill amortization of $0.3 million. Excluding charges and goodwill
amortization in 2001, operating income for this segment decreased $1.0 million
for the nine months ended September 30, 2002 as compared to the same period in
2001 reflecting increased selling, general, and administrative costs partially
offset incremental operating income from the acquisitions of Rotator and Plexus.
30
Other Operations
The following table sets forth certain data regarding the results of our
other business operations for the nine months ended September 30, 2001 and 2002:
<Table>
<Caption>
NINE MONTHS ENDED SEPTEMBER 30,
----------------------------------------
2001 2002
-------------------- ----------------
(IN THOUSANDS)
Revenues............................................ $ 33,205 $ 21,111
Gross Profit (Loss)................................. (2,224)(a) 1,737
Selling, General, and Administrative................ 4,564 2,359
Operating Loss...................................... (7,087)(a)(b) (3,352)
EBITDA, Before Other Charges(d)..................... 131(c) (2,380)
</Table>
- -------
(a) Includes other charges of $3.9 million related to inventory write-offs and
capitalized manufacturing variance write-offs which were classified as cost
of sales.
(b) Includes other charges of $0.1 million for severance and related expenses.
(c) Excludes $4.0 million of other charges discussed in (a) and (b) above.
(d) We calculate EBITDA by taking operating income (loss) and adding back
depreciation and amortization, excluding the impact of other charges.
Calculations of EBITDA should not be viewed as a substitute to calculations
under GAAP, in particular operating income and net income. In addition,
EBITDA calculations by one company may not be comparable to another
company.
Revenues. Our other operations' revenues decreased $12.1 million, or 36%,
for the nine months ended September 30, 2002 as compared to the same period in
2001. This decrease in revenues was from our industrial drill pipe operations
due to decreased activity levels related to depressed fiber optic installation
and construction markets.
Gross Profit (Loss). Our gross profit in our other operations increased
$3.9 million, from a gross loss of $2.2 million for the nine months ended
September 30, 2001 to gross profit of $1.7 million for the same period in 2002.
Excluding the effects of non-recurring charges for the nine months ended
September 30, 2001 of $4.0 million, gross profit was relatively flat year over
year.
Selling, General, and Administrative. Our selling, general, and
administrative expenses for our other operations decreased as a percentage of
revenues from 14% for the nine months ended September 30, 2001 to 11% for the
same period in 2002. This decrease was primarily due to the closing of our
Stephenville, Texas plant in the fourth quarter of 2001.
Operating Loss. Our other operations' operating loss decreased $3.7
million, from an operating loss of $7.1 million for the nine months ended
September 30, 2001 to an operating loss of $3.4 million for the same period in
2002. Excluding the effects of non-recurring charges of $4.0 million and
goodwill amortization of $0.2 million for the nine months ended September 30,
2001, operating loss increased $0.4 million. This reflects the decreased
activity levels in our industrial product line, partially offset by efficiencies
obtained in our organizational restructuring that took place in the first
quarter of 2001. Also included in our other operations for the nine months ended
September 30, 2002 was approximately $2.7 million in research and development
costs associated with our two technology joint ventures as compared to $0.2
million for the same period in 2001.
OTHER ITEMS
Corporate General and Administrative. Our corporate general and
administrative expenses increased as a percentage of revenues from 3% for the
nine months ended September 30, 2001 to 4% in the same period in 2002. This
percentage increase was due primarily to decreased revenues and higher costs
associated with senior management.
Interest Expense. Our interest expense decreased $2.7 million for the nine
months ended September 30, 2002 when compared to the same period in 2001 due to
a decrease in the interest rate related to our Credit Facility, from an average
of 7.9% for the nine months ended September 30, 2001 to an average of 4.7% for
the same period in 2002, and lower debt balances.
Tax Provision. Our effective tax rate for the nine months ended September
30, 2002 was 31% as compared to 34% for the nine months ended September 30,
2001. This decrease in the estimated effective tax rate for 2002 was due
primarily to the effects of ceasing goodwill amortization effective January 1,
2002.
31
LIQUIDITY AND CAPITAL RESOURCES
Overview
At September 30, 2002, we had cash and cash equivalents of $16.1 million
and working capital of $227.0 million, excluding short-term debt, as compared to
cash and cash equivalents of $10.4 million and working capital of $267.3
million, excluding short-term debt, at December 31, 2001. At September 30, 2002,
we also had $5.6 million in restricted cash related to our 54% interest in
H-Tech that is subject to dividend and distribution restrictions. This $40.3
million decrease in working capital is primarily due to the decrease in accounts
receivable, inventory and accounts payable of $60.2 million in light of market
conditions and increased accrued liabilities of $21.7 million, primarily
associated with our acquisitions of a controlling interest in our Chinese joint
venture, Jiangsu Shuguang Grant Prideco Tubular Limited (JSG), in March 2002 and
Rotator AS (Rotator) in May 2002.
The following table summarizes our cash flows provided by operating
activities, net cash used by investing activities and net cash provided (used)
by financing activities for the periods presented (in thousands):
<Table>
<Caption>
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------
2001 2002
--------- --------
Net Cash Provided by Operating Activities............... $ 8,932 $107,912
Net Cash Used by Investing Activities.................... (27,329) (40,415)
Net Cash Provided (Used) by Financing Activities......... 24,986 (61,798)
</Table>
OPERATING ACTIVITIES
Net cash flow provided by operating activities increased by $99.0 million
for the nine months ended September 30, 2002 as compared to the same period in
2001. Changes in working capital items, which primarily includes accounts
receivable, inventories and accounts payable, net, generated $46.7 million of
cash for the nine months ended September 30, 2002 as compared to using $69.0
million of cash for the same period in 2001. Additionally, distributions
received from our equity investment in Voest-Alpine increased from $11.5 million
for the nine months ended September 30, 2001 to $16.1 million for the same
period in 2002. These increases were partially offset by a decrease in net
income, excluding non-cash charges, of $23.8 million.
INVESTING ACTIVITIES
Net cash used by investing activities increased by $13.1 million for the
nine months ended September 30, 2002 as compared to the same period in 2001 due
primarily to an $8.1 million increase in capital expenditures for property,
plant and equipment coupled with a $5.0 million increase in net cash paid for
acquisitions and investments during the nine months ended September 30, 2002.
On March 26, 2002, we acquired an additional 48.5% interest in JSG, a
Chinese entity engaged in the manufacture and sale of drill pipe to the Chinese
and related markets, thereby giving us a 70% controlling interest in JSG. We
paid approximately $0.5 million in cash and issued 1.3 million shares of Grant
Prideco common stock for the additional interest. Goodwill recognized in the
step acquisition of JSG was approximately $11.3 million. Subsequent to acquiring
a controlling interest, our consolidated financial statements include the
accounts of JSG.
FINANCING ACTIVITIES
Net cash used by financing activities was $61.8 million for the nine months
ended September 30, 2002 as compared to net cash provided by financing
activities of $25.0 million for the same period in 2001. The decrease is due
primarily to repayments of borrowings on our Credit Facility.
Capital Expenditures
Our capital expenditures for property, plant and equipment totaled $26.3
million and $34.5 million for the nine months ended September 30, 2001 and 2002,
respectively. We currently expect to expend approximately $45 million to $55
million (including expenditures for Reed-Hycalog) for capital expenditures for
property, plant and equipment during the remainder of 2002 and 2003. This
includes expenditures related to our capital improvement program to reduce
production costs
32
and improve efficiencies and to maintain the existing equipment base. Looking
forward into 2003, we currently expect to spend approximately $45 million on
capital expenditures, including those relating to Reed-Hycalog assuming closing
of our pending acquisition.
Credit Facilities and Long-Term Debt
Existing Credit Facility
As of September 30, 2002, we had no outstanding borrowings under our
existing Credit Facility and $3.9 million had been used to support outstanding
letters of credit. Additionally, at September 30, 2002, there were outstanding
borrowings of $0.3 million under a miscellaneous credit facility and $1.6
million of outstanding letters of credit had been supported under various
available letter of credit facilities that are not related to the Credit
Facility.
9 5/8% Senior Notes Due 2007
On December 5, 2000, we issued $200 million principal amount of 9 5/8%
Senior Notes Due 2007 (existing Senior Notes). The existing Senior Notes were
issued at a discount to yield an effective interest rate of 9 3/4%. Net proceeds
from the issuance of $193.3 million were utilized to repay a $100 million
subordinated note to Weatherford International, Inc. and to repay outstanding
borrowings under our existing revolving credit facility of approximately $80.3
million. Interest is payable June 1 and December 1 of each year. We may redeem
all or part of the existing Senior Notes at any time at a price of 100% of their
principal amount plus an applicable premium and accrued and unpaid interest to
the redemption date. The existing Senior Notes are guaranteed by all of our
domestic subsidiaries. The indenture governing the existing Senior Notes
contains various covenants customary in such instruments, including restrictions
to incur new debt, pay dividends, sell assets, grant liens, and other related
items. As of September 30, 2002, we were in compliance with the various
covenants under the existing Senior Notes indenture.
Other
In January 2002, we made a scheduled debt payment of approximately $1.5
million related to our Voest-Alpine debt, and in June 2002 we received a
distribution from Voest-Alpine in the amount of $16.1 million, of which $4.4
million was applied towards our remaining Voest-Alpine debt, and as a result,
the debt was paid in full.
Financing of the Reed-Hycalog Acquisition
In addition to the approximately $90 million in Grant Prideco stock
included in the purchase price, financing for the Reed-Hycalog acquisition (and
for Grant Prideco's general corporate purposes thereafter) is expected to be
provided through a new credit facility of approximately $240 million (replacing
the Company's existing credit facility) and other public or private placements
of debt securities of up to $175 million. In addition to having received a
commitment from a commercial lender with respect to the new credit facility, we
have received a commitment letter to provide bridge financing for the remaining
financing needs in the event the Reed-Hycalog transaction closes prior to
completion of any public or private debt placements. The actual allocation of
debt financing between the proposed new credit facility and public or private
debt securities will ultimately be determined by existing market conditions,
borrowing base determinations and our determination of our liquidity and
long-term financing needs.
The new credit facility will consist of a term loan of $50 million and
revolving credit line of up to $190 million, and will be secured by
substantially all of our domestic and certain of our Canadian assets. Amounts
outstanding under the proposed new credit facility are expected to accrue
interest at a variable rate based on either the U.S. prime rate (plus 0.75% to
2.00% depending on our leverage ratio and the type of loan, whether revolving or
term) or LIBOR (plus 1.75% to 3.00% depending on our leverage ratio and the type
of loan, whether revolving or term) for the U.S. denominated advances or a
variable rate based on the Canadian prime rate (plus 0.75% to 2.00% depending on
our leverage ratio and the type of loan, whether revolving or term) for Canadian
denominated advances. Interest on outstanding borrowings is payable monthly. The
U.S. revolving credit facility will also provide us with availability for
stand-by letters of credit. Similar to our existing credit facility, we will be
required to comply with various affirmative and negative covenants which will
limit our ability to incur new debt, make certain investments and acquisitions,
sell assets, grant liens, and other related items. We will also be subject to
financial covenants which, under certain circumstances, will require us to
maintain a certain minimum fixed charge coverage ratio and will require us to
limit our capital expenditures.
33
Excluding any financing relating to the proposed Reed-Hycalog transaction,
we estimate our required principal and interest payments for all of our
outstanding debt to be approximately $10.6 million for the remainder of 2002.
Assuming completion of the Reed-Hycalog acquisition, we expect to have $95
million outstanding under the new senior credit facility and approximately
$90-95 million available for additional borrowings based upon our current
estimate of our borrowing base immediately following the closing of the
transaction.
Based on our current projected capital expenditures and required principal
and interest payments, our operating cash flows, existing cash balances, and
estimated availability under the new senior credit facility, and assuming
completion of the Reed-Hycalog transaction, we believe we can satisfy all of our
expected commitments during the next twelve months and will have sufficient
liquidity in the event of a prolonged market downturn to not only maintain our
existing operations but to take advantage of strategic opportunities that may
present themselves during any such period. Acquisitions and expansions will be
financed from cash flow from operations, borrowings under our new senior credit
facility, or through a combination of the issuance of additional equity and debt
financing, as appropriate. Any future financing will be arranged to meet our
requirements, with the timing, amount, and form of issue dependent on the
prevailing market and general economic conditions.
Other Commitments
As part of our agreement to invest in Voest-Alpine, we entered into a
four-year supply contract with Voest-Alpine under which we have agreed to
purchase a minimum of 60,000 metric tons of "green" tubulars per year through
September 2003. The volume requirements represent approximately half of our
normal worldwide requirements for this type of tubulars. Because this agreement
requires us to purchase tubulars regardless of our needs, our purchases under
this agreement may be made for inventory during periods of low customer demand.
These types of purchases would require us to use our working capital and expose
us to risks of excess inventory during those periods. Although these purchases
could require us to expend a material amount of money, we expect that we will be
able to eventually use or sell all of the tubular products we are required to
purchase from Voest-Alpine.
TAX MATTERS
As a result of our spinoff from Weatherford, subsequent to April 14, 2000
we are no longer able to combine the results of our operations with those of
Weatherford in reporting income for United States federal income tax purposes
and for income tax purposes in some states and foreign countries. Under the
terms of a tax allocation agreement with Weatherford, we will not have the
future benefit of any prior tax losses or benefits incurred as part of a
consolidated return with Weatherford. Moreover, we will be liable to Weatherford
for any corporate level taxes incurred by Weatherford as a result of the
spinoff, except to the extent the taxes arise solely as a result of a change of
control of Weatherford. We believe this will not have a material adverse effect
on our earnings.
RECENT ACCOUNTING PRONOUNCEMENTS
For recent accounting pronouncements, see Notes 7, 8 and 11 to the
unaudited consolidated financial statements included herein.
FORWARD-LOOKING STATEMENTS AND EXPOSURES
In light of the SEC's Regulation FD, we have elected to provide in this
report various forward-looking statements and operational details. These
expectations reflect only our current view on these matters and are subject to
change based on changes of facts and circumstances. There can be no assurance
that these expectations will be met and our actual results will likely vary (up
or down) from those currently projected. These estimates speak only of our
expectations as of the date of this report, and we make no undertaking to update
this information. The absence of an update should not be considered as an
affirmation of our current expectations or that facts have not changed during
the quarter that would impact our expectations.
In modeling our earnings for the remainder of 2002, we have made numerous
assumptions regarding our operations. Although we believe that these assumptions
are reasonable, there can be no assurance that they will be correct in the
future. Material assumptions regarding our operations include the following:
o North American rig counts will average 860 during the fourth quarter
of 2002 and will increase throughout this period and during 2003. More
significantly, our customers expectations during the fourth quarter
will be for rig counts to increase during 2003 and that this will
cause North American land drillers to begin placing new drill pipe
orders at increasing rates and OCTG distributors to begin increasing
order rates to replenish and expand their inventories.
34
o International drilling activity and rig counts and international
demand for our drill stem products will continue to be relatively
strong throughout the remainder of 2002.
o We will not experience any material unusual losses, expenses, or
charges associated with litigation, warranty claims, environmental
matters, property losses or inventory write-downs. Our manufacturing
operations will not experience any material disruptions in production,
supply or efficiencies.
o There will not be any material acquisitions or divestments during the
year. Although we have made this assumption for modeling purposes, we
do expect that some acquisitions and divestments will be made during
the year that will affect our projections.
o Our completion of the first step of the SFAS No. 142 transitional
goodwill impairment test indicated the carrying value of the
Industrial reporting unit exceeded its fair value, and we will be
required to perform the second step of the impairment test for this
reporting unit by December 31, 2002. The total amount of goodwill
related to the Industrial reporting unit is approximately $11 million,
and the entire balance is being reviewed and considered for write-off.
We are closely reviewing this goodwill to determine whether all or
part of this amount should be written-off. Once the impairment charge
is determined, it will be treated as a non-cash charge and will be
recorded as a cumulative effect of a change in accounting principle.
Although a complete write-off may be necessary during the fourth
quarter, our forward-looking statements assume no write-off will
occur.
In addition to the foregoing assumptions, investors should carefully
consider the following risks, uncertainties and assumptions when evaluating our
company and the forward-looking statements that we make. If any one of these
risks were to materialize or become true, our actual results would most likely
be different from those projected in our forward-looking statements.
A FURTHER DECLINE IN DOMESTIC AND WORLDWIDE OIL AND GAS DRILLING ACTIVITY
WOULD ADVERSELY AFFECT OUR RESULTS OF OPERATIONS.
Our business and Reed-Hycalog's business we are proposing to acquire are
materially dependent on the level of oil and gas drilling activity in North
America and worldwide, which in turn depends on the level of capital spending by
major, independent and state-owned exploration and production companies. This
capital spending is driven by current prices for oil and gas and the perceived
stability and sustainability of those prices. Oil and gas prices have been
subject to significant fluctuation in recent years in response to changes in the
supply and demand for oil and gas, market uncertainty, world events,
governmental actions, and a variety of additional factors that are beyond our
control, including:
o the level of North American and worldwide oil and gas exploration and
production activity;
o worldwide economic conditions, particularly economic conditions in
North America;
o oil and gas production costs;
o the expected costs of developing new reserves;
o national government political requirements and the policies of the
Organization of Petroleum Exporting Countries (OPEC);
o the price and availability of alternative fuels;
o environmental regulation; and
o tax policies.
Decreased demand for our products results not only from periods of lower
drilling activity, but also from the resulting build up of customer inventory of
drill pipe associated with idle rigs, which can be used to some extent on active
rigs in lieu of new purchases. The time period during which drill pipe inventory
is used is a function of the number of rigs actively drilling and the expected
level of drilling activity. A decrease in the number of rigs actively drilling
results in a large amount of unused drill pipe at the rig site and a decrease in
demand for new drill pipe. In general, customers begin placing orders for new
drill pipe when expected rig utilization over the next two quarters approaches
the number of rigs for which customers have available drill pipe.
35
AN ECONOMIC DOWNTURN COULD ADVERSELY AFFECT DEMAND FOR OUR PRODUCTS AND
SERVICES AND OUR RESULTS OF OPERATIONS.
The United States and worldwide economies slowed during 2001, in particular
following the September 11th terrorist attacks. The decline in the United States
economy has resulted in a softening in projected natural gas drilling activity.
If expected economic improvement in the U.S. does not occur or international
markets decline unexpectantly, our results of operations and financial condition
could be materially adversely affected.
INCREASES IN THE PRICES OF OUR RAW MATERIALS COULD AFFECT OUR RESULTS OF
OPERATIONS.
We use large amounts of steel tubulars and bars in the manufacture of our
products. The price of these raw materials has a significant impact on our cost
of producing products. If we are unable to pass future raw material price
increases on to our customers, our margins and results of operations could be
adversely affected.
DUE TO INTENSE COMPETITION IN OUR INDUSTRY AND THAT OF THE REED-HYCALOG
BUSINESS WE ARE PROPOSING TO ACQUIRE, OUR REVENUES MAY DECLINE IF WE DO NOT
DEVELOP, PRODUCE AND COMMERCIALIZE NEW COMPETITIVE TECHNOLOGIES AND PRODUCTS
OR IF WE ARE UNABLE TO ADEQUATELY PROTECT OUR CURRENT AND FUTURE
INTELLECTUAL PROPERTY RIGHTS RELATING TO OUR TECHNOLOGIES AND PRODUCTS.
The markets for our premium products and services, as well as those of
Reed-Hycalog which are proposing to acquire, are characterized by continual
developments. Substantial improvements in the scope and quality of product
function and performance can occur over a short period of time. In order to
remain competitive, we must be able to develop commercially competitive products
in a timely manner in response to changes in technology. Our ability to develop
new products and maintain competitive advantages depends on our ability to
design and commercially market products that meet the needs of our customers,
including delivery schedules and product specifications.
Additionally, the time and expense invested in product development may not
result in commercially feasible applications that provide revenues. We could be
required to write off our entire investment in a new product that does not reach
commercial viability. Moreover, we may experience operating losses after new
products are introduced and commercialized because of high start-up costs,
unexpected manufacturing costs or problems, or lack of demand.
Many of our products and the processes we use to manufacture them, as well
as those of Reed-Hycalog, have been granted United States and international
patent protection, or have patent applications pending. Nevertheless, patents
may not be granted from our applications and, if patents are issued, the claims
allowed may not be sufficient to protect our technology. If our patents are not
enforceable or if any of our products infringe patents held by others, our
financial results may be adversely affected. Our competitors may be able to
independently develop technology that is similar to ours without infringing on
our patents, which is especially true internationally where the protection of
intellectual property rights may not be as effective. In addition, obtaining and
maintaining intellectual property protection internationally may be
significantly more expensive than doing so domestically. We may have to spend
substantial time and money defending our patents and after our patents expire,
our competitors will not be legally constrained from developing products
substantially similar to ours.
OUR RESULTS OF OPERATIONS AND FINANCIAL CONDITION ARE DEPENDENT UPON OUR
ABILITY TO SUCCESSFULLY INCREASE AND DECREASE, WITHOUT MATERIAL DISRUPTION,
OUR MANUFACTURING CAPACITY AND EXPENSE IN RESPONSE TO CHANGES IN DEMAND AND
TO MAINTAIN PRICES FOR OUR DRILL STEM PRODUCTS, WHICH CAN BE ADVERSELY
AFFECTED BY CHANGES IN INDUSTRY CONDITIONS AND COMPETITIVE FORCES.
Beginning in 2001, we took steps to increase our capacity and reduce costs
in all of our manufacturing operations. Our manufacturing goal is to be able to
produce between 1.5 million and 2.5 million feet of drill pipe during a quarter,
not including China, with little operational change or disruption. We also
intend to increase our production to 3.0 million feet a quarter, not including
China, without significant operational disruptions and process inefficiencies.
We will need to increase our production during peak periods with minimal
operational disruption and inefficiency in order to meet the increased demand.
If there are any material disruptions or excess costs associated with the
manufacturing changes and our ability to alter production with minimal
disruption, our results of operations during ramp-up and peak demand periods
could be materially adversely affected.
Beginning in 2001, we initiated substantial price increases for our drill
stem products, which began benefiting revenues and operating profit during the
third quarter of 2001. Our ability to maintain these price increases is subject
to various risks, including
36
adverse changes in industry conditions, as well as unexpected actions by our
competitors. We believe our current prices are generally at satisfactory levels
given the increased quality and premium nature of our products; but if market
conditions or other factors cause us to decrease prices, our results could be
materially adversely affected.
OUR INTERNATIONAL OPERATIONS MAY EXPERIENCE SEVERE INTERRUPTIONS DUE TO
POLITICAL, ECONOMIC OR OTHER RISKS, WHICH COULD ADVERSELY AFFECT OUR RESULTS
OF OPERATIONS AND FINANCIAL CONDITION.
During the third quarter of 2002, we derived approximately 26% of our total
revenues from our facilities outside the U.S. In addition, a large part of sales
from our domestic locations were for use in foreign countries. We expect this
percentage to increase substantially and the acquisition of Reed-Hycalog, if and
when consummated, will further increase our international exposure. Our
operations in certain international locations, including Mexico, Austria, Italy,
China, and Indonesia, are subject to various political and economic conditions
existing in those countries that could disrupt operations. Reed-Hycalog has
similar risks for its facilities in the United Kingdom and Singapore. These
risks include:
o changes in foreign tax laws;
o changes in regulations and labor practices;
o currency fluctuations and devaluations;
o currency restrictions and limitations on repatriation of profits; and
o political instability or military conflict in oil or gas producing
regions.
Our foreign operations may suffer disruptions and we may incur losses that
will not be covered by insurance, and we have not historically carried political
risk insurance. In particular, terrorist attacks and other threats to U.S.
national security and resulting U.S. military activity throughout the world
increases the possibility that our operations could be interrupted or adversely
affected. Such disruption could result in our inability to ship products in a
timely and cost-effective manner or our inability to place contractors and
employees in various countries or regions.
Any material currency fluctuations or devaluations or political events that
disrupt oil and gas exploration and production or the movement of funds and
assets could materially adversely affect our results of operations and financial
position.
We have entered into an agreement with Voest-Alpine, an entity of which we
own 50.01%, to purchase 60,000 metric tons of "green" tubulars per year through
September 2003. Our future results could be adversely affected if we are unable
to use or resell these tubulars. In addition, we have agreed to be responsible
for paying any "anti-dumping" duties in the United States on the resale of these
tubulars, which could affect our ability to resell the tubulars in the United
States. Further, our long-term supply contract with Voest-Alpine is denominated
in euros. We have no significant offset for revenues in euros and we have not
hedged for currency risk with respect to this contract. In addition, our
manufacturing of tool joints in Italy has benefited from a weak euro against the
dollar. Thus, a material long-term strengthening of the euro versus the U.S.
dollar could materially adversely affect our results of operations.
IF WE ARE UNABLE TO ADEQUATELY RENEW OR REPLACE OUR SUPPLY CONTRACT WITH
VOEST-ALPINE AND OUR PROCESSING AGREEMENT WITH U.S. STEEL, OUR RESULTS OF
OPERATIONS AND FINANCIAL RESULTS WOULD BE ADVERSELY AFFECTED.
Our four year supply contract with Voest-Alpine under which we have agreed
to purchase a minimum of 60,000 metric tons of tubulars per year expires in
September 2003. The volume requirements represent approximately one-half to
seventy-five percent of our normal worldwide requirements for this type of
tubulars during normalized market conditions. If we are unable to successfully
renew or replace this supply contract on terms reasonably acceptable to us, our
results of operations would be adversely affected.
Similarly, we have entered into a contract with U.S. Steel to provide
processing services for virtually all of its large diameter casing products.
This contract expires on December 31, 2003 and we do not expect that it will be
renewed. If we are unable to adequately replace this business with comparable
quantities and sales margins, our results of operations and financial results
could be adversely affected.
37
IN CONNECTION WITH OUR BUSINESS OPERATIONS AND THE REED-HYCALOG ACQUISITION,
WE COULD BE SUBJECT TO SUBSTANTIAL LIABILITY CLAIMS THAT ADVERSELY AFFECT
OUR RESULTS OF OPERATIONS.
We have agreed to assume a substantial portion of Reed-Hycalog's
obligations, responsibilities, liabilities, costs and expenses arising out of or
incurred in connection with their business. Our products, as well as
Reed-Hycalog's drill bits and related technologies, are complex and the failure
of this equipment to operate properly or to meet specifications may greatly
increase our customers' costs of drilling a well. In addition, many of these
products are used in hazardous drilling and production applications where an
accident or product failure can cause personal injury or loss of life; damage to
property, equipment or the environment; regulatory investigations and penalties;
and the suspension of the end-user's operations. If our products or services
fail to meet specifications or are involved in accidents or failures, we could
face warranty, contract or other litigation claims for which we may be held
responsible and our reputation for providing quality products may suffer.
Our insurance may not be adequate in risk coverage or policy limits to
cover all losses or liabilities that we may incur or be responsible for under
the Reed-Hycalog purchase agreement. Moreover, in the future we may not be able
to maintain insurance at levels of risk coverage or policy limits that we deem
adequate or at premiums that are reasonable for us, particularly in the recent
environment of significant insurance premium increases. Further, any claims made
under our policies will likely cause our premiums to increase. Any future
damages deemed to be caused by our products or services, or those of Reed-
Hycalog, that are assessed against us and that are not covered by insurance, or
that are in excess of policy limits or subject to substantial deductibles, could
have a material adverse effect on our results of operations and financial
condition.
WE ARE SUBJECT TO ENVIRONMENTAL, HEALTH AND SAFETY LAWS AND REGULATIONS THAT
EXPOSE US TO POTENTIAL FINANCIAL LIABILITY.
Our operations are regulated under a number of federal, state, local and
foreign environmental laws and regulations, which govern, among other things,
the discharge of hazardous materials into the air and water, as well as the
handling, storage, and disposal of hazardous materials and the remediation of
contaminated sites. Compliance with these environmental laws is a major
consideration in the manufacturing of our products. Because we use and generate
hazardous substances and wastes in our manufacturing operations, we may be
subject to material financial liability for any investigation and clean-up of
such hazardous materials, and any related personal injury damages or toxic tort
claims. We have not historically carried insurance for such matters.
In addition, many of our current and former properties are or have been
used for industrial purposes. Accordingly, we also may be subject to financial
liabilities relating to the investigation and remediation of hazardous materials
resulting from the action of previous owners or operators of industrial
facilities on those sites. Liability in many instances may be imposed on us
regardless of the legality of the original actions relating to the hazardous or
toxic substances or whether or not we knew of, or were responsible for, the
presence of those substances. Liabilities we have agreed to assume in connection
with the Reed-Hycalog acquisition include, subject to certain exceptions,
certain obligations, liabilities, costs and expenses for violations of health,
safety and environmental laws relating to the assets and include certain
unknown, as well as known, obligations, liabilities, costs and expenses arising
or incurred prior to, on or after the closing date. Furthermore, with certain
exceptions, we may be required to indemnify Schlumberger against losses incurred
in connection with or related to these assumed liabilities.
We are also subject to various federal, state, local and foreign laws and
regulations relating to safety and health conditions in our manufacturing
facilities. Those laws and regulations may subject us to material financial
penalties or liabilities for any noncompliance, as well as potential business
disruption if any of our facilities or a portion of any facility is required to
be temporarily closed as a result of any violation of those laws and
regulations. Any such financial liability or business disruption could have a
material adverse effect on our financial condition and results of operations.
WE ARE UNFAMILIAR WITH THE DRILL BITS BUSINESS AND MAY FACE UNEXPECTED
DIFFICULTIES IN OPERATING THE BUSINESS OR MAY NOT ACHIEVE THE EXPECTED
BENEFITS OF THE REED-HYCALOG ACQUISITION IF AND WHEN IT IS CONSUMMATED.
We currently do not own or operate drill bits businesses and the
Reed-Hycalog acquisition will result in a new drill bits product line for us.
Our overall management team has limited experience in drill bits development,
manufacturing and distribution operations, so we may face regulatory and
operational matters with which we are unfamiliar. In addition, we may be
operating in unfamiliar markets and be less able to respond to changes in
markets than our more experienced competitors. Therefore, until the Reed-Hycalog
assets, product lines and operations have been transitioned into our operations,
it is difficult to predict accurately the effects of the Reed-Hycalog
acquisition. Furthermore, synergies and other benefits we expect to result from
the acquisition of Reed-Hycalog may not be achieved or, if achieved, may not be
achieved in the time frame in which they are expected. In addition, whether we
will actually
38
realize anticipated benefits depends on future events and circumstances beyond
our control, such as a decline in economic conditions in general or in the oil
and gas industry in particular, and the other risk factors discussed elsewhere
on this Quarterly Report on Form 10-Q.
WE MAY NOT HAVE THE SAME COMPETITIVE ADVANTAGES IN THE DRILL BITS BUSINESS
AS WE ENJOY IN OUR CURRENT COMPETITIVE ENVIRONMENT.
We hold a leading market position and have greater resources than many of
our competitors in the business of manufacturing, supply and providing oilfield
drill pipe and other drill stem products and premium connections and tubular
products. The competitive environment for the drill bits business we would enter
if the Reed-Hycalog acquisition is consummated differs greatly, with Smith
International, Baker Hughes and Halliburton being the principle competitors.
Each of these drill bits competitors has greater marketing, financial and
technical resources than we do and could use those resources to affect our
ability to compete, thereby reducing the sales, profits and benefits we expect
to receive from the Reed-Hycalog acquisition.
TRANSITIONING REED-HYCALOG INTO OUR CORPORATE STRUCTURE MAY STRAIN OUR
RESOURCES AND MAY PROVE TO BE DIFFICULT.
The Reed-Hycalog acquisition is significantly larger than any of our
previous acquisitions. The significant expansion of our business and operations,
both in terms of geography and magnitude, resulting from the acquisition of
Reed-Hycalog may strain our administrative, operational and financial resources.
In addition, the Reed-Hycalog acquisition will include the drill bits assets,
but will not include all of the corporate infrastructure necessary to operate
such business. The creation of corporate and administrative infrastructure for
Reed-Hycalog and the transitioning of Reed-Hycalog into our company will require
substantial time, effort, attention and dedication of management resources and
may detract our management in unpredictable ways from our traditional business.
The transition process could create a number of potential challenges and adverse
consequences for us, including the possible unexpected loss of key employees,
customers or suppliers, a possible loss of revenues or an increase in operating
or other costs. These types of demands and uncertainties could have a material
adverse effect on our business, financial condition and results of operations.
We may not be able to manage the combined operations and assets effectively or
realize any of the anticipated benefits of Reed-Hycalog.
As part of our business strategy, we intend to pursue other strategic
acquisitions and we may face similar challenges regarding such acquisitions.
OUR RESULTS OF OPERATIONS COULD BE ADVERSELY AFFECTED BY ACTIONS UNDER U.S.
TRADE LAWS.
Although we are a U.S.-based manufacturing company, we do own and operate
international manufacturing operations that support our U.S.-based business. If
actions under U.S. trade laws were instituted that limited our access to these
products, our ability to meet our customer specifications and delivery
requirements would be reduced. Any adverse effects on our ability to import
products from our foreign subsidiaries could have a material adverse effect on
our results of operations.
Additionally, foreign producers of tubular goods from various countries
have been found to have sold their products, which may include premium
connections, for export to the United States at prices that are lower than the
cost of production or their prices in their home market or a major third-country
market. If such orders are revoked or changed, we could be exposed to increased
competition from imports that could reduce our sales and market share.
Furthermore, tubulars produced by domestic steel mills and threaded by us in the
U.S. may not be able to economically compete with tubulars manufactured and
threaded at steel mills outside of the U.S. and we could be forced to our lower
prices to uneconomical levels in order to compete.
WE COULD BE SUBJECT TO ADDITIONAL EXPENSES FROM THE WATTS LITIGATION.
As noted under Item 3. Legal Proceedings in our Annual Report on Form 10-K,
we have recorded an additional reserve as a result of a jury verdict in
litigation involving Mr. John D. Watts and our XL Systems(TM) subsidiary. We
currently are appealing the verdict against XL Systems(TM), and Mr. Watts is
appealing the trial courts determination to reduce the jury verdict and deny
enhanced damages and to grant summary judgment on certain trade secret claims
made by Mr. Watts. If the appellate court rules in favor of Mr. Watts, on one or
more of these issues, it may be necessary for us to record an additional
reserve, which could be material to the applicable periods results of
operations.
39
ITEM 3. QUANTITATIVE AND QUALITATIVE MARKET RISK DISCLOSURES
FINANCIAL INSTRUMENTS
We are currently exposed to certain market risks arising from transactions
that we enter into in the normal course of business. These risks relate to
fluctuations in foreign currency exchange rates and changes in interest rates.
Refer to Note 7 to the financial statements included elsewhere in this Quarterly
Report on Form 10-Q for additional information on financial instruments.
FOREIGN CURRENCY RISK
The functional currency for most of our international operations is the
applicable local currency. Results of operations for foreign subsidiaries with
functional currencies other than the U.S. dollar are translated using average
exchange rates during the period. Assets and liabilities of these foreign
subsidiaries are translated into U.S. dollars using the exchange rates in effect
at the balance sheet date, and the resulting translation adjustments are
included in stockholders' equity. However, foreign currency transaction gains
and losses are reflected in income for the period. We partially hedge our
exposure to changes in foreign exchange rates principally with forward
contracts.
Forward contracts designated as hedges of foreign currency transactions are
marked to the forward rate with the resulting gains and losses recognized in
earnings, offsetting losses and gains on the transactions hedged. We enter into
foreign exchange contracts only as a hedge against existing economic exposures
and not for speculative or trading purposes. The counterparties to our foreign
exchange contracts are creditworthy multinational commercial banks. We believe
that the risk of counterparty nonperformance is immaterial.
INTEREST RATES
We are and will be subject to market risks for changes in interest rates
related primarily to our long-term debt. Excluding the Senior Notes, most of our
borrowings are at variable rates, which reflect current market rates, and
therefore the fair value of these borrowings approximates book value. Based upon
our debt balances, an immediate change of 1% in the interest rate would not
cause a material change in interest expense on an annual basis. The fair value
of financial instruments which significantly differed from their carrying value
at September 30, 2002 were as follows:
<Table>
<Caption>
CARRYING FAIR
VALUE VALUE
----- -----
Senior Notes....................................... $ 199.1 $ 206.6
</Table>
Currently, we have variable interest rate debt totaling approximately $7.8
million. These variable rate debts expose us to the risk of increased interest
expense in the event of increases in short-term interest rates. If the variable
interest rate were to increase by 1% from September 2002 levels, the effect on
our interest expense would not be material. The carrying value of our variable
interest rate debt approximates fair value as they bear interest at current
market rates.
ITEM 4. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
In response to regulations promulgated by the Securities and Exchange
Commission relating to the recently enacted Sarbanes-Oxley Act, we have
instituted a formalized process intended to provide greater focus and accuracy
with respect to disclosures contained in our reports filed with the Securities
and Exchange Commission. These procedures include obtaining input and
recommendations from our key managers in our operating divisions and in our
legal, finance and accounting departments, specific reviews of the financial and
operational results of each of our segments with senior management from these
divisions, input and review from our outside legal and accounting advisors, and
reviews and surveys from our key accounting personnel regarding our results of
operations and books and records.
Within 90 days before the filing of this Report, the Company's principal
executive officer and principal financial officer evaluated the effectiveness of
the Company's disclosure controls and procedures we have instituted. Based on
the evaluation, our principal executive officer and principal financial officer
believe that:
40
(a) the Company's disclosure controls and procedures are designed to
ensure that information required to be disclosed by the Company in the
reports it files or submits under the Securities Exchange Act of 1934
is recorded, processed, summarized and reported within the time
periods specified in the SEC's rules and forms;
(b) such information is accumulated and communicated to the Company's
management, including the Company's principal executive officer and
principal financial officer, as appropriate to allow timely decisions
regarding required disclosure; and
(c) the Company's disclosure controls and procedures are effective.
CHANGES IN INTERNAL CONTROLS
There have been no significant changes in our internal controls or in other
factors that could significantly affect our internal controls subsequent to the
evaluation referred to in the preceding paragraph, nor have there been any
corrective actions with regard to significant deficiencies or material
weaknesses.
PART II
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On August 28, 2002, the Company held its reconvened meeting to stockholders
to finalize the vote on the Company's directors. With respect to the meeting,
there were 110,765,260 shareholders of record and 100,509,733 shareholders
represented in person or proxy at the meeting. All nominees for director were
elected. The following chart sets forth the votes cast in the election.
<Table>
<Caption>
Broker Nonvotes/
Directors Name For Withheld Abstentions
- -------------- ----------- ---------- ----------------
Bernard J. Duroc-Danner 98,382,906 2,126,827 --
David J. Butters 97,751,975 2,757,758 --
Eliot M. Fried 98,693,166 1,816,567 --
Sheldon B. Lubar 99,854,440 655,293 --
Michael McShane 96,888,344 3,621,389 --
Robert K. Moses, Jr. 100,244,636 265,097 --
Robert A. Rayne 99,861,819 647,914 --
</Table>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
a. 99.1 Section 906 Certifications
(b) Reports filed on Form 8-K during the three months ended September 30,
2002 - None.
41
SIGNATURES
Pursuant to the requirements of Section 12 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.
GRANT PRIDECO, INC.
By: /s/ LOUIS A. RASPINO
----------------------------------------
Louis A. Raspino*
Vice-President and Chief Financial Officer
By: /s/ GREG L. BOANE
----------------------------------------
Greg L. Boane*
Corporate Controller
(Principal Accounting Officer)
* Also signing on behalf of each of the
additional registrants.
Date: November 14, 2002
42
CERTIFICATION
I, Michael McShane, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Grant Prideco, Inc;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report is
being prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
the registrant's Board of Directors (or person's performing the equivalent
function):
(a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 14, 2002 Signature: /s/ Michael McShane
------------------ --------------------------------------
President and Chief Executive Officer
43
CERTIFICATION
I, Louis A. Raspino, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Grant Prideco, Inc;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report is
being prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
the registrant's Board of Directors (or person's performing the equivalent
function):
(a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 14, 2002 Signature: /s/ Louis A. Raspino
----------------------- -----------------------
Vice President and
Chief Financial Officer
44
EXHIBIT INDEX
Exhibit Number Description
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a. 99.1 Section 906 Certifications